Markets Don’t Live Here
The Moral Limits of Financial Logic in Essential Services
I was reading Howard Marks’ memo last week. In it he spoke about rent control and insurance premium caps in California. His conclusion around both was that the government can tell owners of capital (landlord and insurance companies) that they can’t charge you more, but the government can’t force the owners to provide the service. Essentially, the government can tell your landlord that your rent can’t be above a certain amount, but they can’t force your landlord to rent the property out. Given that the government then cannot force the capital owner to offer the service the service will disappear if the price that can be charged is not commensurate with the risk they take on.
The idea of risk commensurate returns is at the heart of modern finance, for as long as Markowitz and the Modern Portfolio Theory (MPT) have been in practice. MPT has its own flaws, like most things in life. It is by no means a perfect tool, but it is something that is pretty much universally applied to financial markets. I have no particular concern with the argument made by Marks in his memo, I think it is a logical conclusion based on the application of MPT to rent control and price caps on insurance premiums. It is also an argument that is pretty consistent with one you would expect to be made by a capitalist or someone who supports capitalist views (an important disclaimer here: I do not know Howard Marks, nor do I know if he is a free-market capitalist or not. I am purely stating that the argument made is one I would expect from a capitalist).
My concern with the argument is more the application of MPT itself, does MPT and the idea of risk adjusted returns really belong in an argument around services that are integral to human lives, namely housing. Both rent control and the fire insurance caps that Marks speaks about are the bottom or second bottom layer of Maslow’s hierarchy of needs. If these services are so integral for humans to live, how can you apply a theory that allows prices to force people out of where they live. My previous point might now speak to both MPT in this context and capitalism in general. As I previously said I have no issue with Marks argument itself rather my issue is the application of risk commensurate returns in this context.
My response to the idea that rent control and price ceilings as sent out by Marks would be that people deserve to live in a place where they are able to access required services, reach their place of employment and be within their community. By not having rent control in place, we will see gentrification forcing lower income communities out of areas that are close to wealth areas as rich people attempt to capture more area to expand amenities. Apart from this my critic of Marks argument is similar to the one I have made previously about wealth taxes. If a landlord is not going to rent an apartment if there is rent control, they are likely to sell that unit, this should increase the supply of property and drive prices of property down. If property prices do fall, renters should then be able to become owners and thus they are able to afford to live and increasingly become part of the community. Therefore, rent control achieves the purpose either way.
The insurance premium cap is not as easy to argue against, partly because the second component of my argument in rent control is not possible here. If the insurance company does not offer the fire insurance, then there is not much you can do yourself because you have already made the choice not to self-insure hence why you have reached out to an insurance company in the first place. The first argument still applies, somewhat at least, people deserve dignity and thus should be able to ensure the place where they live so they can continue to live there even if a fire happens. I don’t personally find this as compelling. The obvious solution would have been to not allow global temperatures to rise as much as they have and thus reduce the damage that the climate crisis has caused, in this case wildfires. Because this issue has been created by institutional failing then the government should be required to step in and insure the people who cannot afford to pay for private insurance. Government and institutions have failed the people of California by not preventing climate change and thus government and institutions should have to step up and support those whom they failed. Additional taxes on companies that have been responsible for the climate crisis should be used to insure those who cannot or should not pay for insurance.
Although I do respect Howard Marks and I enjoy reading his memos when they come out, and I do generally think that he is correct or makes strong experience and evidence backed points. I think he missed the mark on this. I think the application of risk commensurate returns to these issues missed the mark and fundamentally ignores the fact that there are people on the other side of this argument.