Invisible Hand

Ann Pettifor argues that we are heading towards a financial meltdown because of the amount of borrowing or ‘leverage’ of financial institutions. In her blog post to Comment is Free she gives the example from the Financial Times of somebody been able to leverage 20,000 Euro into nearly 1 million Euro into a hedge fund.

“The answer of course is that both the Bank and the government decline to intervene in such unseemly affairs. The reason? The conduct of hedge funds, banks and mortgage companies is regulated by an "invisible hand". And so effective is this invisible hand at promoting competition amongst banks, for example, that the average interest rate on the virtually costless business of credit card lending is about 12% above base rate - 17.02%. According to the British Bankers Association, fully 75% of credit card balances were bearing this average rate of 17% interest in October, 2006. Debts of a 980,000 leveraged on €20,000; and usurious interest rates of 17%. It hardly bears thinking about. Which is why most do not. All hail the few who do.”

Is the 12% over base rate for credit cards in the UK telling us that we are heading towards financial meltdown. There are two reasons why the Interest rate is so high above base rates, whether as Ann suggests that the invisible hand is not working or that because the market has priced the risk of the meltdown into the interest rate.

The invisible hand theory only works if the market is efficient. There is evidence to suggest that the market for credit cards is not efficient in the UK. The CEO of Barclays, Matt Barrett, admitted in 2003 that some of his cards are so complex he can not work them out. If the largest Credit Card issuer in the UK can not work out the cost of one his banks cards, then the market is not efficient.

When I the consumer tries to work out the cost of a card, I am faced with a multitude of variables. The Interest Rate of New Credit, The Interest Free period, Charges, Late Penalty charges for paying it off, Balance Transfer Interest, Any benefits that I may get like Air Miles or Donations to Charities (Would I be better to give the money directly). To compare credit cards charges is beyond the normal consumer.

Back to Ann arguments about the markets heading to meltdown and her example of a hedge fund, one wonders if the Rich Mans Hedge Fund is the equivalent of the Poor Mans Credit Card. The gearing and risks in the different Hedge Funds are so complex can a man or even a computer work them out?