Federal Government as Financial Institution

On November 8, 2011, in banking, credit, by Jon Lewis

Uncle Sam in Pinstripes: Evaluating U.S. Federal Credit Programs. Douglas J. Elliott. Brookings Institution Press, 2011, pp. 147, $19.95 Of all the demands of the Occupy Wall Street movement, none probably has more resonance to many underemployed young Americans than their call for student debt relief. Indeed, according to The Federal Reserve Bank of New [...]

Uncle Sam in Pinstripes: Evaluating U.S. Federal Credit Programs. Douglas J. Elliott. Brookings Institution Press, 2011, pp. 147, $19.95

Of all the demands of the Occupy Wall Street movement, none probably has more resonance to many underemployed young Americans than their call for student debt relief. Indeed, according to The Federal Reserve Bank of New York, outstanding student loans will soon exceed $1 trillion; for Americans, student loan debt has even managed to surpass credit card debt. Since it is doubtful that Congress will alter the U.S. Bankruptcy Code to allow for discharging government insured or guaranteed student loans through Chapter 7 bankruptcy, the upcoming generation will be indebted for many years to come. This will almost certainly have substantial effects on this generational cohort’s consumer spending habits, personal savings rate, and overall attitude toward government intervention in the economy.

In Uncle Sam in Pinstripes, Douglas J. Elliott (Brookings Institution) provides the reader with a comprehensive overview of the goals and history of federal credit programs, including those dealing with student loans. “The federal government,” writes Elliott at the beginning of this academic monograph, “is the biggest and most influential financial institution in the world, a fact often hidden by the widespread public conception that the American government largely stays out of business activities.”

The author notes that the federal government provides more credit, either directly or indirectly, than any of the country’s private banks. Indeed, as of 2010, federal loans outstanding exceed $8 trillion. This figure encompasses not only what he terms the four traditional loan and guarantee programs in housing, farming, education, and business, but also the additional credit that the federal government extended to respond to the recent financial crisis. While most federal credit is actually channeled through assistance to private lenders, this does not alter how large a role the federal government plays in the provision of credit.

In Uncle Sam in Pinstripes, Elliott discusses the theories behind, and policy rationales for, federal credit programs (Chapter 2); a brief history and overview of the programs (Chapters 3 and 4, respectively); a discussion of the costs and benefits of the programs (Chapter 5); and an analysis of the recent emergency credit programs put into place in response to the financial crisis (Chapters 6 and 7). Although far too brief, the book’s third chapter, a history of federal credit programs, stands out as particularly relevant to aiding our understanding of how the federal government came to be the largest provider of credit. Elliott aptly recounts how, with the creation of the Federal Reserve System in 1913, the federal government became a major lender, but that the first real federal credit programs were designed to help farmers. The Great Depression, however, was the major turning point; before then, the federal government was not nearly the major provider of credit that it has since become.

Many federal credit programs that exist today such as the Federal Housing Administration, Fannie Mae, and the Export-Import Bank, have their roots in government’s response to the Great Depression. A comparison between the federal credit programs run by the United States and those run by other industrialized countries would have made this chapter stronger. While Elliott is correct that, between the Founding and the early twentieth-century, the federal government did not have a prominent role in supplying credit, it would have nevertheless been helpful to learn if the United Kingdom, France, and Germany maintain long-standing national credit programs and, if so, how they have fared.

As to the question are taxpayers getting their money’s worth, Elliott contends that, in all likelihood, they are not. Although his argument is nuanced, he concludes with dismay that, “the evidence suggests that credit programs, as they are run today, do not provide good value for money in the aggregate.” Elliott is, however, more than a mere critic of the status quo. In the work’s final chapter, he provides a set of ten overall thoughtful recommendations for improving the federal credit programs. Some, such as his proposal to utilize risk-based discount rates for federal budget purposes, should be relatively uncontroversial. Others, such as his proposal that the government incorporate more underwriting and risk-based prices, as well as his argument for the creation of a federal bank to administer all federal credit programs, are likely to be greeted with a bit more skepticism.

Elliott’s fifth recommendation, namely that the Fed “should run credit programs only under extremely unusual circumstances, outside of its normal interactions with financial institutions and its function as lender of last resort for regulated financial institutions” is undoubtedly correct. He rightly notes the Federal Reserve’s lack of experience in this area and the troubling political implications of having the country’s central bank running credit programs. Unlike those who would seek to abolish the Federal Reserve System, Elliott’s criticism is constructive, and should be taken into consideration by Congressional staffers and policymakers.

For those readers interested in learning about student loans, Elliott’s work provides a framework in which one can better understand both how, and why, the relevant federal programs were created. Although the author might have devoted an entire separate chapter with student loans as a case study, his discussion of this particular federal credit program is nevertheless quite informative. The federal government got into the student loan business in 1958 and expanded the program in the 1960s. Congress, through the Health Care and Education Reconciliation Act in 2010, got rid of guaranteed student loans, leaving only direct lending through the Department of Education. Elliott skillfully uses student loans to demonstrate why the federal government is the main source of credit in this area. Student loans are one area in which there are positive externalities, where the acquired education will not only benefit the debtor, but also society as a whole. In addition, as Elliott points out, private lenders will hardly ever make long-term uncollateralized loans to individuals who cannot demonstrate an ability to repay. This is why the federal government, now through direct lending only, is the primary source of credit to university students.

The federal government, whether Americans like it or not, is not only a financial institution, albeit a public one, but it is also an institution that is itself too big to fail. Although not the subject matter of Uncle Sam in Pinstripes, the indisputable fact that the United States is simultaneously a creditor to the private sector, and a debtor to China, raises serious questions about the long-term fiscal health of the American economy. For those individuals interested in learning about the federal government’s increasing role in providing credit to individuals and businesses, this recent work is an excellent place to start.

Jon Lewis (c) 2011

  • Tweet
  • Share
Tagged with:  

Comments are closed.

iblogpro theme