John Locke’s message

Unintended market consequences

Allister Heath

18 August 2007

If only Alan Greenspan had read John Locke more attentively. The 17th-century philosopher, who doubled as a brilliant economist, was among the earliest exponents of the law of unintended consequences.

It is now harder to finance mergers and acquisitions, a development which threatens to halt the infusions of cash that have pumped up share prices and financed private-equity deals. Even more damagingly, it has become more expensive for ordinary companies to borrow money, even for routine investments. It has become harder to obtain new mortgages, even for borrowers on high incomes and good credit ratings, especially in the US.

In recent days central banks have stepped in, buying up hundreds of billions of dollars worth of bonds to inject liquidity into the markets. Their aim has been to prevent short-term market interest rates from surging and to ensure commercial banks are so flooded with cash that they can do little other than lend more. Pressure has also been mounting on Ben Bernanke, Greenspan’s successor as Fed chairman, as well as Bank of England governor Mervyn King, to cut rates.

Given that the global economy remains strong and no ‘systemic’ financial collapse is likely, that would be a terrible mistake. Interest rates should remain as they are; rewarding the markets for their over-exuberance would merely be to repeat Greenspan’s error of 2001. It would eventually guarantee an even more painful hangover.

Finally, to those newly unemployed fund managers foolish enough to have blown billions of other people’s money on doomed, high-risk investments, I have this to say: make use of your unexpected spare time to get better acquainted with the law of unintended consequences. It may help you earn a buck or two in the next bubble.