Monday, February 01, 2010

How the Middleman Can Save You Money

Tonight's Daily Show featured Austan Goolsbee of the Council of Economic Advisers to the President. He argued in favor of the government taking over lending to students and cutting the middleman (various financial intermediaries) to save money. Cutting the middleman is a time-honored way to try to boost efficiency but it doesn't always work. Middlemen exist for a reason. In this case, they provide specialized knowledge and an incentive for efficiency since they keep the profits and suffer the losses (most of the time anyway).

This isn't simply a matter of buying your mattress directly from the factory (though, even there the middleman probably has better customer relations). Lending money is hard because because you have to avoid the twin pitfalls of those who can't pay you back and those who won't pay you back (aka adverse selection and moral hazard). People still default on loans despite various inventive mechanisms banks developed over the years to avoid these pitfalls; mistakes are easy to commit.

But it's even easier when you're not fighting for your life. No matter how well trained a government employee is, they are much less likely to get fired for approving a lot of loans which later default than for an employee at a for-profit company.

It still might be cheaper for the government to provide this service directly (though I'm skeptical). But it's not simply a matter of pocketing the middleman's cut.

1 comment:

Anonymous said...

There is another argument for middlemen when dealing internationally. Bribes. Americans are ‘too clean’ to pay expediting fees which get the job done in foreign markets. Therefore we hire it done. I have seen this done regularly by our Government. If we were to buy foreign military vehicles directly from the foreign governments the delays and paperwork would prohibitive. We therefore hire an expeditor who specializes in the machinations of foreign red tape. We don’t ask how they use the money we pay them. UB