Seems like the "vote with your money" mechanism should solve that: don't buy those securities. Do you claim that this mechanism doesn't work? If so, why is that?
The point is you are being lied to about the nature and. Alice of those instruments, the value of which is manipulated up before you buy and down afterwards. Efficient markets only work when participants have reliable information on which to make buy and sell decisions.
It's like telling someone who bought a car that's had its mileage manipulated that they shouldn't have bought the car. Well duh !
It's not really a lie. It's just that you're getting a bad deal. And it's not in any of the banks' interests to make it easy for you to get a good deal. You see one side of one trade for one security offered by one bank. Your analysis says it's a pretty good deal, but that's based in part on information the banks themselves have provided, and in general is impoverished next to the information the bank has. So you buy the security. Then you find out that you didn't get a good deal on the security. So you go to another bank, and the same things happens again in a completely different way.
Libertarian free-market types love talking about the power of incentives. However, the incentives in the banking industry do not line up with the creation of an efficient market. This much by now should be painfully obvious.
The incentives also don't line up on the buy side. As a buy-side fixed income investor, you can buy a 10-yr US Treasury (AAA) yielding X%, or you can buy a slice of the 10-yr AAA tranche of the Abacus CDO yielding X+0.50% (made-up but representative numbers). You're suspicious of the long-term performance of Abacus (it's 2007 and you're already hearing rumblings about problems in the housing market) but your bonus is based on the quarterly performance of your portfolio. It's pretty clear what most institutional investors did in this scenario.
My point is that you can sue a dealership which sells you a car with manipulated mileage. In addition, a dealership that does this systematically will go out of business relatively quickly (no one will buy cars from them). Why don't those things happen to banks?
They do. It is called a run. Then anything left is bought for next to nothing by a larger bank, and there is then even more opportunity for collusion as there are now less players at the table. It's been going on for a while now and in history seems to be the general trend apart from during those brief times when it is reversed for a while by the invention of new markets and financial technologies.
Albeit, this is only my probably wildly inaccurate and hastily sketched opinion.
[Edit: imagine two bookies, both of them placing odds on different horses. how, exactly, are you going to figure out which bookie to bet with in order to get the fairest odds?]
> [Edit: imagine two bookies, both of them placing odds on different horses. how, exactly, are you going to figure out which bookie to bet with in order to get the fairest odds?]
Isn't that type of problem solved through arbitrage? Frankly, I'm really not sure I get your point.
Arbitrage generally requires with equivalent commodities traded on different exchanges. It doesn't work when everything is different from everything else.
In other words, arbitrage would only work if the bookies showed odds for the equivalent horses. But in this scenario they don't. (also see my most recently posted comment)
"Capitalism works" is a general justification for structuring you economy as capitalist versus say having central planning via a Politburo. It is not a valid general justification for fine grained questions like whether a specific type of financial activity should be regulated or not. That's just hand-waving.
