The Exchange

The One Huge Bank That’s Truly Too Big to Fail

Washington policymakers have spent a lot of time lately trying to figure out how to handle banks so critical to the U.S. economy they’re “too big to fail.”

Yet they’ve ignored the biggest financial institution of all: the U.S. government.

If counted as such, the U.S. government would dwarf every other bank on the planet. Its present-day obligations total more than $18 trillion, according to Deborah Lucas, an economist who worked recently at the Congressional Budget Office and is now a professor at MIT’s Sloan School of Management. Her tally includes federally backed deposit insurance, mortgage, pension and student-loan guarantees, and hundreds of other government credit programs. It does not, however, include the $17 trillion national debt or future liabilities for entitlement programs such as Social Security.

As a financial institution, the government is a weird hybrid of bank and insurance company that’s roughly seven times larger than Bank of America (BAC) or J.P. Morgan Chase (JPM), and nearly 20 times larger than Goldman Sachs (GS). Yet virtually none of the Dodd-Frank reforms or other new rules meant to rein in risk-taking on Wall Street apply to the government.

“We have a system in which we believe credit markets are extremely important,” Lucas says. “The government is a large fraction of total market activity. The question is, why don’t we hold the government to the same standards as private financial institutions?”

Mushrooming obligations

Washington has long lent money and guaranteed private loans to homebuyers, students, small businesses, farmers and many others. But Uncle Sam’s importance as a financial center has mushroomed since the recession that began in the 2007 and the financial crisis that followed in 2008.

With private money that used to back about half the mortgage market in a state of hibernation, the federal government now guarantees more than 90% of new mortgages through agencies such as Fannie Mae (FNMA) and Freddie Mac (FMCC).

Washington also raised the limit on deposit insurance from $100,000 per account to $250,000 in 2008, raising the amount of depositor money it guarantees from $4.3 trillion before the recession to $7.4 trillion at the end of 2012. Fees on banks are supposed to cover losses, but if those fall short, taxpayers would be on the hook.

One of the biggest issues government watchdogs are worried about  is the skyrocketing amount of student debt, which grew from about $350 billion in 2004 to nearly $1 trillion in 2012. With the government backing more than 90 percent of that debt, a troubling rise in defaults could end up causing a significant loss for taxpayers.

The government measures and accounts for student-loan defaults differently than private lenders do, however. A recent study by the Federal Reserve Bank of Kansas City explains how the government appears to make a profit on student loans, even amid rising default rates. But if it accounted for defaults the way banks do, it would show a loss instead of a profit. That discrepancy has become a testy partisan issue, which could affect whether Congress allows interest rates on student loans to double this summer, as scheduled.

Too big for common sense?

MIT has established a new Center for Finance and Policy to scrutinize the federal bureaucracy as if it were a financial institution, and advocate reforms that would make it more stable and accountable. The problem isn’t necessarily that a huge new financial crisis is brewing but that Washington is committing more taxpayer money than ever without a clear analysis of the risks it's taking, or how the government’s financial activity might distort other parts of the U.S. economy.

Lucas and others say sensible reforms might include a plan to consolidate hundreds of individual government credit programs into a single agency, perhaps under the Treasury Dept., with uniform rules, accounting standards and disclosure requirements. If government agencies were forced to conduct risk assessments and stress tests — which Washington increasingly requires banks to do — it might reveal vulnerabilities far before they mushroomed into a crisis.

Congress, for instance, recently required the Federal Housing Administration to undergo the type of stress test the government imposes on banks, and it found that the agency — which among other things guarantees mortgages granted to first-time home buyers — could lose up to $115 billion over the next 30 years under a worst-case scenario. FHA’s own loss estimates have been far rosier.

Better accounting might even allow the government to use credit programs as a stimulus measure to boost the economy, at a far lower cost than simply spending gobs of money, as it did in the highly controversial 2009 stimulus plan.

Beyond that, many finance experts complain that the basic level of financial knowledge in Washington is so low it would barely suffice to run a Mom-and-Pop storefront lending operation.

A few members of Congress, including Republican Rep. Paul Ryan of Wisconsin, chairman of the House Budget Committee, have tried to pass legislation that would require the government to behave more like the huge lender it really is. But like other serious legislation, it has been shunted aside by showy hearings over political scandals, the never-ending effort to repeal Obamacare and other partisan wrangling.

Following the next financial crisis, however, members of Congress may find they need to call themselves as witnesses to explain how manageable problems went neglected until they were too big to ignore.

Rick Newman’s latest book is Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.

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