April 13, 2008

Main Street vs. Wall Street: No Such Thing

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Congress was on a roll this week. On April 1st the House Select Committee on Energy Independence and Global Warming heard testimony from top oil company executives concerning tax incentives for oil companies. On April 3rd, financial industry regulators were called upon by the Senate Banking Committee to justify the Bear Stearns rescue. It is true that Congress has oversight power, but did Congress gain anything from telling oil executives for the zillionth time that profits and oil are bad? Or did Congress help to stabilize markets by hearing apocalyptic stories about what a Bear Stearns failure could cause? The U.S. government, and Congress more specifically, would serve its constituents better by allowing the economy to work itself out rather than holding hearings that produce nothing except for C-SPAN footage.

Politicians, most notably the presidential candidates, have been asking, “If Wall Street gets bailed out, why can’t Main Street?” This is a good line that gets crowds riled up, but the notion that there is a great divide between Wall Street and Main Street is increasingly unfounded. The Investment Company Institute (ICI), a group that publishes research about the financial industry, found that in 2007 about 44 percent of households were invested in mutual funds, representing 89.6 million investors. More significant than this statistic, however, is that approximately every three in five of these households have incomes between $25,000 and $99,000. It is no longer only the wealthy who invest. The ICI also reported that the number of U.S. households invested in funds has increased every year since 2004. Of course, this may change due to market volatility. Nonetheless, these numbers represent a narrowing gap between Wall Street and Main Street.

Government proposals to fix the problems with housing and the broader economy are abundant, but misguided. The only true way for the housing market to rebound is for home prices to be low enough and for the risk-reward ratio to be appropriate, so as to attract buyers and investors. Some efforts by the government, such as reducing the capital requirements of Fannie Mae and Freddie Mac help, but ultimately the market must correct itself. The uproar about the economy has gotten politicians in a frenzy. Yes, the situation is bad and it will take some time and pain for markets to rebound. However, quests to find a culprit for the current problems, in the form of oil executives or Wall Street executives, will not solve anything.

If politicians feel a need to decide how the marketplace should be fixed, they should stop telling oil executives that prices are high and oil is bad. Many mutual funds and retirement funds that ordinary people rely on invest in oil companies. Politicians should also stop blaming financial market participants for taking part in the evils of securitization and risk spreading, because these are what ultimately lead to efficiency. Government’s role should be to ensure that there is as much information as possible concerning the financial markets and that this information is easily accessible. Holding hearing after hearing will not do much, other than give the mere appearance that the government knows what it is doing