The politics of order in informal markets: Evidence from Lagos

That is the title of a new paper by Shelby Grossman, here is the abstract:

Property rights are important for economic exchange, but in much of the world they are not publicly guaranteed. Private market associations can fill this gap by providing an institutional structure to enforce agreements, but with this power comes the ability to extort from group members. Under what circumstances do private associations provide a stable environment for economic activity? Using survey data collected from 1,179 randomly sampled traders across 199 markets in Lagos, I find that markets maintain institutions to support trade not in the absence of government, but rather in response to active government interference. I argue that associations develop pro-trade institutions when threatened by politicians they perceive to be predatory, and when the organization can respond with threats of its own; the latter is easier when traders are not competing with each other. In order to maintain this balance of power, the association will not extort because it needs trader support to maintain the credibility of its threats to mobilize against predatory politicians.

Via Henry Farrell, that abstract reminds me of my earlier essay, and critique of libertarian anarchy, “Law as a Public Good,” shorter version of the argument here.

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Evidence from the US? Look at shadow banking.

Evidence from Italy? Look at the Mafia.

Bonus trivia: the Mafia is actually a 19th century construct, not really as old as people commonly assume. Kind of like cannibalism in Papua New Guinea about 100 years ago, also not that ancient a tradition.

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The Dodd-Frank Wall Street Reform and Consumer Protection Act fixed that. BARF

https://www.cnbc.com/2019/04/11/shadow-banking-is-now-a-52-trillion-industry-and-posing-risks.html

Nonbank lenders, often called “shadow banks,” now have $52 trillion in assets, a 75% increase since the financial crisis ended.
The industry was at the center of the financial crisis when the subprime mortgage market collapsed.
Industry officials say shadow banks still face considerable regulation and can help provide buffers in times of stress.
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Try a little fact checking, it is simple.

Of course, shadow banks are some of the many causes of the 2008 catastrophe. Why the government was compelled to cover their losses is an issue.

Mortgage banks (originators, sellers, servicers) are shadow banks, right? They made the subprime loans that crashed the system aided and abetted by HUD, FHA, FHLMC, FNMA, et al that artificially provided huge amounts of market liquidity.

I think we want to include in the universe of 2008 causes and shadow banks: FHA, FHLMC, FNMA, GNMA, HUD, the VA, etc.

History: who paid off whom for this massive shit sandwich? See Wikipedia: The Commodity Futures Modernization Act of 2000 (CFMA) was signed into law on December 21, 2000 by Clinton. It clarified the law so most OTC derivative transactions between "sophisticated parties" would not be regulated as "futures" under the Commodity Exchange Act of 1936 (CEA) or as "securities" under the federal securities laws. Instead, the major dealers of those products (banks and securities firms) would continue to have their dealings in OTC derivatives supervised by their federal regulators (FRB, FDIC, OCC, OTS bank examiners) under general "safety and soundness" standards. The Commodity Futures Trading Commission's (CFTC) desire to have "functional regulation" of the market was also rejected. Instead, the CFTC would continue to do "entity-based supervision of OTC derivatives dealers." These derivatives, including the credit default swap, are a few of the many causes of the financial crisis of 2008 and the subsequent 2008–2012 global recession.

Huge money market funds - shadow banks - busted the buck because of the "carry trade." And, the Fed covered their losses.

The article cited "maturity intermediation" (we in the real World call that the "carry trade") wherein financial intermediaries (including regulated commercial and savings banks) employ FDIC-insured deposits) employ lower-rate, short term funding liabilities to fund higher rate, long-term, fixed rate interest yielding assets, has been around a long time. In rising interest rate environments (like the 1970's into the early 1980's) the interest expenses on deposits rise while long-term mortgage interest incomes remain stable. Net operating losses result. That did not happen in 2007 and 2008, but too many subprime and prime loans defaulted,, i.e., were not making payments.

Shadow Banking, intermediaries not subject to regulation, includes hedge funds, unlisted derivatives; and other unlisted instruments. Examples of unregulated activities by regulated institutions include credit default swaps (CDS).

Two major "unexpectedlys" afflicted CDS: one, no one ever imagined that 20% to 30% of underlying mortgages in a mortgage-pass-through investment vehicles would stop paying; and two, there was no capital or reserve behind the CDS, such capital/reserves are always present in insurance schemes which effectively CDS are.

Thew Fed is losing market share, none of the banks want to pay for millions of central banking police. We are going to an almost complete shadow banking system. You will love it, a loan market for every risk level, no one left out of banking. All you need is an AppleID and you can log into any of the numerous shadow banking networks, starting with JPM. great stuff, pure liquidity.

Are you employed by a bank?

I keep forgetting most MR followers never experienced (or even dreamt of) a rising rate, inflationary long-trend economy - like 1946 to 1981.

JPM, GS and all the others just this week were STRESSED TESTED by Thew Fed, OCC, et al.

Possibly my (now only) loan was sold to a dreaded shadow bank. The only leverage I carry is a 3.875%, 30-year, fixed rate mortgage with a federal credit union. The FCU is nuts if it holds that loan: interest rate risk out the kazoo. Is Toyota Financial Services a shadow Bank? I had a loan with them onst. I recently paid of a loan with CitiMortgage - was that a shadow loan?

JPM is a Federally-chartered bank holding company. It or one of its subsidiaries may or may not provide shadow banking or products and services. However, if said products/services are not closely related to banking, the bank or BHC must make a charge to its regulatory capital maintencne calculations.

Plus, I will love "it" to the extent that the American people do not bail out/cover the losses of the shadow banking system or unregulated banking products.

FYI - with an above-899 FICO score, I can get a loan anywhere I want.

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If the government doesn't interfere when economy gets wrong,why does it exist?

You meant to write "intervene" not "interfere," right?

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National security, crime and punishment. Interfering in the economy would likely only make it worse

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Can we call them "trade associations?" Do such trade associations have powers (police, militia, judicial) to defend their prerogatives?

Change the government.

Prosperity is lacking in many nations. It needs physical security, property rights, an independent judiciary, political stability, the rule of law, and a functioning civil society.

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"I find that markets maintain institutions to support trade not in the absence of government, but rather in response to active government interference."

...so Shelby just discovered the economic mechanism of Black Markets

wow

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