Small businesses are thought to be rather inefficient because of fix and because of other issues that hamper the exploitation of increasing returns to scale in their size range. Yet, policies keep popping up that try to protect them. Why? Is it nostalgia, throwing us back to times were "better?" Or do we want to protect (inefficient) employment? Even this may be moot according to a previous post.
Ben Craig, William Jackson, and James Thomson claim that small businesses should be encourage because they have an inherent disadvantage on credit markets: there are information problems, more acute in downturns, that make access to credit more difficult for small businesses. Thus, it is good for a government agency to provide loan guarantees. Still, this does not address why we would want to have small businesses in the first place. If inefficient firms are getting rationed on credit markets, I am fine with that.
Showing posts with label credit markets. Show all posts
Showing posts with label credit markets. Show all posts
Thursday, September 29, 2011
Tuesday, April 12, 2011
Optimal securitization
Before the crisis, securitization of debt was quite uniformly seen as a very good idea, after all it made house ownership available to many families. After the crisis the assessment is much more negative, in fact there is a large backlash against the idea, seeing at the root of all evil. Of course, the truth is somewhere in the middle. Securitization provides a powerful way to diversify risk, but as the crisis showed, it can make fraud easier.
Guillaume Plantin tries sort this out by looking at how banks react to the availability of securitization. He points out that the risk diversification gives less incentives to banks to screen well loans. This is not necessarily a bad thing, as the optimal contract literature would tell you that the bank would be required to bear some more risk. The fact that their would be more borrower failures would have to be weighted against the increased availability of credit, and society would overall likely be a winner from securitization. The problem is that these contracts were not optimal. There is evidence that banks have been negligent if not misleading with information about the underlying loans. The issue thus goes beyond the (fixable) moral hazard with selecting loans. Indeed, when banks have private information about the loans, we have a lemons problem wherein they push the worst loans to the securitization market (and when the US Treasury buys up those loans from the banks, of course it inherits the lemons as well). The policy prescription is clear: either restrict to some degree securitization or, better, alleviate the opaqueness of the securitization market.
Guillaume Plantin tries sort this out by looking at how banks react to the availability of securitization. He points out that the risk diversification gives less incentives to banks to screen well loans. This is not necessarily a bad thing, as the optimal contract literature would tell you that the bank would be required to bear some more risk. The fact that their would be more borrower failures would have to be weighted against the increased availability of credit, and society would overall likely be a winner from securitization. The problem is that these contracts were not optimal. There is evidence that banks have been negligent if not misleading with information about the underlying loans. The issue thus goes beyond the (fixable) moral hazard with selecting loans. Indeed, when banks have private information about the loans, we have a lemons problem wherein they push the worst loans to the securitization market (and when the US Treasury buys up those loans from the banks, of course it inherits the lemons as well). The policy prescription is clear: either restrict to some degree securitization or, better, alleviate the opaqueness of the securitization market.
Monday, February 7, 2011
The impact of credit card cash-backs
Banks seem to really push credit card use on their customers, seeing all the junk mail, the recruitment stands in malls, campuses and airports, and the various incentives (frequent flyer miles, cash-backs). Why are they doing this? One would think the marginal customer is less profitable, and may even be detrimental to the bottom line as he is more likely to default.
Sumit Agarwal, Sujit Chakravorti, and Anna Lunn look specifically at cash-backs using administrative data and find that a 1 percent increase in cash-back leads to a US$68 increase in spending and US$115 increase in debt in the first quarter. While one can understand this would increase spending, it is puzzling to see the debt increase even more. Why would people substitute debt away from other cards? Indeed debt is not tied to this cash-back. It turns out this comes mostly from people who have previously barely used the card, thus they basically switch allegiance both in spending and debt. A reduction in the interest rate has similar consequences.
Are cash-backs good or bad. This paper shows that they are mostly used to steal customers from other cards. Such competition is good. However, the ones who pay for these rewards are the merchants, who face basically a duopoly and are caught between a rock and a hard place. Ultimately, the consumer ends up paying for these cash-backs through higher prices in the store, and those using cash or debit cards loose out.
Sumit Agarwal, Sujit Chakravorti, and Anna Lunn look specifically at cash-backs using administrative data and find that a 1 percent increase in cash-back leads to a US$68 increase in spending and US$115 increase in debt in the first quarter. While one can understand this would increase spending, it is puzzling to see the debt increase even more. Why would people substitute debt away from other cards? Indeed debt is not tied to this cash-back. It turns out this comes mostly from people who have previously barely used the card, thus they basically switch allegiance both in spending and debt. A reduction in the interest rate has similar consequences.
Are cash-backs good or bad. This paper shows that they are mostly used to steal customers from other cards. Such competition is good. However, the ones who pay for these rewards are the merchants, who face basically a duopoly and are caught between a rock and a hard place. Ultimately, the consumer ends up paying for these cash-backs through higher prices in the store, and those using cash or debit cards loose out.
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