Thursday, January 5, 2012

The Great Government Risk Transfer

One of the most singular characteristics of government policy since the Great Depression has been to shift financial risks from private hands to the government. Early programs in this respect had broad support because they benefited most citizens. Federal deposit insurance, Social Security and Medicare are notable examples. Other such programs benefited those thought to deserve special protection, such as subsidies for farmers, Aid for Dependent Children, and Medicaid. Fannie Mae, Freddie Mac, Ginnie Mae and HUD were created to boost home ownership, which was believed to promote good citizenship. America, once riven by dissension and social conflict from the sufferings of the Great Depression, stabilized and prospered (helped in part by the fact that it was the one big industrialized nation left standing after WWII). The middle class, in particular, enjoyed the fruits of a life in which many of the vicissitudes of dependency in an industrialized world were lessened. Income inequality shrank and optimism swept away the despair of the Depression.

In the past thirty years or so, the nature of government risk transfers has changed. More recent federal policies have taken financial risks off the hands of the well-to-do and transferred them to taxpayers. Most prominent has been the Federal Reserve's relentless low interest rate program, which boosted the value of risk assets like stocks, bonds and commodities. The Greenspan/Bernanke put--a dramatic lowering of interest rates and expansion of the money supply every time the stock market throws a hissy fit--is now a permanent feature of federal monetary policy. The Fed could not step back from providing, at zero cost to investors, the Grand Put without triggering a horrendous stock market crash. It's no wonder that the rich--whose burgeoning wealth derives mostly from stocks and other risk assets--have gotten richer. With the almighty Fed running interference for them, it's hard for the owners of risk assets not to get wealthier.

Other aspects of federal risk transfer benefitting the wealthy include Fannie Mae, Freddie Mac and HUD, without which the mortgage-backed securities market could not exist. Wall Street banks and financiers are among the biggest beneficiaries of this market. Other familiar examples are the evolution of large-scale farming subsidized by large amounts of farm subsidies and physicians who speed-treat patients to maximize their Medicare billings. Developers and homeowners in flood zones benefit from federal flood insurance, at the expense of taxpayers living on higher ground. Bailout programs like TARP disproportionately benefited the wealthy, while federal mortgage refinance and principal writedown programs that would benefit the unfortunate, have been largely ineffectual.

It's no surprise the wealthy have gotten the most out of federal risk transfers. They control the political process and can steer government policy in their favor. Mitt Romney's narrow victory in the Iowa caucuses only reinforces this trend. Money talks. Those with money have staying power in the political process. The ABM movement in the Republican Party (read Anyone But Mitt) isn't over his wealth, but his moderate views. So if another candidate surpasses Romney in the end and wins the White House, expect the Republicans not to disturb the prosperity of the well-to-do, although those less well-off and retirees should be apprehensive.

The Obama administration, for all its rhetoric, has presented little true threat to the wealthy. It agreed to a moderate temporary version of the estate tax, and has grudgingly gone along with a temporary continuation of the Bush II income tax cuts. Its Treasury Secretary has, overall, been a solid supporter of Wall Street (in spite of occasional politically motivated rhetoric to the contrary). And, despite policy proposals floated to the contrary, Fannie Mae and Freddie Mac continue in their central role financing the U.S. real estate market.

The question is whether this risk transfer can continue. Taxpayers don't have endless resources. Already we have a fierce debate over federal deficits, and there is much talk of imposing more risk on those of moderate and low income (by reducing Social Security, Medicare and Medicaid benefits). In Europe, we see the makings of a taxpayer revolt, with those in southern Europe objecting to paying more to cover the profligacy of their governments while those in northern Europe object to paying more to cover the profligacy of their southern neighbors.

American taxpayers haven't really honed in on the Great Government Risk Transfer in the U.S., even though it underlies many of today's political controversies. If the costs of such risk transfers continue to mushroom, citizens will eventually figure out that their pockets are being picked. If we truly believe in a market-based economy, governed by the principles of free markets, we have to cut back on the government's risk transfers, especially the ones benefiting the wealthy. Those who have capital to invest can do the most for society if they invest in ways undistorted by government subsidies. As things stand now, the wealthy have the incentive to profit off of taxpayers. It's fine if someone works hard, saves, invests wisely and gets rich. It's not fine if someone pigs out at the public trough. Income inequality honesty earned is deserved. Income inequality fostered and supported by government policy is unacceptable.

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