Welfarizing Credit

By Llewellyn H. Rockwell, Jr.

There are at least three ways to expand the welfare state: tax and spend, impose new mandates on business, and politicize the banking and credit system. President Clinton is trying to do all three, although we hear little about the third. Yet it is the most insidious sort of welfare. It undermines the integrity of the banking and credit system while being largely invisible to the voting public.

In a free economy with a sound currency, credit is allocated by merit. Say an acquaintance asks you for a $1,000 loan. If you are in principle willing to make the loan, you will take into account his job, his assets, and his character – whether he pays his bills. You can then predict with some assurance whether he will repay your loan, and therefore whether you should make it.

The free-market banking system takes largely the same approach. When a person applies for a loan, the financial institution checks job history, assets, and loan history, summarized in a person’s credit rating. Though reviled by deadbeats, the credit rating is a magnificent creation of the free market.

But Clinton has a different view. Forget justice or economic efficiency. He wants banks to make welfare loans that ignore the market-driven standards. That is, he is using the powers of the federal government to force banks to make loans to people who shouldn’t be getting them.

The excuse is only too familiar. Clinton says that racial minorities are being unfairly discriminated against in mortgage and business loans. The answer? Dispatch hirelings from the Office of the Comptroller of the Currency, the agency which oversees federally chartered banks, and the Department of Housing and Urban Development, to pose as potential borrowers.

These government “testers,” as Clinton calls them, will be members of minority groups. If they don’t get a loan, the government will cry foul and slap big fines on the banks. And given the reward system in Washington, D.C., the testers will have strong incentives to act so as to be denied a loan.

The “testers” should actually be called intimidators or even terminators. No bank will know whether a minority applicant is real or a federal phony. So whether the person passes the usual qualifications tests or not, the bank will tend to make the loan.

If a man comes in with a stocking mask, a gun, and a note for the teller, the bank calls the cops. But under the Clinton plan, the mask covers the Controller, the Congress writes the note, the executive branch holds the gun, and the Federal Reserve (the lender of last resort) provides the getaway car.

Any bank that has denied credit to as few as five minority applicants will be targeted. And small banks will be disproportionally affected, for they can afford to take fewer risks than the big banks.

“This is good news,” said Democratic Rep. Joseph Kennedy from the big-bank state of Massachusetts. The “testers program will go a long way to remedying the discrimination that study after study has shown exists in the banking industry.”

Study after study? Every year the Federal Reserve System publishes a study on discrimination in lending. But its figures are not adjusted for credit rating, job history, income, or other relevant factors. The Fed always finds that blacks do indeed get fewer loans than whites, while Hipanics are in the middle. But Asians always get more loans than whites. Either bankers are yellow supremacists or Asians are simply better credit risks.

A special study by the Boston Fed did adjust credit rating, and that pulled the black-white loan ratio within seven percentage points. But the author of the study, Alicia Munnell, admitted to Peter Brimelow of Forbes magazine that her study didn’t take into account enough variables to prove lending discrimination, despite her statements to the press. Munnell, who also wants to tax the present value of all pension plans, is Clinton’s assistant secretary of the Treasury.

Other studies to which Kennedy might be referring come from the far-left Association of Community Organizations for Reform Now, or ACORN. They too failed to adjust their data for income, job history, or credit rating. Yet they stupidly insist that blacks are not getting their fair share of loans. The remedy? A system of mortgage quotas, which Clinton seeks to impose by default rather than design.

The dozens of programs already in place to give minorities preference in lending – especially the Community Reinvestment Act – are tying banks in regulatory knots. This new form of welfare will further destabilize the banking system, something we ought to worry about in the aftermath of the S&Ls.

As H.L. Mencken said, the world is divided into those who pay their bills, and those who don’t. A free-market banking system, which properly discriminates between these groups, rewards responsible behavior and punishes the form of theft practiced by the deadbeat.

Once the banking system fell under the control of government, as it did with the Federal Reserve Act of 1913, it became a tool for government planners to use to further their ends. Thanks to the Federal Reserve, and the destruction of the gold standard, the government has funded half a dozen wars, expanded itself in the process, elected its favored candidates to office, manufactured phony booms and all-too-real depressions, and has now become the welfare provider of last resort.

What to do? Ironically, the answer was provided by Alan Greenspan in 1966. “An almost hysterical antagonism toward the gold standard is one issue which unites statists of all persuasions,” he wrote before becoming rich, famous, and powerful. Statists know that “gold and economic freedom are inseparable.”

The virtue of gold, wrote Greenspan, was that it “is incompatible with chronic deficit spending (the hallmark of the welfare state).” “Under a gold standard, the amount of credit that an economy can support is determined by the economy’s tangible assets, since every credit instrument is ultimately a claim on some tangible asset.” Abandoning the gold standard “made it possible for the welfare statist to use the banking system as a means to an unlimited expansion of credit.”

A return to a rigorous gold standard would have the same effect on big government egalitarians as a father taking the car keys away from his tipsy son: it would no longer be a threat.