Are financial markets fit for purpose?

De Koning, Kees (2014): Are financial markets fit for purpose?

Abstract

Savings can be used in two different applications. Companies will nearly always use savings –equity, loans and bonds- to help produce and increase output and increase employment levels –the economic use of savings-. Individual households will take up mortgages. However the collective mortgage providers may grant new mortgages at a speed, which not only helps new construction of homes –an economic use of savings-, but also forces house prices up above the increase in average incomes. The latter use can be called the financial use or the un-economic use of savings. No output is created through these price increases, nor are any jobs created. Governments create government deficits, by spending more than their tax revenues. After the year of spending, unless an outside contract creates a cash flow to repay the debt, government debt is another example of the financial use of savings.

Stock markets assist in the allocation of savings, but their time horizon is very short term because the market participants have moved from individual households to institutions. The latter trading behavior has moved from active to passive management and technology has induced super fast trading patterns. There is no price set for holding securities, only for trading. Most government debt needs a repayment period of well over seventy years.

Study the un-economic use of savings in mortgage-backed securities and the causes of the 2008 financial crisis become a lot clearer. The value of a dollar saved out of incomes was depreciated as compared to the dollar invested in mortgage-backed securities. The reactions of the authorities and of the outside equity providers caused this discrepancy to widen over the period 2004- 2012 rather than helping individual households to get their own balance sheet back to order. The shift in the uses of savings from an economic use to an un-economic one can cause economic recessions.

• Item Type: MPRA Paper
• Language: English
• Keywords: economic savings; financial (un-economic) savings, financial markets, financial crisis, savings depreciation factor, deflation, economic easing
• Subjects: E - Macroeconomics and Monetary Economics > E2 - Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy; E - Macroeconomics and Monetary Economics > E2 - Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy > E21 - Consumption ; Saving ; Wealth; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E58 - Central Banks and Their Policies

References

The benign neglect of the individual households' equity crisis, Drs Kees De Koning, U.K. 29th January 2014, MPRA Paper 53273, University Library Munich,

Federal Reserve Bank of St.Louis, U.S. Monthly and annual housing starts: Balance Sheet of Households and Nonprofit Organizations, quarterly and annual statistics