Free market defense

By DAVID MOON, Moon Capital Management, LLC
August 31, 2008

In suggesting that a housing and mortgage market built on free-market principles was 'a false idol after all,' a recent New York Times article examined what it called the dominant idea guiding U.S. economic policy for a quarter-century: that the free market is unfailingly wise.

Is the bursting of the housing bubble also a bursting of the free-market phenomenon?


Any capitalist understands that risks should be priced into security prices; mortgage loans are assets, similar in many ways to other types of bonds. But unlike most homeowners, IBM doesn't usually have an emotional attachment to the assets used to collateralize its debt. And houses aren't homogeneous or evenly divisible assets like stocks.

Wall Street did its best to accommodate the special characteristics of houses by creating bonds that were backed by packages of house loans.

It was the free market at work.

A free market is not unfailingly wise. Despite the suggestion of the New York Times, no learned analyst would suggest so. Only an opponent of free markets would use that phrase, and then only in an attempt to set up a straw man that could easily be defeated.

Free markets aren't unfailingly wise, but like Churchill's observation of democracy, free markets are wiser than any other economic arrangements.

Despite their wild vacillations from overpessimism to irrational exuberance, free markets provide better access to capital than any centrally planned economy. With access to capital ' that is, opportunity ' comes responsibility and the possibility of various outcomes. A controlled market that requires little or no responsibility from buyers and sellers is usually accompanied by a lack of variability in outcomes. No failures, but no real success, either.

Free markets provided billions of dollars of capital to lenders that originated mortgages they would have otherwise never been able to grant. Hundreds of thousands of families own homes who would have been unable to get financing if a free market hadn't allowed the securitization and packaging of mortgage loans.

Yes, many of those loans are in default. People are losing their houses and becoming renters.

But how many of them would have remained renters under a 1970s-style mortgage system in which a local bank made a mortgage loan, held it on its books for 30 years, then made another loan? This free market, complete with greedy mortgage brokers and stupid products like negative-amortizing adjustable-rate option ARMs, provided increased ownership opportunities for hundreds of thousands of Americans.

From 1960 to 1994, home ownership rates remained relatively constant, around 63 or 64 percent of all households. That began to change about the time of the popularization of the mortgage-backed financial instrument.

From 1994 to 2005, overall home ownership in the U.S. increased 7.66 percent. The gains were most notable, however, among minorities (24.1 percent) and low-income individuals. While many variables help explain this, one of the major contributing factors ' especially among middle- and lower-income groups ' is greater access to various forms of capital.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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