Afternoon Must-Read: William K. Black: Foreshadowing the Three Fraud Epidemics that Drove the Crisis

William K. Black: Foreshadowing the Three Fraud Epidemics that Drove the Crisis: “[Piskorski, Seru, and Witkin] were not aware, however…

…of the answers to these fundamental questions [about mortgage fraud]…. ‘These misrepresentations are not instances of the classic asymmetric information problem in which the buyers know less than the seller. Rather, we contend that they are instances where, in the process of contractual disclosure by the sellers, buyers received false information on the characteristics of assets.’ The use of the word ‘classic’ indicates an important (retrograde) movement in economics. The ‘classic’ treatment of asymmetry… George Akerlof’s 1970 article on a market for ‘lemons’… all about ‘buyers receiv[ing] false information on the characteristics of assets’ in the process of ‘contractual disclosure by the sellers.’ Akerlof presented a dynamic process in which the seller makes false disclosures… to maximize the asymmetry of information…. Indeed, Akerlof emphasized the propagation of that fraudulent asymmetry through the industry as a result of what he dubbed a ‘Gresham’s’ dynamic. ‘[D]ishonest dealings tend to drive honest dealings out of the market. The cost of dishonesty, therefore, lies not only in the amount by which the purchaser is cheated; the cost also must include the loss incurred from driving legitimate business out of existence‘ (Akerlof 1970). The fact that top economists, 40 years later, claimed that fraud does not represent a ‘classic’ pathology of asymmetrical information demonstrates how far economics has fallen…”

February 15, 2015

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