Banks have largely been disintermediated in favor of credit markets
Fifty years ago, banks and their loan officers still did most of the work. They’d use quantitative yardsticks, but the terms would come down to a banker’s discretion and a negotiation with the borrower. Now banks have largely been disintermediated in favor of credit markets.
Markets have clear advantages over banks. In the long run, the wisdom of crowds ensures they incorporate more points of view and arrive at a better price.
And trading credit in securities markets avoids the inherent weakness of all fractional reserve banking: that a loss of confidence can render the institution insolvent.
In a market, if confidence is lost in a credit, then buyers have an opportunity to snap up bargains. The risk of a systemic crisis is much reduced.
But even strong believers in free markets are worried that the new system is distorting judgments and misdirecting credit.
Amar Bhide, an economist at Tufts University near Boston, argues that Friedrich Hayek, the great libertarian philosopher and founder of the Austrian school of economics, would oppose credit markets in their current form.
He further contends that Hayek might even argue that their judgments are no better than a central planner could achieve. Hayek wanted decisions to be decentralized and made by people as close to each situation as possible, Bhide says.
Think only of the blind faith that investors showed before the global financial crisis by pouring money into any credit that had been labeled AAA by the rating companies.
After the financial crisis, unnaturally low interest rates, which fell to zero in 2020 in response to the pandemic, exacerbated the problem. Industrialized credit markets have pumped out even more debt. The questions now are whether there could be another crisis and whether credit investors have priced the risks well enough to be protected.
John Authers Bloomberg 17 december 2023
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