Maturity Mismatching and “Market Failure”

Abstract

The present article is a continuation of the debate two sets of authors (Bagus and Howden vs. Barnett and Block) have been engaging in regarding one type of maturity mismatching: borrowing short and lending long (BSLL). All four authors had agreed that this practice can set up the Austrian Business Cycle; the present author denies that BSLL would be a legitimate commercial interaction in the free society; Bagus and Howden continue to maintain that it would be licit. Our main criticism of Bagus and Howden is a reductio ad absurdum: that this opens them up to the charge of embracing the doctrine of market failure; this is something highly problematic for the two of them, since all four contributors to this debate are well-known supporters of laissez faire capitalism.

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Notes

  1. 1.

    BH, henceforth.

  2. 2.

    For an analysis of debates, apart from their substantive content, see Block et al. 2008.

  3. 3.

    BSLL is one way of describing the primary type of maturity mismatching. Another, and, we think, more discerning, and therefore more useful way is LSBL; i.e., lend short—borrow long. The former considers the two transfers from the point of view of the intermediary, whereas the latter contemplates the transactions from the perspectives of the ultimate lender and borrower.

      Perspective
      Financial intermediary Ultimate transactors
    Primary type of maturity mismatching BSLL LSBL
    Secondary type of maturity mismatching BLLS LLBS
  4. 4.

    Block (1973, 1980, 1999), Batemarco (1985) Fox (1992) Hoppe (1989, 1991, 1992, 1995) Hulsmann (1999) Mises (1969, 1998), Polleit (2008, 2011), Rizzo (1979) Rothbard (1951, 1957, 1960, 1971, 1973, 1976, 1997a, b, c, d, 1993) Selgin (1988).

  5. 5.

    On subjectivism see also Barnett (1989), Block (1988), Butos and Koppl (1997), Cordato (1989), DiLorenzo (1990), Garrison ( 1985), Gunning (1990), Kirzner (1986), Mises (1998), Rizzo ( 1979, 1980), Rothbard (1979, 1997a, b, c, d).

  6. 6.

    There was an entire Austrian journal, Market Process, devoted to this perspective, in print from 1983 to 1991.

  7. 7.

    Austrian economists have set up a blog on this basis: http://austrianeconomists.typepad.com/; see also Block (2003), Boettke (2001), Garrison ( 1985, 1994), Loasby (1998), O’Driscoll (1977a, b), Salerno (1991).

  8. 8.

    See Barry (1982), Boettke and Coyne (2005), Hayek (1960, 1967, 1973), Klein (2006), O’Driscoll (1977a, b) also: http://www.google.ca/#hl=en&gs_nf=1&cp=17&gs_id=4&xhr=t&q=spontaneous+order&pf=p&output=search&sclient=psy-ab&oq=spontaneous+order&aq=0&aqi=g4&aql=&gs_l=&pbx=1&bav=on.2,or.r_gc.r_pw.r_qf.,cf.osb&fp=ebde00da22e92377&biw=1280&bih=907.

  9. 9.

    For the view that the Austrian school may possibly be defined in terms of its finding that there are no constants in economics as there are in physics and chemistry, see Wenzel (2012). See also Clark and Primo (2012). This is not to say that those Austrians who focus, say, on only one of these, reject all the others. Rather, it is a matter of emphasis. Our contention here is that all members of this school adhere to most if not all of these doctrines, but place different emphases on the importance of each.

  10. 10.

    Perhaps we should rather say, “very often.”

  11. 11.

    “Involuntary unemployment” is another of those terms about which economists disagree. Praxeologically, there can be no such thing, although, of course, thymologically it is a well know phenomena. Keynes (1965, p. 15), himself, had a most unusual concept, and expression thereof, of involuntary unemployment.

  12. 12.

    Keynes (1965) and Hazlitt (2007, 1960).

  13. 13.

    Consult any introductory, intermediate, or advanced microeconomics textbook.

  14. 14.

    Sometimes, the market failures can become pretty esoteric. See Block (2001).

  15. 15.

    For a critique of that institution on this score, see Hoppe (2002); (Block 2002a; Rothbard 2002; DiLorenzo 2002; North 2002).

  16. 16.

    Friedman and Schwartz (1963).

  17. 17.

    See on this: Anderson (1998), Barnett and Saliba (2005), Block (2002b), Callahan (2000), Cowen (1988), Guillory (2005), Higgs (1995), Hoppe (2003), MacKenzie (2002), Rothbard (1985), Simpson (2005), Tucker (1989), Westley (2002), Woods (2009).

  18. 18.

    It cannot be denied, however, that there are exceptions to this general rule. See for example Block (1977).

  19. 19.

    Evidence for this claim is provided below.

  20. 20.

    A negative externality is said to exist when an action of A negatively impacts one or more other people. If A is within his rights, then in a free society such act would not be considered a market failure; e.g., if a person paints his house white and you don’t like white houses that does not make this act a negative externality in any meaningful sense. However, if A is not within his rights then we have a “failure” but it is not a market failure, as A is operating outside of the law. Positive externalities are merely situations where one or more people think that X should act in certain ways to benefit Y, even though, in a free society, X would have no such obligation.

  21. 21.

    This assumes, of course, that the magnitude of the BSLL is non-trivial.

  22. 22.

    A complication; the present authors define economic freedom so as to include a ban on BSLL; Bagus and Howden contend that BSLL is compatible with free enterprise. In contrast, all four of us maintain that in the truly free society, fractional reserve banking would be outlawed. For a critique of the latter, see Bagus (2003, Bagus, Howden and Block, forthcoming, Barnett and Block (2005, 2008, 2009a, b), Block (2008), Block and Caplan (2008), Block and Garschina (1996), Block and Humphries (2008), Block and Posner (2008). See also Bagus (2007, 2008), Hoppe (2006), Barnett and Block (2007).

  23. 23.

    BSLL, even excluding its fractional reserve subset, can cause the ABC, depending upon the extent of the mismatching and assuming sufficient magnitude.

  24. 24.

    Here is another formulation of this rule: “21(1) Subject to this Act, where goods are sold by a person who is not their owner, and who does not sell them under the authority or with the consent of the owner, the buyer acquires no better title to the goods than the seller had, unless the owner of goods is by his conduct precluded from denying the seller's authority to sell.” Source: http://www2.derby.ac.uk/ostrich/The_law_of_the_art_and_antiquities_market/recovery%20of%20stolen%20art_wimba/page_05.htm. For more on this see: https://www.google.com/?gws_rd=ssl#q=nemo+dat+quod+non+habet+.

  25. 25.

    Actually, it is more appropriate to speak of the “structure of action,” to include both the structure of production and the structure of consumption, its analog re consumption, however to pursue that path would take us far afield, and, in any case is not necessary to our point.

  26. 26.

    We are tentative in claiming full support for our position by Salerno (2012) since he also writes thusly: “Thus for short-term business lending they would issue certificates of deposits with maturities of 3 or 6 months. To finance car loans they might issue three-year or four-year short bonds. Mortgage lending would be financed by five- or ten-year bonds.” That is, Salerno seems to favor a rough, but not an exact, matching. However, that is not perfectly clear. Moreover, he only addresses bsll and not borrow long, lend short (blls).

  27. 27.

    To our way of thinking, this indicates ever the more that these authors, as in our case also, are intent upon getting to the truth of these matters, let the chips fall where they may We greatly appreciate this.

  28. 28.

    This seems to be a constant refrain between them and us. We tend to see similarities, continuums, they, black and white sharp differences.

  29. 29.

    Is the mother guilty of fraud at the outset, when she makes these incompatible promises? Or, only at the end of the year when she is to make good on both these promises? We incline toward the former.

  30. 30.

    And, if not prohibited by law, they constitute a “market failure.”

  31. 31.

    Although an important subset of BSLL, in the modern financial system, fractional reserve banking does not appear to be the most important one. In 2008, it was primarily investment banks; e.g., Bear Stearns and Lehman Bros., and not commercial banks that collapsed. And, they did so because of BSLL that did not involve fractional reserve banking; rather, it pertained to all sorts of other very short-term debt that was used to acquire securities and other financial assets of much longer terms to maturity. That is, our most recent and major economic collapse was caused by BSLL, but not its fractional reserve banking subset. Rather, the non-commercial-bank financial intermediaries that borrowed short did not do so by means of demand deposits but via BSLL; e.g., repos. This should put paid to any claim that not only is BSLL theoretically unimportant, but also that it is of no practical consequence.

  32. 32.

    Oxford English Dictionary (Online). oversubscribe, v. trans.

  33. 33.

    See our discussion, supra, of the nemo dat quod non habet rule.

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Maturity Mismatching—Merely because the average duration, however defined, of a financial institution’s assets and that of its liabilities is the same is no guarantee of the absence of maturity mismatching, any more than saying that because the average height of two groups of youths is the same, there is no height mismatching between the two groups. This should be kept in mind in interpreting Mises’s and Rothbard’s statements on pages 3 and 4, infra.

Market Failure—As with so many terms in economics; e.g., value, wealth, income, money, and capital, there is no unique definition of “market failure” accepted by all professional economists. Cf., e.g., Eatwell et al. (1991, Vol. 3, pp. 326–328), and Hummel (2008). Of course, all economists would agree that markets “fail” in the sense that all humans are imperfect creatures, and markets consist of the actions of our species. This of course is not at all what is meant by “market failure” in the economic literature. To prevent misunderstanding, herein, “market failure” is taken to refer to a situation or condition arising in a free-market economy in which governmental intervention, taking into account the costs of such action(s), would improve the allocation of resources in the sense of a Pareto improvement.

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Block, W.E., Barnett, W. Maturity Mismatching and “Market Failure”. J Bus Ethics 142, 313–323 (2017). https://doi.org/10.1007/s10551-015-2706-1

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Keywords

  • Borrow
  • Lend
  • Deposit
  • Maturity mismatching
  • Fractional reserve banking
  • ABC
  • Banking ethics

JEL Classification

  • E2
  • E59
  • P16