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.