Topic: Finance, Banking & Monetary Policy

Duncan Dunked in WSJ

Last week, U.S. Secretary of Education Arne Duncan had an op-ed in the Wall Street Journal declaring that it’s time to end the Federal Family Education Loan program (FFEL) which subsidizes banks and insulates them against almost all lending risk.  Duncan wants to eliminate the “middle man” and have the vast majority of student loans come directly from Uncle Sam, a goal central to the Student Aid and Fiscal Responsibility Act (SAFRA).

Incongruously, after ripping the poor middle people, Duncan explains that they should actually stay firmly attached to federal funds as loan servicers. He then goes on to applaud as an incredible money-saver going to all direct lending.

Fortunately, several astute readers – as well as yours truly – saw right through Duncan’s heap of contradictions and dissembling, and the WSJ has printed numerous letters speaking the truth about student lending and SAFRA.

The Pope Center’s George Leef – who has done great higher-education work with Cato – leads things off with a letter pointing out all the perverse incentives and painful unintended consequences emanating from federal student aid. I bookend that by attacking the most aggravating of all SAFRA-related lies: that the bill would provide $10 billion for deficit reduction. Read any CBO estimate for SAFRA and you’ll see that that is just a bald-faced lie.

Of course, if they didn’t have lies, our student-lending overlords wouldn’t have much to say at all. Which is one of many reasons that the feds should get out of education – including student aid – altogether.

SBA Is Not Small Business Solution

There is a lot of talk in the press about the difficulty small businesses are having obtaining credit. President Obama recently admonished bankers for not lending enough to small businesses. However, it seems obvious that lenders would have a more difficult time finding creditworthy borrowers during a recession. So we don’t need a politician who has demonstrated zero accountability to taxpayers second-guessing lenders, who are accountable to shareholders and markets.

Is a lack of credit a major problem facing small businesses? According to the most recent survey of small businesses by the National Federation of Independent Business, 10 percent reported problems obtaining financing and a net 15 percent reported more difficultly compared to their last attempt. But when asked what is “the single most important problem” facing their business, 32 percent of respondents cited “poor sales,” followed by taxes (24 percent), then government regulations and red tape (11 percent). “Finance and interest rates” came in at 4 percent.

In other words, the NFIB survey indicates that government – not credit availability – is the biggest problem facing small businesses right now.

Regardless, President Obama and members of Congress see the Small Business Administration’s lending subsidies as a solution to the supposed credit problem. The “stimulus” bill passed in February gave the SBA an extra $730 million to make more credit available to small businesses. The government guarantee on SBA’s flagship 7(a) loans was increased to 90 percent and fees intended to help offset losses were eliminated. (The legislation also created a separate program with an anticipated 60 percent default rate that has since become an embarrassment to its patron, Sen. Olympia Snowe, although politicians are rarely embarrassed by their failures.)

Not apt to pass up a practically free lunch, SBA lenders blew through the money and have been pressing Congress for more. The just passed defense appropriations bill gave the 7(a) program another $125 million to extend the higher guarantee and reduced fees. The House’s latest “jobs” bill would spend another $350 million extending the provisions through September. What’s going on is that the extra money is needed to fund the losses that will result from the loosened requirements.

According to Cato adjunct scholar, Veronique de Rugy, the SBA’s default record was already poor:

The Small Business Administration, according to its own inspector general’s Office, has a long-term default rate of roughly 17 percent. This compares to 4.3 percent for credit cards and 1.5 percent for bank loans guaranteed by the Federal Deposit Insurance Corporation.

And a recent report by the SBA’s inspector general concluded that the agency’s improper payment rate was 27 percent, not the 0.53 percent of FY 2008 program outlays it reported.

Adding insult to taxpayer injury, the SBA is largely irrelevant in the credit markets. As Veronique points out, no more than 1 percent of all small business loans are backed by the SBA. Moreover she finds that 75 percent of 7(a) loan guarantees go to about 1 percent of all small businesses in  the service, retail, and wholesale sectors – Subway franchises, for example.

In sum, the economy doesn’t need a president pressing banks to make uneconomic loans simply so that he can pretend to be doing something. Nor does it need a government agency like the SBA fostering the same sort of moral hazard that helped sparked the housing bust and recession. The small business community is telling the administration that it would like to see lower taxes and less government red tape. Unfortunately, the administration is promoting higher taxes, costly mandates, more labor regulations, and further government meddling.

Good News on Housing!

The Wall Street Journal reports that some mortgage insurers and lenders are beginning to relax their down-payment requirements, so that buyers in some parts of the country can now borrow 95% instead of 90% of a property’s value. Buyers who can’t come up with even a 5% down payment can turn to the Federal Housing Administration, which will make loans with as little as a 3.5% down payment. Unsurprisingly, the FHA is increasing its market share.

Meanwhile, the Treasury department is pressuring mortgage companies to reduce payments for many more troubled homeowners, averting foreclosures. So, good news: people who lack income and assets will be able to take out loans to buy houses, and if they can’t make the payments they signed up for, the government will pressure their lenders to accept lower monthly payments in return. We’re back on the road to easy, universal homeownership.

Oh, wait.

Don’t You Mean Financial Illiteracy?

According to a story out yesterday, the federal government is starting a new campaign to promote financial literacy among high school students. That’s right, federal politicians, who have given us Fannie, Freddie, the Community Reinvestment Act, endless pork binges, and a national debt surpassing $12 trillion have the absolutely staggering hubris to think that they somehow have what it takes to teach your kids about sound financial practices!

This would actually be pretty funny (for instance, it reminds me of this classically trite PSA) were the complete unshackling of the federal leviathan of which it is a symptom not, potentially, utterly devastating. Unfortunately, we simply can’t afford, either literally or figuratively, to laugh at absurdities or patently unconstitutional overreaching like this anymore.

The Audacity of Hypocrisy

In his ongoing effort to micromanage the U.S. economy President Obama used his Dec. 12 weekly radio address to promote his proposed Consumer Financial Protection Agency.  It will be filled with bureaucrats second-guessing entrepreneurs and is sure to improve the performance of our financial institutions – much in the manner of the SEC’s bureaucrats alertly nailing Bernie Madoff just 30 years into his Ponzi scheme.  Never mind that the federal government had much more to do with the financial meltdown than the banks did, the real knee-slapper in his address was his claim that the CFPA “would bring new transparency and accountability to the financial markets…” This, from a man demanding passage of a 2000-page health care reform bill that no one, including Mr. Obama, has read.  So much for transparency and accountability.

Great Moments in Bureaucracy

The picture below, taken from a story in The Economist, shows that France, Germany, and Italy are among the nations with the most central bank employees (as a share of the population). In some sense, this is a dog-bites-man factoid. After all, is anyone surprised that Europe’s major welfare states have bloated public payrolls? But there’s more to this story. All three of these central banks ceased to have a monetary policy, starting back in 2002, when their nations adopted the euro. The mission is gone, but the bureaucracy lives on.

Central bank bureaucrats

To be fair, the bureaucrats in these nations presumably are not sitting in quiet rooms playing minesweeper. Perhaps these central banks are responsible for other functions, such as financial regulation. Of course, given how governments around the world pursued policies that led to a financial crisis, perhaps all of us would be better off if bureaucrats did play computer games all day.

Volcker Unloads on Bankers

As reported in today’s Wall Street Journal, Paul Volcker, who is a former Fed Chairman and current adviser to President Obama, challenged bankers to produce a “shred of neutral evidence about the relationship between financial innovation recently and the growth of the economy.”  Yet some of these innovative financial products brought the economy to “the brink of disaster.”   Profits in banking are being restored in part by playing financial brinkmanship once again.

How can this be?  Volcker focuses in on public policies that back excessive risk taking by bankers.  They and their stockholders garner the profits, but, through bailouts and government guarantees, manage to socialize the losses. That process is what economists call moral hazard.

He questions whether improved regulation can resolve the problems without serious structural change.  He repeats his longstanding policy of separating traditional commercial banking from what has been aptly termed casino banking. Casino banks must not be protected by the government.

Here is my suggestion for a start.  Hedge funds can serve a very useful function in the economy. But banks taking insured deposits should not be permitted to operate hedge funds in their institutions.  Most proprietary trading by banks amounts to an in-house hedge fund.  Separate the activity from banking.