Dissatisfaction Guaranteed

The federal government should stop guaranteeing loans.

(Page 2 of 2)

It’s also worth noting that interbank lending froze completely when the bailout was announced. Why take the risk when Washington can force taxpayers to take it for you?

Nor are such programs likely to stave off massive job losses. In a 2003 speech to the National Economists Club in Washington, D.C., then–Federal Reserve Governor Edward M. Gramlich argued that loan guarantee programs are unable to save failing industries. Lack of access to credit markets is caused by serious industrial problems, he explained, not vice versa. If an applicant’s business plan cannot be made to show a profit under reasonable economic assumptions, private lenders are unlikely to issue a loan.

Then why is the federal government still guaranteeing loans? Because it serves two powerful constituencies: lawmakers and bankers.

Politicians love loan programs because they’re a wonderful way to reward interest groups while hiding the costs. When the programs are established, the mathematical certainty of future defaults and their potential effect on the deficit are never considered. It’s like buying a house on credit without having a trace of the transaction on your credit report.

But the true beneficiaries are lenders. Take small business loan guarantees. When a small business defaults on its obligation to repay a loan, bankers do not bear most of the cost; taxpayers do. Meanwhile, lenders make large profits on SBA loans by pooling the guaranteed portions and selling investors trust certificates that represent claims to the cash flows.

How profitable is this? Testifying before Congress in April 2006, David Bartram, the president of the SBA Division of U.S. Bancorp, the nation’s sixth-largest financial services company, explained that “return on equity of SBA loans can exceed 70 percent.” A 70 percent return on equity (RoE) is remarkably high. Right now, the five-year average RoEs for the two biggest banks in America—Citigroup and Bank of America—are 16.2 percent and 14.5 percent, respectively.

For years, banks have reaped the profits from loan guarantees, whether for small businesses or homeowners. Now that the skim has been exposed, taxpayers, not banks, are asked not only to pay the cost of the defaults but to bail out the irresponsible lenders. And the government has decided to encourage more lenders to take more chances by guaranteeing yet more loans to high-risk borrowers. The only guarantee for these loans is that our children will be paying billions to cover the losses.

Veronique de Rugy is a senior research fellow at the Mercatus Center at George Mason University.

Editor's Note: We invite comments and request that they be civil and on-topic. We do not moderate or assume any responsibility for comments, which are owned by the readers who post them. Comments do not represent the views of Reason.com or Reason Foundation. We reserve the right to delete any comment for any reason at any time. Report abuses.

  • The Federal Government||

    psssst...

    I'm not wearin' any underware.

  • The Wine Commonsewer (you can ||

    The Federal Government | February 9, 2009, 12:53pm | #
    psssst...

    I'm not wearin' any underware.



    [chuckles for a few moments]

  • The Wine Commonsewer (you can ||

    Why the Federal Government Should Stop Guaranteeing Loans

    Preachin' to the choir, Babe. :-)

  • ||

    Lest anyone (like Joe, for instance) trot out that old canard about how the Chrysler bailout in the 1980s was supposedly just peachy because they paid it back, I will point out that the money lent to Chrysler was not available for better, more profitable businesses to borrow to expand their operations or employ people.

    -jcr

  • Alice Bowie||

    The entire America is a Ponzi scheme.

    -Social Security
    -Unemployment Insurance
    -Health Insurance
    -Disability Insurance
    -EVERYTHING

    Let's atleast bail out the little guy and the regular guy. Trust me, if you bail out these people...the big guy will be happy as well.

  • Colonel_Angus||

    But the free market was responsible for the recession. Yeah, this is really a fucking free market. More like corporate welfare ponzi scheme.

  • ||

    Broadly available loan guarantees interferes with the price mechanism on interest rates, thus reducing productivity in the long term, as unprofitable ventures are kept alive, and profitibale ventures are undercut by the supports their competators receive.

  • ||

    Without DOE's program, there will be no new nuclear power facilities in the US.

    Existing fleet covers large baseload megawatts and are competitive with coal (and becoming more so) now that they're paid for. However, state PUCs do not allow pay-as-you-go (i.e., you can't charge current customers till watts are on the grid) so the capital intense nature and long-lead time to get a new 7 to 10B nuke up and running cannot be borne by the utilities and banks will not sign-on without assurances.

    You can argue the merits of that one way or the other and from a financial perspective, that's probably how it should be (i.e., "risky" investments). But if you are at all serious about reducing CO2 emissions, nukes have to be part of the short-term mix. And they have the potential to be moneymakers, just like the current fleet.

  • ||

    Or we could deregulate energy prices, they would double, and nukes would be economically viable. Or we could tax coal. We don't have to fund this as a country - we choose too, because power-grade uranium is a proliferation concern.

  • ||

    You can't have it both ways. You can't call it "Reason" and then just make up the facts to support your argument. For example, Never, in it's entire history, has the SBA done 40 billion in loans in any one year. If it's Reason, you can't make it up.

  • battery||

    Thanks for this useful post,I can not express my feeling now Welcome to Chinese Tea And Chinese Tea Sets Store ,We Provide High quality Chinese Tea

  • nfl jerseys||

    hye

  • Scarpe Nike||

    is good

  • قبلة الوداع||

    ThaNk U

  • ugg boots outlet||

    good

  • دردشة زين العراق||

  • caibutou||

    thank

GET REASON MAGAZINE

Get Reason's print or digital edition before it’s posted online

  • Progressive Puritans: From e-cigs to sex classifieds, the once transgressive left wants to criminalize fun.
  • Port Authoritarians: Chris Christie’s Bridgegate scandal
  • The Menace of Secret Government: Obama’s proposed intelligence reforms don’t safeguard civil liberties

SUBSCRIBE

advertisement