Federal Credit Programs and the Birth of Lemon Socialism

We regularly criticize government-subsidized lending as a terrible way to achieve policy goals. First, it’s less efficient since you are laundering the subsidies through the financial system, thus unnecessarily enriching middlemen. Second, it’s well nigh impossible to know the effectiveness of the program. It’s not clear how many people would have gone ahead without the cheap credit, meaning the government is rewarding activity that would have taken place anyhow. Moreover, lending subsidy programs often wind up being overly broad and thus are transfers to people who aren’t the purported beneficiary of the gimmie. One classic example is the mortgage tax deduction. It was slotted to be eliminated, along with the tax deductibility of all other consumer borrowing, in the 1986 Tax Reform Act. Instead, it was preserved because brokers and homebuilders howled bloody murder. The mortgage tax deduction is often depicted as a motherhood and apple pie policy, “promoting the American dream” of homeownership. That implies it helps what the Australians call battlers: those who rely on the tax break in order to afford their first home. But as we know, the presence of the tax break merely leads to housing prices being higher than they otherwise would be (as in prices are bid up to reflect the impact of the tax bennies). And the tax writeoff is far more valuable to homeowners in higher tax brackets, meaning the middle and upper middle class, that the aspiring middle class (to the extent it still exists).

Here, Professor Sarah Quinn describes how, starting with the Johnson administration, the Federal government played a large role in using lending subsidies to support preferred policies and was responsible for key credit market innovations like mortgage securitization. Quinn also describes how the targets for stealth industrial policy have changed over time.

From the INET website:

President John F. Kennedy once said that success had many fathers, whereas failure was an orphan. One wonders what he would have made of today’s Federal credit programs, a vast network whose obscure political origins have finally been laid bare by sociologist Sarah Quinn of the University of Washington. As Professor Quinn, an Institute grantee, points out in the interview below, government-originated credit programs barely existed before the time of the Great Depression until, in 1934, the New Deal chartered the Federal Housing Administration to stimulate mortgage lending. It’s hard to believe that within a generation, the FHA spawned 74 separate programs to bolster credit through guarantees, insurance or outright loans.

But that’s nothing compared to today.

Uncovering securitization’s connection to the vast network of federal credit programs in the postwar era, Quinn’s research seeks to demonstrate how credit programs and securitization together distilled and then exacerbated core tensions running throughout U.S. history, tensions that emerged in the earliest days of the nation and then were crystallized in a fragmented federal government. The point, Quinn says, was nearly always the same: to camouflage, hide, or understate the extent to which the U.S. government actually intervened in the economy. But the problems went well beyond that. As many of the government’s credit programs were partly privatized (with a view simply to getting them off the government’s balance sheet, if not government care), they were authorized to issue securitized bonds, while encouraged private companies to do the same. The legislation created a system that increasingly encouraged people to take on more risks, and to feel more comfortable holding risks that they did not fully understand. We all saw the rotten fruits of that process in 2008.

For one thing, many of these quasi-public companies, such as Fannie and Freddie, have acted like pure private companies, obscuring the social goals that underlay their inception, whilst using their government heritage to exploit the perception of an implied government guarantee for any loan, no matter how bad. It is a type of securitization that Paul Krugman has called, “lemon socialism”, where profits are private and losses are socialized. Quinn sets all of this out in the interview and provides the historic context to explain how it happened. This is important because if we fail to understand the past, it’s hardly likely that we can construct a future set of policies which avoids these problems going forward.

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  1. Roland

    Canada’s CMHC public mortgage insurance has had a similar effect. At least we haven’t yet afflicted ourselves with the mortgage interest tax deduction.

    The CMHC guarantees not only reduce risk for banks and benefit most strongly those who buy the most valuable properties. The guarantees also have a positive-feedback effect on regional wealth concentration. The biggest cities, with the most expensive real estate, benefit most from the indirect subsidy, yet the risk is spread evenly across the whole country. In net terms, the hinterland subsidizes the metropole.

    This could be all be somewhat mitigated by linking the mortgage guarantee to the national median home value. But I don’t imagine any Canadian political leader would be in a hurry to try it.

    I think that many questionable housing and land development/planning policies, both in the USA and Canada, were born of the post-WWII housing crunch. Between the Depression and the War, housing investment fell behind population growth. This happened to the extent that depreciation of existing stock actually reduced the available housing and also led to many people living in condemned buildings. On top of that, during the war some areas grew in population because of war industry (the war also accelerated rural to urban shift). Finally, the population started growing rapidly right after the war and there was a huge pent-up demand to form new households. By the late forties there was overwhelming momentum to “do whatever it takes.”

    You can get a taste of the popular mood from all the housing jokes and housing shortage themes in radio comedy from that period.

  2. B. Examiner

    The lack of a Postal Savings Service is itself a huge implicit subsidy for private credit creation since it forces* most of us to lend our money to the banks (a bank deposit is legally a loan to the bank). More to the point, it allows the banking system as a whole** to create deposits (“bank loans create deposits”) that are only VIRTUAL liabilities that are rarely redeemed since cash has a theft risk and thus rarely kept out of the banking system for long. So what use is accounting with mostly virtual liabilities?

    *Physical currency and the mattress or a safety deposit box is not a realistic option and hasn’t been for centuries.

    ** Yes, inter-bank liabilities are real indeed but that’s only among themselves (fellow cartel members, including the central bank) and their monetary sovereigns (eg. US Treasury).

    1. human

      “Physical currency and the mattress or a safety deposit box is not a realistic option and hasn’t been for centuries.”

      Why not? Any number of societies consider silver, gold and jewels (maybe cash less importantly, for very good reasons!) held by the family as important. I’m not certain who your generalization applies to.

        1. human

          Banksters, have the potential to do (and have done) far greater damage.

          “Capitalism is the legitimate racket of the ruling class,” ~ Al Capone

          1. B. Examiner

            Banksters, have the potential to do (and have done) far greater damage. human

            Yes, but the solution is not to retreat to primitive (and unethical in their own way) money forms but to move on to truly ethical money and credit creation.

  3. Paul Tioxon

    Karl Polanyi describes the interaction of the state and markets in making markets. See the 3 Min mark in the INET video. Working together, the state and the private sector is capitalism, not fascism, not sorta socialism, because the markets turn anything into a commodity by assigning a price. The issuance of money, fiat money by the bourgeoisie reckoning, by the state is the necessary element for not only the MMT idea of taxation, but for the full partnership of the state actors with the private entrepreneurs who pay wages in the issued money and most importantly for capitalism, to take any profits at all in order to endlessly pursue the accumulation of wealth. Profits need a state issued money to exist at all in the capitalist system. The state and private sector are the necessary and sufficient components of the capitalist social order. We can also see this in Japan, post WWII with MITI.

    Today’s imbalance of the relationship between the state, with the demonization of government, and the private sector, with not only the accumulation of economic wealth but the amassing of political power to only serve the profit making action at the expense of any other consideration that maintains the social order, is destroying the capitalist social order. The view of corruption, of the action of banksters too big to jail, is a political realization of the the political power of the finance capitalists but also a new relationship of an actor as above the rule of law, because the rule of law no longer orders the society, the state or the markets. What new social order is struggling to be born in the end process of the volatile capitalist crackup that is an event so large, that it is not measured by just one generation, but can be seen since the great depression.

    When at one time, the state worked to create the markets with entrepreneurs, now the entrepreneurs come into the operational institution of the state, the US Federal Government, and seek to shut it down using finance guerrilla tactics of the Federal budgeting processes. The partnership that creating capitalism is now breaking capitalism up, but for what new political goal? The private sector had the capacity to make all of the money in the world with a strong, centralized state but now cripples its own partner with no new taxes and seeks to strangle the source of revenue necessary for the government to function at all. Karl Polanyi saw a great transformation in the creation of the social system that is now being torn apart. What sort of transformation are witnessing now?

    1. susan the other

      We are witnessing an enormous amount of capital with no where to invest. Funny that.

    2. JTMcPhee

      …one can maybe start to see the reason that ALEC and other “capitalist tools” are very anxious about any possible spread of “Sharia Law,” that they have propagandized as some pathogenic virus: Stuff like this, from Frank Gaffney’s “Center for Security Policy,” one of many hair-on-fire neoconservative thinktankereries, http://www.holology.com/neocon.html, and here is some of the propo pitch: http://www.shariahfinancewatch.org/blog/about-shariah-finance/

      There are real reasons our western sets of “financial-industrial” tapeworms and tumors that inflict the “market” pain on the rest of us should be concerned, since if the operating tenets of halal were in place, Goldman and the fed and so much of the financialized millstones hanging around our ordinary-people necks would not exist:

      “Shariah law governs nearly all aspects of Muslim life, and hence Shariah law imposes certain restrictions on finance and investments within the Muslim community.
      The 2 most significant effects of Shariah law on Islamic finance are the restrictions on:
      Usury (Riba), paying excessive interest.
      Impermissible (Haraam) investments.
      These additional set of rules on top of conventional common laws, leaves little permissible (Halal) investment options for Muslims to pursue, especially in the Western world.
      http://islamicinvestmentnetwork.com/sharialaw.phphttp://www.investopedia.com/terms/s/shariah-compliant-funds.asp , and this, “Sharia Investments,” http://en.wikipedia.org/wiki/Sharia_investments

      Lots of unpalatable stuff, to our western tastes, is attached to the whole Sharia package especially in its more neoconservative forms, but then the genius of our western tradition has been the eclectic incorporation of Great
      Ideas from all over, hasn’t it? Check out the restaurant scene in Manhattan, right?

  4. Chris

    Not only consumer credit programs, I read an eye-popping overview a few months back (here or in another blog) tracking the stealth rise (capture) of off-budget government subsidies to all sorts of private energy, agriculture, manufacturing, trade businesses, etc. via non-obvious programs that no one hears about, along great with loss rates of >90% in many of them. Solyndra was only the top of the iceberg.

    1. susan the other

      The US government has been a huge accomplice in the destruction of the environment. That would be a good place to begin to make reparations.

  5. John Yard

    It;s called State Capitalism. The state no longer seeks to create conditions that promote commerce and the general welfare, but subsidizes individual businesses and industries , in the name of promoting the general welfare. The end result is prosperity for favored industries – currently health care, real estate, finance , higher education – and corresponding higher costs. Another word for crony capitalism.

    1. susan the other

      It all in the name of profits for “private” corporations, social welfare comes in a distant second.

  6. susan the other

    The interviewer looked so much like Marshall Auerbach that I’m sure they are related. It was a great interview. Right to the heart of the matter. Economics is sociology. Now that capitalism has been so perverted that it can no longer function, everybody is calling it socialism. But these same perversions and paralyses happen in socialist countries. Poor people are disadvantaged. The environment is neglected everywhere. Militarism is outside the reach of democracy. Sarah Quinn talked about governments regulating exchange. She could easily have realized that today the idea of democratic exchange is dead. Well, she says, forms of social insurance work. Right, like AIG. and when they fail there is always the ultimate insurance of socialization of losses. Paul Craig Roberts had a post today on our dying planet. The death of the oceans. Much like the death of 99% of all humans. He said “Capitalism can work if social (and environmental) costs are included in the cost of production.” But I think it is going to be a very, very prolonged salvage operation.

  7. Saltaire

    New here and so impressed with the discussion. In appreciation of a central theme of fairness to all parties in the capitalist experiment both corporate and individual and keeping in mind the many examples such as oil depletion allowances, free grazing rights on government lands, transfer of scientific knowledge from government financed research, holding corporate wealth offshore without taxation to the corporate political campaign donations paid directly to political action committees in lieu of taxes. We must be cognizant of the very scarce means available to the unincorporated individual to realize any financial benefit of investment in productive activity involving leveraging capital borrowed from a societies’ common savings or debt. The playing field is hardly level, and until it is level there is little hope or incentive to continue playing the rigged game.

  8. Adam Eran

    I don’t know whether it was strategic or actual ignorance, but Ms. Quinn didn’t mention that government financing rose as a response to the failures / outrageous “successes” of private finance. This occurred because private financial arrangements like crop liens reduced farmers to debt peonage in the late 19th century. The privatization of government finance was, in part, because LBJ wanted to fund the Vietnam war, by selling Fannie and Freddie… no mention of that either. Could that sale have occurred because LBJ was Brown & Root’s (KBR’s) chosen legislator? Gosh! I wonder!

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