Crowding Out Private Alternatives

Due to the very nature of political pressures as well as poor accounting, a lot of government services are provided to the public below their true cost or market clearing price  (there are exceptions, like intra-city mail, but in these cases the government must pass laws to prevent private competition in order to maintain its market share).  When the government provides these below-cost or below-market-price services, it tends to crowd out private options.  So I am wondering why Kevin Drum is so surprised:

I guess rescuing them was the right thing to do. I'm still a little
taken aback by the apparent fact that American banks are now almost
flatly unwilling to make mortgage loans unless they're backed by Fannie
or Freddie, but that seems to be the case whether it takes me aback or
not. So rescue them we must. I suppose my next question is whether it's
worth thinking about how to restructure the American home mortgage
industry so that it can operate efficiently even in the absence of
massive levels of government backup. Or is Fannie/Freddie style backup
just the way the world works these days and there's no point fussing
over it?

As evidenced by the current bailout (and their huge accretion in market share over the last several years), Fannie and Freddie were under-pricing the service they were providing.  So of course, all things equal, bankers will demand the Fannie/Freddie backing because that will be a more profitable product and will be less work for the banker.  This seems like a "duh" kind of thing.  Like the "mystery" of why in Massachussetts, while everyone is obligated to sign up for health insurance, only the ones who were eligeable for free coverage did so.

I have written before of a similar phenomenon in business loans, where loans with SBA backing have crowded out everything else out there, such that a small business really can't find a lender who will make small business loans except with SBA backing.  Bankers are people too, and they can get lazy.  They have come to rely on these government programs, but certainly the lending function would still exist in a robust form if these programs did not exist.  Bankers would have to find other risk-mitigation tools, or else the loans would be more expensive, reflecting that the banks could not get rid of all the risk and had to price that into the loan.

By the way, don't you love the technocratic hubris of "thinking about how to restructure the American home mortgage
industry so that it can operate efficiently even in the absence of
massive levels of government backup."  Why do I, or Drum, or anyone outside of banking have to think about this at all?  I don't personally know the best private alternative to government mortgage gaurantees.  So what?  The financial field has been rife with innovation over the last several decades.  Just remove the government backup and let the the banks figure it out.  And let them go bankrupt when they figure wrong.

Postscript: As an ironic aside, the bank that holds my SBA loans was closed by the FDIC last week, my guess is due to a bad mortgage book in the Las Vegas area.  This doesn't have a lot of impact on me except that as I have paid down my loans, they became wildly overcollateralized, and I was in the process of trying to renegotiate some of my collateral out of the deal.  That will have to be put on hold, I guess.

Update:  More on government crowding out private options, in an entirely different industry:

dental care in Britain is free to those under 16 or over 60, the
unemployed, students, military veterans and some low-income families.
For others, government dentists offer lower prices than private

the government does not cover cosmetic dentistry, and a recent
reorganization of the way dentists work has prompted many to leave the
public sector. Katherine Murphy, a spokeswoman for The Patients
Association, an advocacy group, said it was proving increasingly
difficult for Britons to get anything beyond basic dental care from
Britain's National Health Service.

Update #2: More on Fannie and Freddie, again via Rick Perry:

Fannie Mae-Freddie Mac crisis may have been the most avoidable
financial crisis in history. Economists have long complained that the
risks posed by the government-sponsored enterprises were large relative
to any social benefits.

now realize that the overall policy of promoting home ownership was
carried to excess. Even taking as given the goal of expanding home
ownership, the public policy case for subsidizing mortgage finance was
weak. The case for using the GSEs as a vehicle to subsidize mortgage
finance was weaker still. The GSE structure serves to privatize profits and socialize losses.
And even if one thought that home ownership was worth encouraging,
mortgage debt was worth subsidizing, and the GSE structure was viable,
allowing the GSEs to assume a dominant role in mortgage finance was a
mistake. The larger they grew, the more precarious our financial
markets became.


  1. Al Globe:

    "it was proving increasingly difficult for Britons to get anything beyond basic dental care from Britain's National Health Service": oh woeful understatement! It's proving impossible in much of the country to get even basic dental care on the NHS. When the national government mucks up a contract negotiation, those patients who rely on the NHS are really in the soup.

  2. davej:

    As a dentist in the (US)Air Force, update #2 brings back memories of how it works in a military setting. Command dictates how we should treat military members. Aesthetic procedures were mostly frownd upon. the main objective was to get as many people "dentally fit" as possible, at the bare minimum of treatment. I practice quite differently in the private world. I see it as a preview of universal health care.

  3. Bob Smith:

    Technocrats are always surprised when their schemes don't go as planned.

  4. gadfly:

    Mark Perry's link to EconLog's article on "The No Bailout Option" ended with this comment:

    The moral of the story is that Barney Frank's idea of a financial system, in which a very forgiving government-sponsored lender makes low down-payment loans in the name of "affordable housing," only works for a while. Eventually, it uses up a lot of money and a lot of time and effort on the part of the civil servants trying to put Humpty-Dumpty back together.

  5. Nicole:

    Why do you keep calling your source Rick? His name is Mark. Rick Perry is the name of the NWO cronyist governor of Texas.

  6. Jeff:

    I like how the business media always claims Fannie/Freddie are "necessary for an efficient, liquid mortgage market". Of course it was efficient from their perspective, they got to make an easy buck, and the Federal Government got to eat the losses.


  7. Yoshidad:

    Warren's conclusion is a statement that ignores an awful lot: "Just remove the government backup and let the the banks figure it out. And let them go bankrupt when they figure wrong."

    Why would anyone with even the slightest sense say this? Among others, we have the fairly recent example of the S&L disaster thanks to Reagan / Bush 41's faith in "deregulation." Part of the reason the S&L bailout occurred is because these presidents said "Free markets need unburdening..." ...and threw out legitimate accounting standards ("Carrying non-performing loans on your books is OK now!"). This led to a disaster orders of magnitude larger than Teapot Dome or Credit Mobilier.

    We can even thank that Ayn Rand acolyte, Alan Greenspan, for ignoring, and certainly not regulating what led to the current sub-prime mess. The Clinton administration is responsible for letting FNMA purchase sub-prime loans, and Bush 43's guys expanded these purchases tenfold, so this is a bipartisan failure too.

    And why no mention of the lack of anti-trust enforcement to split up the too-big-to-fail private financial institutions (Fannie, Freddie, *and* Bear Stearns)...?

    So calling for *less* regulation in a market where the result of that "less regulation" or "bad regulations" have produced the current and previous disasters just doesn't make sense. There is even no mention of whether allowing these institutions to fail would produce a larger financial meltdown (it would).

    Yet this is what passes for intelligent discussion of public policy nowadays. "Who cares if there's a baby in this bathwater! Throw it out!" [sigh!]

    Doesn't Warren know that there before FNMA and FHLMC the idea of a 30-year loan was simply not explored by a completely free (no FDIC) banking system? In the 1920's interest-only mortgages ("straight notes") were a commonplace, and were rolled over by the banks every five years. Of course if some catastrophe struck, and the bank or the borrower couldn't roll these loans over, then massive foreclosures occurred. That's one reason we had the financial meltdown called the "Great Depression." ...Another reason the FDIC (and FSLIC) existed in the first place.

    Don't get me wrong. The government has done a terrible job with Fannie and Freddie, but the bad job is because of under-regulation, not a lack of "free markets." This is congruent with a recent trend noted by Sara Robinson: ". . . for the last 30 years, conservative governments have resolutely cut budgets and driven out the experts whose job it was to keep the country's public works in good working order. They did it on purpose, to prove their ideological argument that putting infrastructure in the hands of government was always a bad idea. And they were also quietly licking their chops, waiting for the day that the people's capital—the stuff built up and bequeathed to us by so many generations of Americans before us—could be declared salvage, and sold off to their cronies for the price of scrap in one last privatizing fit." (from here)

    And no one was immune from the temptations the mortgage crisis presented in its early stages; even Countrywide, a completely private institution, threw away its previously sterling reputation (it was the gold standard in the '80's when I worked in the mortgage business) in pursuit of the quick buck. Private / public doesn't make much difference when it comes to corrupt practice.

    To me, the kind of idolatrous thinking that concludes no matter what the problem, free markets or privatization are the answer... This thinking makes sense only if it's part of a larger story. Here's that story promulgated by the Imperial Amurricans:

    Empire Story:
    Free markets unburdened by rules and trade restrictions direct investment to its most productive use, provide jobs, give consumers the lowest prices, and maximize the well-being and happiness of the society.

    There actually is an alternative story:

    Earth Community Story:
    The term "free market" is a code word for an unregulated market that frees the rich to consume and monopolize resources for personal gain free from accountability for the broader social and environmental consequences. Markets are an essential institution, but to allocate efficiently they must have intelligent and fairly enforced rules.

    Looks like it matches reality better to me, but I'm sure there are those who will disagree (Ain't it awful how those regulations give you age spots too?)....8^)

    Incidentally, I'm wondering what y'all would think of this stuff in the context of Chris Martenson's Crash Course