Alan Boyce, Glenn Hubbard, and Chris Mayer (“BHM”) have published an important paper, “Streamlined Refinancings for up to 30 Million Borrowers,” which makes the case for refinancing all loans – trillions of dollars in face amount — now covered by the housing GSEs, Fannie Mae and Freddie Mac. This proposal breaks-down the evil cartel of banks and GSEs currently blocking more than 30 million American families from refinancing their homes and thus stalling economic recovery.
But this proposal, while admirable, has a cost. Income now flowing to investors and banks who own GSE paper will instead be retained by consumers to the tune of $70 billion annually. If other proposals to compel refinancing of non-GSE mortgages are adopted, the reduction in income to investors, banks and the GSEs themselves as a result of mass prepayments is over $100 billion per year. The banking system made $28 billion in Q2 2011, thus the dilemma.
I use the term “dilemma” deliberately. The GSEs and large banks are still hiding losses on their books and subsidizing these losses by preventing consumers from refinancing their mortgages. It remains only to recognize these losses, restructure insolvent institutions and get on with the business of recovery and growth by refinancing eligible home owners. Let’s ponder two figures from the 1930s who typify the sort of focus and purposefulness required by our government today — Jesse Jones and Leo T. Crowley.
Jones is the better known of the two men, having headed the Reconstruction Finance Corporation during the Great Depression. Jones was a businessman and public citizen first and foremost, a man who saved several banks in his home town of Houston, TX, before he traveled to Washington to serve on the board of the RFC under Presidents Herbert Hoover and Franklin Roosevelt. He also wrote a great book describing his experiences, Fifty Billion Dollars: My thirteen years with the RFC (1932-1945).
Under Jones, the RFC issued debt, purchased commodities, invested equity in solvent banks and closed insolvent institutions, and operated as the merchant bank and receiver of the US government in tandem with the FDIC. While the Fed played a relatively minor financial role during the Depression and WWII, the RFC was where the action was happening, financially and politically. Jones reported to two men: FDR and Senator Carter Glass of Virginia, who helped to create the Fed and served as Treasury Secretary under Woodrow Wilson.
Jones understood that recapitalizing sound banks helped to stabilize communities, but that closing insolvent banks and selling the assets quickly was also a necessary condition for economic revival. In his memoir, Jones tells of meeting with the Maine Trust Company in 1933, which sought an RFC loan of $1 million.
“We in the RFC knew what their situation was,” wrote Jones. “I replied that they needed not $1 million but $4 million, and that they would raise $2 million and the RFC would buy preferred capital of $2 million.” Jones, you see, had his own “stress tests” even in the 1930s.
At first the bankers from Maine Trust Company balked at the idea of raising capital, but Jones persuaded them to go back home and raise the $2 million from the community in a scene right from Frank Capra’s film “It’s a Wonderful Life.” The alternative was closing the bank, and prosecution for the officers and directors. Jones wrote about the episode: “The truth can hurt, but not as badly as uncertainty and fear.”
Leo T. Crowley was appointed Chairman of the FDIC in 1934 and was the agency’s first chief executive. A banker from Wisconsin, Crowley organized the state’s first banking agency in the early 1930s and then went to Washington seeking funds to help 385 of his state’s banks qualify for FDIC insurance. In a 1945 letter to Jones, Crowley recalled “how overjoyed I was to be able to go back home and report that every one of these banks had been accepted for [FDIC] deposit insurance.”
Not only did Crowley get money from the RFC, but he also got a job from FDR and became one of the most important leaders of Depression era. He worked closely with Jones and helped restructure hundreds of banks. Under Crowley the FDIC took on the organizational design it still has today, including insurance, resolutions & receivership, regulation and research. The agency requested and obtained from Congress more time for smaller banks to qualify for permanent FDIC insurance in 1935 and full membership in the Fed in 1937. Crowley knew that “the small bank was really the backbone of the nation’s financial structure” and was then, as it is now, the nation’s largest employer.
Crowley became even more significant than Jones during his years of public service and also as a powerful political ally of FDR. He joined the wartime cabinet in September 1943 and ran the Lend-Lease program that financed much of WWII. Like FDR and most reasonable people, Crowley did not get on with President Harry Truman. At the end of 1945, Crowley cut off the Soviets from the Lend Lease program, provoking the Cold War in Truman’s view, and then returned to private life. Crowley did not write a memoir, but Stuart Weiss wrote a biography in 1996, The president’s man: Leo Crowley and Franklin Roosevelt in peace and war.
The lesson to be taken from Jones and Crowley is one of defining economic problems and acting decisively to deal with these problems so that fear does not conquer all. Today the task is to restructure the largest banks and GSEs, reliquify the economic situation of millions of American home owners, and deal with the financial consequences of that adjustment. If we remember that there is a cost to doing nothing and that prompt action to eliminate insolvency and uncertainty can restart economic growth, then the path ahead is clear.