Martin Wolf is the latest observer to note that the US has created a lot of financial lemons that left a sour taste in the mouths of investors around the world. Lemons that have prompted policy makers around the world to seek a bit more say in how the US regulates its financial markets.
And lemons in the economic sense as well.
Buyers of used cars have to worry that the original owner is selling the car because the seller knows that the car has problems – and since the seller knows more about the car than the buyer, the risk that the seller is trying to pass on a lemon inhibits transactions. Buyers of used securities apparently have similar concerns about a lot of complex financial products. Martin Wolf writes:
What is driving this is “asymmetric information”: buyers believe sellers know more about the quality of what they are selling than they themselves do. This seems to be precisely what has now happened to trading in certain classes of security. The crisis is focused in markets in structured credits and associated derivatives. The cause seems to be rampant uncertainty. Investors have learnt from what happened to US subprime mortgages that these securities may be “weapons of financial mass destruction”, as Warren Buffett warned. With the suckers fled, the markets have frozen. The people who created this kind of stuff distrust both the instruments and their counterparties.
That distrust is one reason why the stock of outstanding money market instruments has shrunk by close to $250b — an amazing number — over the past three weeks.
I suspect – and I am certainly not an expert on this, only an interested observer – that a lot of this complexity is central to a certain part of the securitization process.