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Stiglitz on Securitization and Mistrust

November 11, 2010

Apropos to my last post, here is an excerpt from Freefall: America, Free Markets, and the Sinking of the World Economy, in which Joseph Stiglitz explains how securitization breeds mistrust:

Securitization, and how it was abused, epitomized this process of how markets can weaken personal relationships and community. The “friendly” relationship within a stable community between the banker and the borrower, in which the banker knew the person who was borrowing money (so if the borrower genuinely had a problem, the banker knew when and how to restructure the loan), may have been partly a myth. But, still, there was also some some truth in it; it was a relationship that was based partly on trust. With securitization, trust has no role; the lender and borrower have no personal relationship. Everything is anonymous, and all the relevant information on the characteristics of the mortgage is summarized in statistical data. With those whose lives are being destroyed described as merely data, the only issues in restructuring are what is legal — what is the mortgage servicer allowed to do — and what will maximize the expected return to the owners of the securities. Not only has trust been destroyed between borrow and lender but it also does not exist among the various other parties: for example, the holder of the securities does not trust the service provider to act in his interests. Given the lack of trust, many contracts restrict the scope for restructuring. Enmeshed in legal tangles, both lenders and borrowers suffer. Only the lawyers win.

It is difficult not to notice Stiglitz’ yearning for “the good old days” here. Does that make Stiglitz a conservative at heart? Well, not exactly. Stiglitz goes on to insist that securitization is “part of the reality of a modern economy.” Stiglitz, in other words, accepts that firms have become large and impersonal; his point is that government can play an important role in restoring trust. And he is right. At the same time, Stiglitz brings into view a compelling, authentically conservative alternative: breaking up the big banks — and, more generally, big business — so as to reduce the need for bailouts and bureaucracy to begin with.

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