It’s About the Money Supply!
The problems in the financial markets are certainly related to the sub-prime mortgage market. The story is, by now, familiar to many: Banks made too many risky loans, the risky loans were divided up and packaged in securities, the securities were sold all over the world. A good question to ask, therefore, is: why were so many risky loans made?
A good answer seems to be: banks had a ton of “cheap” money to lend out. The logic is described nicely in this article, which a friend emailed me earlier today. (The article describes an interview with Ted Forstmann, the man behind a very successful private equity fund.)
Essentially, the government has subsidized lending, which means we get more of it than we would have otherwise had. If you’re running a bank, and you lend money to all of the borrowers you deem “good” risks, but you still have funds to lend, who will you lend to? That’s right, higher risk customers.
This is the sort of problem that gives economists a bad name. It is very easy to predict that too much money in the system will lead to some sort of crisis. It is very difficult, though, to predict exactly when it will show up. Of course, nobody pays attention to the practical economists who argue we shouldn’t be messing around with the money supply in the first place.
NM
