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July/August 2006

In This Edition

  • Federal Credit and Insurance Programs: Housing

    This paper reviews the evolution of the major credit and insurance programs undertaken by the U.S. government in support of urban housing. As the review makes clear, the Federal Housing Administration (FHA), Veterans Administration, Federal National Mortgage Association, and Federal Home Loan Mortgage Corporation have played major roles in the development of liberal and efficient primary and secondary mortgage markets in the United States. The development of capacity in mortgage lending and securitization in the private sector does suggest, however, that federally subsidizing mortgage market activities can be restrained with little effect on homeownership"”the principal goal of this federal activity. In particular, the orderly reduction in the mortgage investment activities of the government-sponsored enterprises (GSEs) and the imposition of guarantee fees on mortgage-backed securities insured by the GSEs are first steps in restraining federal activity. More generally, a concentration of FHA and GSE activity on first-time homebuyers would reduce federal risk exposure while preserving the economic rationale for government activity.

  • Is the United States Bankrupt?

    Is the United States bankrupt? Many would scoff at this notion. Others would argue that financial implosion is just around the corner. This paper explores these views from both partial and general equilibrium perspectives. It concludes that countries can go broke, that the United States is going broke, that remaining open to foreign investment can help stave off bankruptcy, but that radical reform of U.S. fiscal institutions is essential to secure the nation's economic future. The paper offers three policies to eliminate the nation's enormous fiscal gap and avert bankruptcy: a retail sales tax, personalized Social Security, and a globally budgeted universal healthcare system.

  • On Asset-Liability Matching and Federal Deposit and Pension Insurance

    Asset-liability mismatch was a principal cause of the Savings and Loan Crisis of the 1980s. The federal government's failure to recognize the mismatch risk early on and manage it properly led to huge losses by the Federal Savings and Loan Insurance Corporation, which had to be covered by taxpayers. In dealing with the problems now facing the defined-benefit pension system and the Pension Benefit Guaranty Corporation (PBGC), the government seems to be making some of the same mistakes it made then. Among the causes is the fallacious belief that because pension funds have a long time horizon the risk of investing in equities is negligible. In fact, the opposite is true. Moreover, for the PBGC, the mismatch risk is magnified by moral hazard and adverse selection. Distressed companies facing the prospect of bankruptcy have an incentive to underfund their pension plans and adopt risky investment strategies; healthy companies have an incentive to terminate their plans and exit the system. The paper explores some ways to limit the costs of a potential PBGC bailout.

  • On the Importance of the Plumber: The Intersection of Theory and Practice in Policymaking for Federal Financial Institutions

    The federal government's role as lender and insurer is very important, with over $ 1.4 trillion of loans and guarantees and at least $ 7 trillion of insured risk. Tens of millions of Americans benefit from housing loans, student loans, flood insurance, etc. Yet the federal financial institutions established to run these activities are often created almost as an afterthought, with little focus on their structure. This paper emphasizes the crucial importance of ending this neglect and recognizing how proper structure can help avoid major failures, such as the current problems at the Pension Benefit Guaranty Corporation, and enhance successes. The author also challenges the economics profession to provide more guidance on a range of specific analytical issues with real-world implications, because economists have often failed to extend analyses derived from the private sector into useful formulations for public sector practitioners.

  • Should the Government Provide Insurance for Catastrophes?

    This paper evaluates the need for a government role in insuring natural and man-made catastrophes in the United States. Although insurance markets have been stressed by major natural catastrophes, such as Hurricane Katrina, government involvement in the market for natural catastrophe insurance should be minimized to avoid crowding-out more efficient private market solutions, such as catastrophe bonds. Instead, government should facilitate the development of the private market by reducing regulatory barriers. The National Flood Insurance Program has failed to cover most property owners exposed to floods and is facing severe financial difficulties. The program needs to be drastically revised or replaced by private market alternatives, such as federal "make available" requirements with a federal reinsurance backstop. A federal role may be appropriate to insure against mega-terrorist events. However, any program should be minimally intrusive and carry a positive premium to avoid crowding-out private market alternatives.