Persons tempted to seek government credit might be interested in this “other side” of the story of government lending activities.
Government lending is not limited to the lending of money. The government’s guarantee, when it is held by private people, is no less a pledge of the public credit than is the government’s direct loan paid out in cash; each is the undertaking to risk the government’s funds in a venture managed by private parties.
In the sense that each borrower undertakes to repay out of the revenues produced by his Work, all government lending is lending to finance enterprise. Where there is no enterprise, there is no prospect of repayment. In this broad sense, where enterprises and enterprisers are discussed in these general comments, the terms are used to apply to farmers and working people as well as to businessmen, partnerships, and corporations.
The theory of government lending is that it produces economic activity which otherwise would not occur. This means that if the government offers to pay the bills, now or later, homes will be built, factories will be constructed and outfitted, minerals will be mined, crops will be grown, electric power and telephone lines will be erected, goods will be exported for sale abroad, employment opportunities will be created, and many other business transactions will be undertaken, even if in each case it would have been unattractive or financially impossible for the people concerned to undertake the transaction unassisted.
Thus, by having the use of the government’s financial resources, through a loan or a guarantee, a man can become the owner of a home without first having earned and saved enough money to make a substantial down-payment. A manufacturer, producer, or distributor can expand his facilities and his output without first having accumulated enough property to collateralize a bank loan. A rural cooperative group can sponsor the extension of power and telephone lines into sparsely populated areas without first having acquired enough wealth to make the initial investment and to pay the premium costs of a marginal operation. An exporter can ship his goods for sale abroad in the face of substantial uncertainty concerning profits and collections. An employer can meet payrolls even though his resources may be temporarily frozen in overstocked supply bins and warehouses or in over-expanded customer charge accounts. And many businesses are afforded the opportunity to recover from disaster or from the mistakes of faulty management which, but for the government’s assistance, would have brought the threat of business failure and bankruptcy . . . .
These are the aims and the direct results of government lending, and they are represented to be its benefits. What are the indirect results and what, if any, are the drawbacks?
By legal restrictions and other requirements of trusteeship, private lenders are sometimes restrained from making a loan simply because the borrower’s need is too great or because it extends over too long a term.
When the government lends to fill this so-called credit gap, or when through its guarantee it induces private lenders to do so, it takes a considerable share in responsibility for initiating the borrower’s project, or for sponsoring its continued operation, more or less in the form in which the borrower conceived it. By doing so, the government relieves both the borrower and the private lender of responsibility for finding additional private investors, for reorganizing the project in other ways, or for working it out by other private means. Among other things, in a particular case, this may tend to stifle initiative.
The need for funds in large amounts or for long periods of time more often than not is the need for owner’s capital, and it is unsound economically to try to meet this need by supplying lender’s capital instead. Owners are free to tie up their funds for long periods. They also may take risks which lenders may not take. Where the government undertakes to lend what should be owner-cap-ital, or where a. banker does so in response to the government’s urging, they shift the business risk from owner to lender and the effect is to lower the standards of lending.
The hazard which goes along with lowering the standards of lending is the hazard that an owner will lose his property by inability to repay the loan with interest, and the lender will become the owner in his place.
The risks of ownership are inseparably woven into the concept of private property. When an owner is relieved of his normal risks other than by his own effort and industry, he is beholden to those who assume the risks in his place. This increases the likelihood that he also will be relieved of the other attributes of property ownership—the right, for example, to decide how, when, where, and by whom the property shall be used. In the end he is likely to be relieved of the property as well. When these things occur where the government provides the financing, the private property becomes public property instead and the government has the right to decide how, where, when, and by whom the property shall be used.
Responsibility follows risk. When an owner’s risk in an enterprise has been minimized or eliminated because the government has supplied the funds which he otherwise would have to supply, then, speaking comparatively, the owner tends to feel no great pain from the failure of the enterprise. He would stand to gain by its success, of course, and so he would tend to work for its success; but his position is an unbalanced one because he will not try desperately to prevent its failure . . . .
Private lenders are sometimes restrained from making a loan because the borrower’s collateral is not sufficiently marketable or because there is not enough of it and accordingly the risk of loss is too great.
When the government lends to fill this credit gap, or when through its guarantee it induces a private lender to do so, it takes the risk of tying up its funds beyond the time agreed upon; or it takes more than the normal risk of losing them in whole or in part. It may take both. Also, it takes the responsibility which goes along with the decision to initiate or prolong what certainly is a marginal enterprise and what may well be an uneconomic enterprise.
Here the government not only shifts the business risk from owner to lender, but also it weakens the nation’s economic structure by preventing the failure or other elimination of weak links in the chain.
We may not like to acknowledge it, but it is an essential truth that many in our society, though they may honestly wish to try, are not capable of being successful businessmen, successful farmers, or even successful homeowners. The failures of such people may be personal misfortunes, but there seems little justification for assessing the taxpayers to cover their losses.
The effect of government lending in these circumstances is not only to lower the standards of lending but to encourage mistaken enterprise with its accompanying dissatisfactions and frustrations.
Private lenders are sometimes restrained from supplying funds to a particular borrower because, though the risks are not too great, equally good investments are more conveniently available, or more profitable investments can be made at a lesser risk.
Where the government lends to fill such a credit gap as this, it is assisting unsuccessful competitors. The risks are the normal risks of conventional lending. But in addition, the government assumes responsibility for launching the projects which the borrowers could not launch through their own contacts in the private economy; and it does so without curing the defects which stood in the way.
When loans are made to business enterprises under these circumstances, the borrowers and their business associates are assisted in their competition with others who do not have the backing of the government. This raises in each case the question of whether the general public gains more benefit from helping the otherwise unfortunate loan applicant than it loses by hindering his otherwise more fortunate competitor. It is not possible for the government to assist one competitor without placing handicaps in the path of another.
When a private lender advances funds to a private borrower, both have a stake in the borrower’s enterprise. The lender will see to it that the borrower has a sufficient investment to assure his wholehearted effort for success of the undertaking; and once the lender has invested, he may generally be counted on to support the enterprise in every way that he can. Both stand to gain by its success. Lenders looking out for their own best interests can be, have been, and should continue to be a constructive force in the sound development of homes, communities, and businesses in the United States.
Something less than this occurs when the government makes direct loans. The government will not fail and go out of existence because its loans go bad. It will not even be seriously inconvenienced, and its officials are less likely to be criticized for having made a bad loan than they are for having rejected a borrower’s application. The government’s interest in success of the borrower’s enterprise is a remote, impersonal, statistical sort of an interest, almost totally dissociated from its interest as a lender.
A private lender’s interest in a borrower’s enterprise tends to be equally remote and impersonal when the lender holds the government’s guarantee. This has been amply demonstrated of late by the Senate’s inquiry into the “Federal Housing Administration scandal.” The private lender’s investment here is not a stake in an enterprise. It may appear to be one, but it actually is an investment in governmental debt and its financial soundness as an investment is unaffected by the fortunes of the borrower’s enterprise.
Irresponsible undertakings occur in these circumstances, and they are directly the result of the circumstances. Government lending tends to increase the incidence of irresponsibility in the undertaking of business transactions, including the undertaking to own a home.
Whether we like the idea or are repelled by it, promoters have always been important figures on our national scene. These are enthusiastic people with attractive ideas and persuasive ways. They know how to make friends and influence people.
The function of the promoter has been to originate new ventures and then to find operators and financiers and bring them together. The promotion may be as small a thing as the making of home repairs, and it may be as large a thing as the building of a bridge over the Bosporous . . . .
The economic problem concerning promoters is to keep them responsible, to restrain them. A part of the restraint comes from the prospective operator who, knowing his business, decides that the promoter’s dream makes sense or it doesn’t; in part, it comes from the prospective financier who, knowing his business, finds the financial risks acceptable or not. The financier and the operator working together explode the promoter’s dream or bring it to fruition, or they may give it a try and fail. Between them also they help to control the promoter’s fee, commission, or other compensation, this being a matter directly related to the success of their mutual undertaking.
When the government is the financier much of the restraint on promoters is gone; government lending officials have nothing at stake in the borrowers’ ventures. When the government is both the operator and the financier, the lack of restraint is even more severe. And anything can happen when the government is the promoter as well as the operator and the financier.
The establishment of a government lending program is an invitation to promoters . . . . It is particularly an invitation to the irresponsible element among the promoters because the government is not a canny lender. When the lender is not canny, promotion meets with less resistance and it is more than likely to yield the promoter more lucrative returns.
An important feature of the study of Reconstruction Finance Corporation lending made by the Senate’s Fulbright subcommittee in 1950 and 1951 was the disclosure of the weakness of the government’s officials and their inability to stand off the promoters. Now in 1954 we read of roving bands of promoters who sell overpriced substandard repair jobs to unwary homeowners to be paid for with the proceeds of loans guaranteed by the government . . . .
A good loan is one which is certain to be repaid with interest at maturity. The certainty of repayment is at risk on a poor one. The better the collateral pledged to secure repayment, the better the loan. Possession of the collateral, however, and freedom to use it, are at least as valuable to the borrower as they are to the lender and so it is generally to the borrower’s narrow interest to pledge as little as he can get by with. If only the borrowers’ inclinations were to govern, the nation’s loans would grow more and more speculative.
When private lenders are the custodians of the standards of lending, there is a strong resistance to a lowering of the standards. The lenders’ own selfish interests are involved. This is one of the strengths of our American competitive economic system . . . .
Government lending programs and government guarantee programs have a fatal attraction politically. They can be used handily to bestow favor on particular groups and persons. Through them the use of the nation’s wealth can be channeled to those people who are adjudged to have the need but not the means, and this can be done in large part without the appearance of taxing those who have the means. For lending purposes, the savings and other wealth of the people are assembled in the national treasury by issue of the government’s obligations in one form or another and through the lending programs, they are applied where their owners would not otherwise willingly apply them. Indirectly, this is compulsory lending. It is politically acceptable—even desirable—because the compulsion is concealed by the indirection. Who could object to the exchange of his savings for government bonds? And who really feels injury when a bad loan comes to light, as in recent years they have been doing with disturbing frequency?
Because it is attractive politically, government lending grows and grows. Each successive national administration offers more than the last, lest there appear to be retrogression where progress is desired; and there are plenty of pressure groups ready, willing, and able to point to any appearance of retrogression. On the face of it, the only way for a new national administration to offer more than its predecessor did is to expand the volume of the programs and the fields in which they are available, and to ease up on the standards so that more and more people can have the advantages with less and less risk on their own part.
When FHA began in 1934, a very substantial equity investment, as high as 50 per cent in some areas, was necessary before a man could borrow enough to build himself a home. Now, 20 years later, the proposal has been made in all seriousness, that FHA be authorized in some circumstances to pledge the government’s credit where a prospective homeowner has no resources at all and where 40 years is fixed as the term in which he will work out the mortgage. Forty years for many of us is the entire span of our working life and for some it is even more . . . .
Important economic degradation inevitably results when the government’s credit is placed at the disposal of private persons and private business concerns to help them gain competitive advantages, and it is the opinion of the task force that the long-term debilitating effects of this latter class of lending outweigh the benefits which the activities yield. These lending programs stifle the private initiative of individual people and though the government can rather easily engage in activities which stifle initiative, there is no positive way in which it can repair the damage. Initiative is encouraged and character is strengthened mainly through the opportunity and experience of overcoming adversity. 
Extracted from the February 1955 report by the Task Force on Lending Agencies, prepared for the Hoover Commission on Organization of the Executive Branch of the Government.
But the same government that fears the too-rapid growth of installment credit, even when financed by private lenders at their own risk, has promoted an enormous housing boom by itself guaranteeing mortgages on shoestring margins that make the installment-credit . . . . . . terms on automobiles or television sets look like the acme of conservatism. It has forced Americans who want to invest in American corporations, to pay down 70 per cent of the purchase price, while it uses the taxpayers’ resources to encourage other Americans to buy houses for 7, 5, 2, or 0 per cent of the purchase price.
Henry Hazlitt, Newsweek, February 13, 1956