With more than 150 credit programs providing, subsidizing, or guaranteeing loans, the U.S. government—not big banks or Wall Street—is the world’s largest financial institution. As such, it is an important source of systemic risk, Deborah Lucas told participants at the MFM Summer Session.
“Academics often focus on government as a regulator; what I want you to start thinking about is that governments are the world’s largest financial institutions in their own right. They have first-order effects on the distribution of risk and allocation of capital in the world economy through their real and financial investments,” said Lucas of the Massachusetts Institute of Technology.
Deborah Lucas talks with a participant
The government provides direct loans, implicit or explicit loan guarantees, and credit subsidies for housing, education, agriculture, small businesses, energy, trade, and other private activities. In 2010, citizens borrowed $1.6 trillion through these credit programs.
This was a significant and effective but unacknowledged form of fiscal stimulus, Lucas said. Her calculations indicate that private borrowing through these federal programs provided roughly $344 billion of stimulus in 2010, similar to the impact of the American Recovery and Reinvestment Act. Because those programs are already in place they can inject money into the economy faster than new spending projects and Congressionally approved stimulus packages. However, the reported budgetary cost of stimulus through existing credit programs was close to zero.
Lucas quipped that as Chicago-trained economist, she was taught to believe that governments set distortionary taxes and throw the revenue in the ocean. Whether you viewed government as incompetent or a benevolent force for good, the actions of government-run institutions don’t fit either view, she said.
Rather, these agencies exhibit the same biases that behavioral economics has identified. They make decisions on rules of thumb and inconsistent, time-varying policies—not the market fundamentals of supply and demand. “Optimal design of financial products is not the focus,” she noted.
Lucas stressed that it’s important to recognize that, with such a large footprint in credit markets, governments can have an impact on markets, consumption, and the economy in ways that go far beyond traditional monetary and fiscal policy.
This raises many fundamental issues faced by private financial institutions that are not yet well understood in the public sphere. “What are the systemic and macroeconomic effects of government financial activities? How should a government assess its cost of capital? How should its financial activities be accounted for?” Lucas asked. “Are the institutions well-managed? Are financial products well-designed and correctly priced? What consumer protection safeguards are needed?
“There are a whole lot of questions that together constitute a research agenda but focus on governments as financial institution,” she told participants. “These are research topics I hope I can sell you on.”
— Toni Shears