Viewpoint: The Specter of Credit Controls
For a mere $5,000 of added salary, Alfred Kahn switched from deregulating airline fares to regulating all other prices. And even when he argued that guidelines would somehow prevent a "banana," Dr. Kahn was not so quickly hushed by the administration as when he hinted that it was considering imposing credit controls. After all, the element of surprise would be essential to such a game, since those who expect to be rationed out would otherwise rush to line up their credit in advance.
The White House has no legal authority to impose formal wage and price controls and only questionable authority to manipulate federal purchases and regulations to achieve the same effect. But the Credit Control Act of 1969 confers virtually unlimited authority on the president to decide who gets credit on what terms. In a period of soaring inflation and interest rates, some such gimmick might have considerable political appeal.
The Carter administration is now reaping the consequences of blatantly inflationary policies, and no graceful exit seems possible. If inflation continues to roar along at 9 or 10 percent, fueled by a reversion to sloppy monetary policy, people and firms will be eager to borrow and reluctant to save, putting pressure on nominal interest rates. In this situation, selective credit controls might be sold as a snake oil remedy for high interest rates or inflation. Never mind, for the moment, that selective credit controls can't have any such effect.
If money growth slows for a sustained period, businesses will find it hard to pass on soaring unit labor costs, thus forcing layoffs and consumer retrenchment. That would end the spending spree and create a buyers' market for supposed "hedges" that consumers might have to unload in hard times. Individuals and firms could have a hard time rolling over their debts in this situation, so credit controls might be sold as a way to divert credit into worthy hands—that is, toward those most likely to vote correctly.
Either way, the risk is real. Most risky of all, selective credit controls might substitute for general monetary restraint, taking us a giant step closer to the "banana republics."
The Credit Control Act of 1969 (Public Law 91-151) authorizes the president to instruct the Federal Reserve to "regulate and control any or all extension of credit." And the Fed may "utilize the services of…any other agencies, Federal or State, which are available and appropriate." Among other things, the Fed could license people to borrow or lend, set loan limits for any purchase of new or used goods, prescribe maximum interest rates and credit terms, set maximum ratios of loans to deposits or assets, and "prohibit or limit any extensions of credit under any circumstances the Board deems appropriate."
In his wildest fits of megalomania, even Mussolini would never have dared to go this far.
The problems that credit controls are supposed to solve are all the consequence of an excessive growth of bank reserves and currency and cannot be solved by measures that seek to shuffle the excess purchasing power around a little differently—even if that were possible. Inflation is high because money growth has fueled an 11.6 percent rate of increase in spending while production cannot possibly keep pace.
Real, after-tax interest is probably still too slow to dampen the insatiable public and private appetite for credit that the Federal Reserve has so generously accommodated over the past two years. A 10 percent mortgage rate is only 6 percent for someone in a 40 percent federal-state tax bracket (which includes most working families in California). So long as housing prices are expected to rise at a 14 percent rate, and mortgages can easily be refinanced if interest rates come down, a 10 percent nominal mortgage rate is about 8 percent less than zero. The same is largely true for business inventories and consumer durables. A believably sustained period of monetary restraint would reduce expected inflation, reduce credit demands, increase savings, and bring interest rates down.
The usual rationale for credit controls is to divert credit from corporations to mortgages and government debt. A ceiling on business loans, in particular, creates a captive market for government securities. Actually, corporate borrowing in the third quarter of 1978 accounted for less than 23 percent of all funds raised in credit markets by nonfinancial sectors; governments absorbed almost 27 percent, households about 40 percent.
The real threat to housing is not that mortgage funds will be unavailable, except where usury laws pinch, but that housing will become a relatively unattractive investment. With government and business scrambling for credit, relatively postponable purchases and long-term investments, like housing, are quite properly deterred by interest rates that are perceived as only temporarily high. Moreover, housing prices already incorporate considerable expected inflation, so the value of homes as "hedges" is no longer obvious.
A significant reduction in federal borrowing, which is not in prospect, would help lower real interest rates and shift money out of T-bills into savings and loans. But the effect of a less inflationary monetary policy would be ambiguous at this time—because both mortgage rates and housing prices would soften, and the latter effect would slow the tendency to trade up to a better house.
Credit allocation or rationing overestimates the power of regulations and underestimates the power of market incentives. Lenders want to maximize their return; borrowers want to minimize their borrowing costs; and both are clever enough to figure out ways to get together outside of formal, regulated channels.
The trouble is that such alternatives are relatively inefficient, or else they would prevail even without overregulation of banks and thrifts. So credit controls would impair the functioning of credit markets, raising transaction costs and interest rates.
Restrictions on the purposes for which credit is used are likewise easy to circumvent, but at the social cost of greater inefficiency. Margin requirements on stock purchases, for example, don't keep people from taking out loans, ostensibly for other purposes, in order to free cash for such investments.
Suppose reserve requirements were raised for institutions lending to large corporations and lowered for those stressing home mortgages—essentially the plan of the so-called Lower Interest Act that died a timely death in 1975. Interest rates to large business would initially rise relative to mortgage rates. But life insurance companies, pension funds, other relatively unregulated intermediaries, and private individuals would all have a powerful incentive to pull deposits out of both banks and thrifts in order to get the higher yield available by lending their money to big business or other uses not favored by politicians. There are already plenty of instruments available for this purpose, such as corporate bonds and commercial paper, and more could easily be created through mutual funds or whatever.
So, financial institutions subjected to credit allocations would be placed at a competitive disadvantage in the competition for loanable funds. Both banks and thrifts could be expected to shrink significantly relative to all alternatives that are harder to control. To some extent this is already happening, due to regulatory costs. Since the end of 1972, demand and time deposits have increased 78 percent, but various private money market instruments (including commercial paper and money market funds) have grown by 226 percent.
Finally, there is a very real threat to individual freedom of choice implied in the mere suggestion that Washington's value judgments should prevail in the use of peoples' savings. Rationing credit according to political priorities is equivalent to controlling who shall be able to buy what—a very fundamental assault on the free-market principle that resources should be allocated toward uses that consumers value most highly. Although such efforts are likely to prove futile against the forces of market incentives, the whole idea that a law like the Credit Control Act could be passed says a great deal about the autocratic tendencies of our legislators.