Government: The Dominant Player in US Credit Markets?

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The latest column by Gillian Tett provides further support for our pet thesis: that the role of the state in banking is so great and the subsidies so wideranging that they cannot properly be considered private companies and should be regulated as utilities.

Key extracts:

By the time you read this column today, a fascinating shift will almost certainly have occurred in the nature of US finance: for the first time the government will be the biggest source of outstanding home mortgage and consumer credit loans in the US, eclipsing private sector banks or investors…

What should investors make of this? There are at least three lessons to ponder. First, the data provide a powerful sign of just how distorted the US financial system remains in the aftermath of the great credit crunch…

The second fascinating point, though, is the cognitive dissonance surrounding this pattern. Six years ago, when I first started writing about the credit markets, I often heard US financiers praise America’s capital markets as the most developed system of free market finance in the world. Indeed, techniques such as securitisation were presented as a natural outcome of American enthusiasm for free market ideals.

But the dirty secret behind this rhetoric was that government-backed institutions such as Fannie and Freddie were playing an important role in the modern financial system, even before the credit crisis erupted. And what is remarkable now, given that the role of Fannie and Freddie has swelled, is just how little debate this patter continues to generate.

I agree that there is cognitive dissonance aplenty. As we discussed in ECONNED at considerably length, the concept of “free markets” is inconsistent and internally incoherent.

But Tett doesn’t have it right either. As Amar Bhide pointed out in a 1994 Harvard Business Review article, when US capital markets really were held in high esteem around the world, it was because they were the cleanest: they were the best policed and had the most extensive disclosure requirements. That was the result of effective and heavy regulation of securities markets that dated from the 1933 and 1934 securities laws (former Australian Treasury official and hedge fund manage John Hempton has declared the Securities Exchange Act of 1934 to be one of the best pieces of legislation ever written).

What bizarrely appears to have happened is that the belief that markets were effective devices got a considerable boost from the performance of US securities markets. In fact, the “free markets” ideology may be an attempt to claim the success of these heavily regulated markets and would have occurred in a state of nature. Our Andrew D observes:

Consider provisions like bans of insider trading, mandatory disclosure of business financial information, separation of the financial sector from the business sector. All of them seem geared to set up a model in which:

• Businesses are not allowed to freely provide or not provide propaganda about their current status
• Instead they are forced to provide “objective information” about their well-being
• And securities market participants are put in the role of evaluating this (presumably accurate) “information” and of deciding how to reward or penalize the company in its access to capital markets.

This vision for securities markets is far from a radical one. In fact, it resembles nothing so much as a neoclassical point of view – and SPECIFICALLY, it is the vision of financial economics, EMH, CAPM, etc.

So maybe the New Deal planners were trying to instantiate the vision of classical economics, applying it to the field of securities instead of just goods. But there is a little chronological problem here…

Which is that financial economics, as a discipline, almost entirely postdates World War II. That means that it is quite possible that, far from the New Deal regulators trying to implement financial economics, certain economists of the 50s and 60s took the heavily regulated securities markets of their time, pretended as if they were unregulated and had arisen naturally, and proceeded to produce a theory (financial economics) that described this “spontaneous”
system as the most perfect way conceivable to allocate capital to different pursuits.

If this is correct, then little of modern financial economics would exist without the interference of the Roosevelt administration.

I’m not as keen re Tett’s third point, she starts on the usual concerns about US debt levels. The problem is that these worries focus unduly on the numerator and neglect what is happening with the denominator. That’s why Europe is madly deflating its economies, acting as if they can stave their way to growth, when the resulting contraction leads debt to GDP to worsen rather than improve. A sovereign currency issuer like the US will never be unable to service its debts, ex mad Congressmen who refuse to send the checks to people we owe the money (that is, we have political rather than real economic constraints). The risk is generating too much inflation.

It is also important to note (but we’ll get to that in a separate post) that financial flows (those are often not properly accounted for; that’s how we could have a huge shadow banking system develop and have regulators remain blissfully unaware of its existence until its collapse nearly destroyed the global economy. So as much as Tett’s narrow conclusion is correct (the fact that the government has pretty much take over mortgage finance is not news; it’s disproportionate role in consumer credit is an interesting factoid), the shadow banking system still remains large and largely unrestrained. So even though the authorities are involved in the financial markets in a profound way, the perception of largely unregulated markets exists because there still is a lot of terrain where the cowboys are free to roam.

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  1. Richard


    The observation made by Andrew D is right on target. The key to a functioning financial system is the government ensuring that market recipients receive all the “information” to evaluate.

    The breakdown in the financial system occurred where the government stopped doing this (think structured finance securities for example).

    As you have pointed out many times, Wall Street rewards opacity and the profits it brings and not transparency and small margins.

    This is a fact well known to the regulators and why they and not investors were given the responsibility for ensuring that all the information was available in a timely manner to evaluate.

    The fact that investors only want to buy government guaranteed paper is simply a reflection of how bad a job the regulators have done in ensuring access to all the information.


    1. Richard


      One more item, what FDR put in place was the philosophy of disclosure in combination with the practice of caveat emptor (buyer beware).

      Prior to the Securities Acts, the markets practiced only caveat emptor – so firms were able to spin whatever stories they wanted and withhold objective information.

      FDR changed this dynamic. Specifically, he set up the SEC. It had a simple mission of ensuring that market participants had access to all the useful, relevant information in an appropriate, timely manner so they could make a fully informed investment decision.

      Wall Street’s ability to produce opaque financial products over the last two decades has been mirrored by the failure of the SEC to perform its simple mission.

      What caused this failure is a question for another day.


      1. corporate_serf

        “Wall Street’s ability to produce opaque financial products over the last two decades has been mirrored by the failure of the SEC to perform its simple mission.

        What caused this failure is a question for another day.”

        SEC having too many lawyers and not enough competent capital market participants won’t be it would it?

      2. monday1929

        The SEC does, supposedly, do a decent job on the disclosure aspect of their duties, and on those items narrowly required to be disclosed.
        Why is ANYTHING allowed to be “off-balance sheet”?

        1. Richard

          If only the SEC had done a decent job. From the standpoint of disclosure should it make any difference if the “asset” or “liability” is on- or off-balance sheet? I think the answer is no. The SEC thinks the answer is yes.

          Unfortunately, it is the SEC that sets the disclosure requirements. They let opaque, toxic structured finance securities be issued.

          Had the SEC done is job, the securities might still have been toxic, but they would not have been opaque.


  2. Philip Pilkington

    Andrew D: “If this is correct, then little of modern financial economics would exist without the interference of the Roosevelt administration.”

    ALL economic theory is a description of institutions that have been established due to either (a) political decision-making (e.g. the above example) or (b) social institutions that are not formed through economic rationale but acquire an economic rationale post factum (bringing the pig to market etc.).

    The fact that neoclassical economic theory grew up in 18th and 19th century Britain and (badly) describes the institutions that existed then is as contingent as the theory itself. We may as well be building a theory on the economic observations made in Aristotle’s ‘Nicomachean Ethics’ — observations that apply to a slave economy.

  3. F. Beard

    The government should have nothing to due with money and credit other than to manage its own fiat money supply. There should be no lender of last resort, no deposit insurance, no legal tender laws for private debts and no capital gains tax.

    But before we have fundamental reform, the entire population should be bailed out both for the sake of justice and to prevent the severe deflation that honest banking would cause without vastly larger reserves.

    So-called “credit” is a means by which the rich (the so-called “credit worthy”) steal purchasing power from the poor. Why do liberals and progressives tolerate it?

    1. liberal

      So-called “credit” is a means by which the rich (the so-called “credit worthy”) steal purchasing power from the poor. Why do liberals and progressives tolerate it?

      This is true, but it’s dwarfed by the theft created by land ownership in in the absence of land value taxation.

      A better question is why liberals, progressives, and you tolerate that.

      1. F. Beard

        This is true, but it’s dwarfed by the theft created by land ownership in in the absence of land value taxation. liberal

        And how was that land bought? With so-called “credit” which is actually stolen purchasing power?

        But I am not opposed to land taxes. Land cannot be hidden for one thing.

        But liberals make a fundamental mistake in thinking they should counter the thefts of banker fascism with increased socialism. Why not prevent the theft in the first place? Or take the taxes from the rich and distribute them equally to the population to spend as they please?

      2. nonclassical

        tsk, tsk, “liberal”…

        you are aware neocons have thoroughly discredited any attempt to include the U.S. in international consideration of such issue as landowner monopoly…

    2. parttimeauditor

      no deposit insurance,

      you libertarian idealogists really get on my nerves.

      what am I supposed to do, get an accounting degree and do an audit on a bank before I put my money in.

      when my money is lost because the bank did something they weren’t supposed to do, or LIED about, and I lose all my money then I can just be sure to never bank with them again ?


      1. F. Beard

        Well, if the government is going to insure deposits then it should have 100% control of the banks or go after the personal assets of the bank managers and stock holders in the event of bank failure.

        However, I see no reason why the government shouldn’t provide a 100% safe “Savings Bureau” that paid no interest and made no loans.

        1. parttimeauditor

          However, I see no reason why the government shouldn’t provide a 100% safe “Savings Bureau” that paid no interest and made no loans.

          right. so for some reason I don’t deserve a secure deposit when it pays 3% or some paltry interest barely above or below inflation. if I take such a “risk” I deserve to LOSE ALL OF MY MONEY, because I had the audacity to try and earn 3%.

          The problem with a bank going under is that I am NOT taking a foolish risk , but you’re saying the “free” market should be allowed to relieve me of ALL my money when something, completely out of my control, goes wrong. At the same time, for taking the risk of losing all my money a fair return is 3%.

          aargh… why am I bothering…

          1. F. Beard

            At the same time, for taking the risk of losing all my money a fair return is 3%. parttimeauditor

            You wouldn’t lose it all. Depositors would be first in line for the money raised when the bank’s assets was liquidated.

            But all investments including loans entail risk. How could it be otherwise?

            And like I said, the government could provide a risk-free money storage service for money that could not be put at risk.

            Plus don’t forget, once the money system is reformed the real risk in investing should go down.

            Or maybe you prefer the present system where the poor and middle class subsidise the risk-taking of the rich?

          2. F. Beard

            aargh… why am I bothering… parttimeauditor

            Consider yourself lucky that there is not an outright ban on usury. Lucky for you, no true libertarian would propose such a thing. But if usury was banned then corporations would most likely be forced by competitive pressures to pay their workers with common stock.

      2. F. Beard

        you libertarian idealogists really get on my nerves. parttimeauditor

        Imagine how I felt when I discovered our banking system is based on systematic, government backed theft of purchasing power from all money holders including and especially the poor for the sake of the banks and the rich.

      3. chris

        The idea of buyer beware is automatically giving the upper hand to bankers and institutions. We have seen over the years that politicians and corporate CEOS tend to have a personality type. It is typical they are self absorbed, narcissitic and primarily concerned with their own interests despite the propaganda they produce. They are usually in love with their power as well and it leads to reckless disregard for shareholders, clients and constituents.
        We have let the capital markets be dominated by government and corporations that are so intertwined with the government it is often hard to tell which has more influence on policy.
        Free market captialism is a fantasy. Limited government is also a fantasy at this point. Government has been digging deeper and deeper into the market system for years while pretending to be backing out.
        Unless corporations are forced to be trasparent they will not do so and there is no way possible to have perfect information or even remotely balanced information by the parties involved. The corporations don’t even trust each other so why would an individual consider trusting them.

  4. joebhed

    Government: The Dominant Player in US Credit Markets?

    Well, yeah, of course, under the debt-money system of fractional-reserve banking, the government must be the dominant player.

    If by credit markets we mean bank credits that are fully created by multiplying the “reserves” of all member banks, and, if the “reserves” of all member banks are a little currency and GOVERNMENT bonds, then, yes, the government IS the dominant player, the foundation if you will, of the credit markets.
    And, someone should tell the Congress, if the GOVERNMENT ever stops issuing securities, or paying them off en masse, without changing the system to fully-reserved banking, the credit markets will dry up.
    Or the private bankers will be taking their own money out of circulation to provide for reserves, a further step down the debt-deflation syndrome.

    What we need is a new money system.
    For the government to issue the nation’s money.
    For the bankers get back to taking deposits and making loans.

    1. Susan

      I read some articles at FDL from a couple of months ago about the litigation mess the Banksters are now facing. And one of the commenters was Marsdragon who said something that rang true: The United States does NOT have a sovereign currency. So since we are entangled with private bankers who create their own money at our expense we cannot successfully print our way out of it any more than Greece can. And that in order to make things work for the common good we need to establish a true sovereign currency and control it. Only then will the rules of money function rationally. For instance, MMT really is risky without sovereign control because inflation gets out of hand at a much faster pace – I suppose when you are not paying yourself the interest, but stuffing the pockets of the banksters.

      1. F. Beard

        Price inflation from sovereign money creation could be precluded by:

        1) Removing all government backing for fractional reserve lending. This would greatly limit leverage.

        2) Allowing genuine private money alternatives.

        That way, any price inflation in the government’s money would only hurt the government and its payees who then would have a strong incentive to spend more wisely.

        1. Susan

          You know F., when I read Kucinich’s bill to create jobs and restructure the banking system, I was surprised that he talked sraightforwardly about fractional banking. I know you’re not much of a liberal, I’m not sure if Kucinich is – he’s too rational, but have you read the bill?

          1. F. Beard

            I know you’re not much of a liberal, Susan

            Liberals are not very effective at helping the poor so I am proud not to be one. If liberals would simply tax the rich and send the money to the poor that would be more effective and just. Instead, liberals pretend that something is wrong with the poor and design expensive and wasteful programs to “help” them when all the poor really need is the money that was stolen from them.

            I’m not sure if Kucinich is – he’s too rational, but have you read the bill? Susan

            I have not finished it. I got discouraged because he advocates “stimulus” instead of a general bailout of the population.

        1. F. Beard

          Sure, why not? “Printing” could be done safely if it were combined with a 100% reserve requirement on the banks to preclude run-away inflation.

          1. Because

            This, my great grandfather fought for the end of fractional reserve banking in the 1890’s as part of Bryan’s Midwestern Democratic coalition. About all the populists or socialists did then.

      2. Yves Smith Post author

        The US is a sovereign currency issue. That means, colloquially, that it can just “print” rather than borrow. The fact that the US Treasury issues bonds is a political, not operational, constraint.

        The credit creation by banks is not the same, it is subject to limitations put on it by regulators and central bankers. The fact that those have been missing in action in the last few years does NOT make banks sovereign currency issuers.

  5. Brett

    What is Tett talking about when she says “the two entities wrote $3,500bn of loans on risky assets in the boom, with minimum collateral, which makes AIG’s adventures seem almost tame in comparison” Since they guarantee over $5 trillion total, she’s saying that 70% of what they guaranteed was “risky”? That’s a pure lie. The default rates for Fannie and Freddie would be enormous if that was the case. Instead they are much lower than private banks:

    Most of what Fannie and Freddie were guaranteeing were prime loans, the safest housing loans. They only stooped into the subprime business late in the game when they were losing market share to Wall Street competitors.

    1. corporate_serf

      The definition tett uses for “risky assets” is standard: it simply means they carry credit risk, which they do.

      For example, you can be completely invested in a stock index fund, entered at 2003 and exited in the summer of 2007 and still you would have been invested in a risky asset.

      1. Because

        Yes, but everything carries credit risk. F/F are far less than the market price. Which is why they were getting raped while private markets went mad.

    2. Poli Fry

      Late in the game? Oh bullshit. Try starting in 2000, before the revelations of cooked books.

  6. Steve Roth


    Efficient markets require complete information.

    The inherent incentives in markets are for sellers to conceal as much information as they can get away with. (As it turns out, they can get away with concealing a lot.)

    Incentives matter.

    The only correctives for those incentives are uniformly imposed market regulations requiring disclosure.

    So only regulated markets can be efficient.

  7. Because

    Government involvement with credit markets is minimal. If they weren’t, you would see a growth boom in America as the government would be pumping “credit” into infrastructure like mad ala China. Mortgage finance is only a small chunk of credit markets. Others have made the same mistake.

    That is the point, to many people get all happy over the crisis phase of fractional reserve banking when the government through the central bank seeks to resolve it aka transfer payment crisis. Was the resolvement handled poorly? Sure. But it was resolved and the contraction ceased. Before the Central Bank, the US economy struggled. GDP per capital between the 1870’s-1900’s was weak. To weak to support its people. You had labor strife, strikes and riots. Armed fights against capitalists that created a body toll(convient how that has been thrown under the rug historically). GDP per capita between 1914-2000 was much much stronger. Hence the rise of the middle class. The FDR era reforms helped, but they weren’t as huge onto the capital structure as the central bank and its requirement to resolve the transfer payment crisis of fractional reserve banking. However, we have reached a point of endgame. The US is old. Growth is no longer going to come easy. The central banks resolvement of transfer payment crisis is not going move GDP per capita anymore. We are entering a new era.

    Tett’s problem is she is intellectual following a lie. She doesn’t want to admit that the general flows of capital are controlled privately and they make their own choices. They wanted offshoring and it has destroyed investment vehicles. So there was a flight to saftey in real estate. By 2003 finance saw surge in homebuilding and saw a money making oppourtunity. They expanded credit that went toward people in vast sums to buy houses no matter their lifestyles to fill the building boom created by capital. At the same time, the upper middle classes saw houses as a investment “flipping” tool. It was carnal, a urge that needed to be satisfied. Tett cannot understand that because she worships the nature of market driven forces. To her, they can do no wrong.

    What she should say is she believes in boom/bust, but she can’t. That kind of failure is not possible. Stop using stuff like F/F to whip your doubts away. Get rid of fractional reserve banking and you won’t have these issues.

  8. decora

    Let’s say that you wanted to start a website that was an encyclopedia of the shadow banking system?

    A sort of wikipedia of the shadow banks? An article on each CDO, maybe even on some of the more prominent RMBS series.

    All content licensed under Creative Commons.

    Question: How do you fund such an endeavor?

  9. Thomas Barton, JD

    Yves, I hope you will inform us of any Eurozone cracks in the making as these tortured Franco-German plans—really folks we are not restructuring debt just fine tuning EU,ECB and IMF official vision of reality—- as these bizarre hybrids sally forth over the next several weeks. In a way I have to give grudging admiration to these entities for finding a way to keep an incredibly deeply stalled fighter jet of a finance system airborne.. Or at least not yet a fireball in the rocky soil of reality. Perhaps they have discovered their own anti-financial gravity levitation machine. Perhaps endless manic liquidity can postpone a solvency crash, perhaps they have found the financial equivalent of the cosmic beast known as dark energy. Maybe that is why the new EU building is so bizarre. It is a conduit for bringing dark energy into the world of EU finance.

  10. razzz

    SEC is now a misdirection play. Congress has oversight of SEC.

    During hearings of malfeasance concerning wall street, the last thing heard is that Congress will notify SEC of their findings. A complete circled jerk.

    When members of SEC are before Congress, a grant of presidential immunity (Executive Privilege) is claimed by a SEC lawyer just before any meaningful answers can be obtained. i.e. questions during hearings concerning SEC investigation of Bernie Madoff.

    SEC has become a pawn, Congress is the problem (banker’s money).

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