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Bank Profits Soar as Washington Subsidies Flow

Posted By Salim Furth, Ph.D On December 18, 2012 @ 6:09 pm In Economics | Comments Disabled

Too often, government policies designed to ameliorate a general problem merely benefit a special interest. A case in point [1], highlighted by Binyamin Applebaum on the Economix blog, is the Home Affordable Refinance Program (HARP).

HARP is part of the complex federal effort to stabilize the home mortgage market and stem the flood of foreclosures, and it will continue to operate through 2013.

HARP gives subsidies to homeowners who refinance with the banks that currently hold their mortgages—but not with other banks. In a market with restricted competition, HARP allows lenders to capture a government subsidy, sharing little of the benefit with borrowers.

A team of researchers recently investigated the post-recession rise in bank profits [2] on refinanced mortgages. They ask, “Is there evidence that lenders can exploit this higher pricing power?” Parsing technical data on interest rates and secondary mortgage markets, they answer their own question in the affirmative: “[T]he evidence strongly suggests that originators make larger profits on HARP loans than on regular loans, by being able to exploit their pricing power.”

Of course, it’s easy in hindsight to point out the obvious economics of the case: Competition lowers prices, but government-created monopolies are highly profitable. We might also conclude that since big banks were heavily involved in crafting policy after the mortgage-market collapse, it is no surprise to discover that government subsidies are flowing to bank coffers.

The market failure created by HARP (in this case, segmented monopoly) fits an economy-wide pattern that I documented in October [3]: Greater government regulation since 2007 led to greater profits for incumbent firms while making it more difficult for startup companies to succeed.

The most important lesson to draw, however, is that when government has the power to remake markets and establish preferential arrangements, errors will always creep in, and unintended consequences will sometimes outweigh intended ones. From Adam Smith [4] to public choice theory [5], economists have warned that government can create market failures as well as it can eliminate them.

As government grows in reach and complexity, it becomes more likely that bad policies will go undetected or unaddressed.


Article printed from The Foundry: Conservative Policy News from The Heritage Foundation: http://blog.heritage.org

URL to article: http://blog.heritage.org/2012/12/18/bank-profits-soar-as-washington-subsidies-flow/

URLs in this post:

[1] case in point: http://economix.blogs.nytimes.com/2012/12/12/another-asterisk-for-asset-purchases/

[2] post-recession rise in bank profits: http://www.newyorkfed.org/research/conference/2012/mortgage/primsecsprd_frbny.pdf

[3] I documented in October: http://www.heritage.org/research/reports/2012/10/why-the-slow-economic-recovery

[4] Adam Smith: http://www.adamsmith.org/wealth-of-nations

[5] public choice theory: http://en.wikipedia.org/wiki/Public_choice_theory

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