Do we need informationally insensitive debt? April 17, 2011 at 5:22 pm
Yes we do. Felix Salmon is wrong. Let me explain.
First, what is informationally insensitive debt?
financial assets which (normally) don’t change in price when new information about them emerges
That’s not a good definition, actually, as there are no assets (apart from cash) which satisfy it. But it hints at a more useful definition, namely an asset whose credit spread does not change when more information about its issuer becomes available. A good example is a government bond from a genuinely AAA issuer. (See here for a longer discussion from Gary Gorton where he mentions the content of a CDS spread and conjectures that the universe of informationally insensitive assets has declined thanks to CDS trading.)
Now, Felix thinks assets like this are a bad idea because “bankers and other financial innovators the world over have every incentive to structure products which turn risky assets into informationally-insensitive debt“. These then “cause crises“.
I see it entirely the other way. The absence of enough genuinely informationally insensitive assets caused a demand which was met by the creation of almost, but not quite informationally insensitive ones, namely AAA-rated ABS. There is a massive demand for informationally insensitive assets, notably from those with low risk tolerance. We need more of them, as I suggested in my posts on policy on the asset side. Indeed, as Matt Yglesias says:
we need to do something—like maintain the existence of a large pool of federal debt—to make sure that the world has the quantity of information-insensitive debt it needs to continue routine operation.