The SEC action against Goldman again has me asking whether the industry might not actually be better off with some serious regulation of adverse selection. Goldman sold an asset hand-picked to fail as if it were just the average security. The retail investors has lots of protection, and so does the consumer. Imagine buying a car, and then being sold one off the lot that the mechanic who just tuned the engine is betting will break down. And not being told this. If car dealers could do this, cars would be hard to sell (this is the model and application for which George Akerlof won the Nobel prize in economics). Adverse selection makes assets illiquid. The more disclosure is required in simple, transparent ways, the more easily assets can be traded. If Goldman can hide the adverse selection behind tens of thousands of pages of “disclosure,” surely it makes it harder for any bank to securitize?
And this need not be regulation. Why doesn’t some bank start a private initiative of this sort? In the car market, dealers provide guarantees. Suppose that one of Goldman’s competitors made a pledge and provided a money back guarantee on losses directly caused by a listed set of shady practices. Wouldn’t that that bank almost never have to pay off and wouldn’t it gain a huge amount of business? Is the industry colluding to keep things opaque so they all decrease liquidity and increase profits? I thought innovations that provided greater liquidity were the source of securitization and the financial boom, but maybe not . . .