The genesis of this ongoing version of Washington “Keystone Cops,” with a perpetual cycle of distortive interventions, followed by bubbles, followed by crashes and bailouts, extends back to the early days of the 20th century. Judge Glock, a scholar at the Cicero Institute, has undertaken painstaking research into the legislative and policy history of mortgage and related agricultural land policy in his well-timed first book, The Dead Pledge.
“Privilege” morphs into “balance” / Glock begins his historical review by explaining that the Democratic Party of Andrew Jackson stood hard and fast against legislative privilege for politically powerful groups. “In Jackson’s view,” Glock writes, “the central desideratum of government was to provide equal protection of the laws to all and to abjure special privileges to any…. The president had a special duty to protect the public from the grasping pleas of special interests.” To that end, Jackson vetoed the re-chartering of the Second Bank of the United States in 1832, which was “the grant of a special privilege by the government to one group of men … [and his veto] protected ‘the humble members of society — the farmers, mechanics, and laborers.’ ”
But by the Progressive Era, the Democratic Party had abandoned this stance and instead advocated granting privileges to special interests that were deemed deserving. Glock explains the rationalization for the change:
Certain interest groups and intellectuals began to claim that the old idea of equal protection would still leave some groups behind. They advocated that the government act as a force intervening directly for the benefit of certain classes in order to “balance” different economic sectors. Stagnant agriculture and booming industry especially needed to be brought into some new sort of equality.
A flurry of big-government interventions / Glock traces through some of the activist legislation of the Progressive Era, all approved during Woodrow Wilson’s administration and all intertwined and reinforcing: the Federal Reserve Act (FRA, 1913); the Federal Farm Loan Act (FFLA, 1916); and the War Finance Corporation Act (WFCA, 1918).
The FRA and FFLA created banks that were a hybrid of government and private institutions, privately owned but government-backed, what Glock references throughout Dead Pledge as “semipublic” institutions. This started with the Federal Reserve Banks: “The federal guarantee established a precedent. Although in the pre-Jackson era the government had invested in some private corporations…, it had never before given its complete credit to a private or semiprivate organization.” The FRA also granted national banks the power to grant loans on farmland.
The FFLA was modeled on the FRA. Glock writes, “Almost all of the important revisions in the act were done to inspire more confidence in the financial world and … to make the [FFLA] ‘harmonious with the Federal Reserve Act, which it mirrored in many respects.” The FFLA also included a mandate for the government to purchase stock in the Federal Land Banks (FLBs) created as part of the legislation. The FLBs were defined as “instrumentalities” of the federal government in the final legislation, with an “implicit guarantee from the government,” a structure that would “help market its bonds to the investing public.”
Finally, the WFCA “created a new semipublic corporation that guaranteed bank loans to necessitous war industries…, which became another implicitly backed government enterprise that aimed to support banks and investors.” The WFC itself lingered well beyond wartime, cooperating with the Federal Reserve Banks and FLBs to support the weak bank and agricultural lending sector. Collectively, Glock referred to this legislation as “a new era of government-privileged banks.” The bank lobby and the farm lobby were united in support of these semipublic institutions.
Continuity and predictable outcomes / The subsequent Republican administrations under Warren Harding and Calvin Coolidge did little to reverse the momentum of these proliferating semipublic institutions. Instead, they became more entrenched during the 1920s in what Glock refers to as a state of “continuity of political support.” Harding rode into office “on the pleas of farmers oppressed by the panic” building in the farm belt. In an early State of the Union message, he took on the rhetoric of those desiring explicit intervention favorable to the agricultural sector in order to “restore the proper balance between city and country.”
As a result, Republicans and Democrats alike were responsible for the cocktail of conflicts of interest, nepotism in hiring, and the rapidly weakening condition of the FLBs that flowed from their rapid growth. According to Glock, Charles Lobdell, one of the four original members of the Federal Farm Loan Board that oversaw the FLBs and “Republican standard-bearer…, rarely missed an opportunity to feather his own nest.” Treasury Secretary Andrew Mellon bemoaned those who were “daily leaving the public service and taking advantage of the information that they acquired in public service for private gain adverse to the government.”
The deep recession of 1920–1921 hit the agricultural sector particularly hard as “crop prices collapsed,” harming farmers’ ability to pay their debts. That, in turn, weakened the FLBs and commercial banks. This would linger throughout the decade:
Mortgage debts, so freely given by both the Land Banks and private banks during the boom and based on inflated crop and land prices, now proved burdensome…. [This] stress … was particularly severe because of a large increase in the number of farms mortgaged and the amount of mortgage indebtedness.
By the mid-1920s, the Spokane, WA FLB was in poor condition, with delinquent loans exceeding 25% of total loans. An investigative committee found it was on “the brink of failure,” and it was placed in a form of bankruptcy overseen by a committee of the other FLBs, which extended $4 million of support. Not surprisingly, the Spokane FLB had received “the most sustained political pressure for loans,” and in order to keep the loans coming, it was “lying about its finances.”
By 1932, with Herbert Hoover in the White House, one of his appointees proposed a plan to “bail out the Land banks…, the first explicit bank bailout of a financial institution by the federal government…. The government would become a part owner of the new system in order to prevent its collapse.” The Reconstruction Finance Corporation (RFC), a government bailout entity, provided further aid for the Land Banks. Hoover also secured creation of the Federal Home Loan Banks, which were based on the failing FLB business model. They “would support the small urban mortgages made by banks and building and loans.”
These actions were only the first of what would become a familiar vicious cycle for semipublic corporations of increased mortgage debt, an inflated asset bubble, followed by recession and a bailout.
Doubling down on the mortgage market / Those commitments to propping up the mortgage market were just the beginning. As the Great Depression began to accelerate, farm foreclosures spiked and Franklin D. Roosevelt was inaugurated after a campaign emphasizing the devastation of the foreclosures. A further layer of government corporations was created to go on top of the earlier ones. Roosevelt told one of his advisers to flood the banks with more cash: “If you and I force these funds on [the banks], they will have to act in accordance with our desires.”
Glock describes the overall objective: Roosevelt “focused on restoring farm purchasing power and fixing farm mortgages as the means to reestablish prosperity.” An executive order centralized rural credit programs into the Farm Credit Administration and employees under its umbrella swelled from 2,500 to 10,000 in 1933, managing $3 billion in assets and earning the nickname “the world’s largest bank.” The government’s share of the farm mortgage market broke the 50% mark, more than doubling its share under the old land bank system. The Federal Savings and Loan Insurance Corporation was also created, which would approach failure decades later, requiring a massive bailout.
Some of the New Deal’s programs were at cross-purposes. The National Industrial Recovery Act of 1933, in an effort to balance production across sectors, “tended to reduce competition and raise prices,” including higher building costs. So much for a robust housing recovery. Amid calls for more action, even the president became frustrated with the massive mortgage interventions that did not appear to improve the market:
Roosevelt raged against the expansion of guarantees. He said that people “should be told all the different things the government cannot do…. You know we are getting requests practically to finance the entire United States.”
Complementing the work of the Roosevelt administration, the Federal Reserve broadened the types of loans eligible for discounting:
[Fed Chairman Marriner] Eccles agreed that specifically allowing mortgage discounts at the Federal Reserve would help because, with constant access to the Fed, “the mortgages in the banks might be given the liquidity needed.” … In effect Eccles wanted to socialize liquidity, to make the salability of all financial assets a government-guaranteed benefit.
The Fed also adopted a policy of “low interest rates as a continued encouragement to capital expenditures, including housing.” On other fronts, the newly created Federal Housing Administration (FHA) ramped up its coordination with the Federal Reserve and commercial banks to convert traditional mortgages to FHA-insured mortgages, and the RFC created its own mortgage company to offer mortgages directly. But as Glock explains: “Unfortunately for Roosevelt, the much-promised housing revival never happened…. Part of the problem was that the … new RFC and FHA loans … simply refinanced existing mortgages.”
With all the disparate agencies taking on so many tasks in the mortgage market, 37 federal agencies in all, “Roosevelt declared housing policy ‘to be in a mess.’ ” A Central Housing Committee was added to coordinate all these agencies, becoming the 38th. Notwithstanding four years of stimulus, including to the mortgage market in particular, the economy slipped into recession by early 1937. The response was yet more intervention, as Fannie Mae was created with RFC funds in 1938. It would approach failure decades later, requiring bailouts more than once.
Conclusion / The Dead Pledge is a very detailed, well-documented (70 pages of endnotes), and readable history of the mortgage market during the first half of the 20th century. I learned quite a bit in an area that I have researched extensively. I would quibble with a few of the statements set forth in the book; for example, I don’t believe labeling the bailout of the Federal Land Banks during the early 1930s as the “first explicit bailout of a financial institution by the federal government” is accurate. But these are very minor quibbles, and I give the book a strong recommendation.
With only a few exceptions, Glock does not aggressively take one side or the other on the policy development of the mortgage market, but presents the historical details for the objective assessment of the reader. To me, the historical details make crystal clear that heavy intervention by the government in the mortgage market has put it “in a mess” (to use Roosevelt’s description), and it continues to be so to this day. The mortgage market is entirely removed from a free market and, sadly, vested interests will keep it that way for decades to come.
