June 16, 2019

by Steve Stofka

What if the federal government offered competitive products that help individuals and businesses manage risk? Today, the government insures many Americans through a variety of programs and a potpourri of agencies. I am proposing that the government do more risk management through a separate and independent agency like the Federal Reserve.

Well, doesn’t the financial industry already act as a risk broker? It does – and it doesn’t. It picks the risks that it wants to broker – and leaves those it doesn’t want to the government. The 1986 S&L crisis, the 1987 stock market crash, the 1998 Asian financial crisis, the 2002 Enron crisis and the 2008 financial crisis indicate that Wall Street is not an efficient risk manager.

Let’s look at some common risks that the government already manages. The federal government insures mortgage risk through an umbrella agency called the Federal Housing Finance Agency, or FHFA (Note #1). Financial companies do not want the risk of loaning money to people for thirty years at a low fixed rate. Why? People’s circumstances and the housing market change over such a long period of time. Finance companies might prefer a shorter time period – say five years – so that they could renegotiate the terms of the mortgage. Many mortgages are bundled by banks and mortgage companies, then sold to investors with guarantees from the government.

The government manages the risk of poor asset management by its member banks. In the late 1920s, the onset of the Great Depression caused the failure of many banks and millions of people lost their life savings. Who would insure a bank against its own lack of judgment or improper management? The government became the insurer of last resort when the Federal Deposit Insurance Corporation (FDIC) was created in 1933 (Note #2).

There were a lot of bank failures during the 2008 financial crisis. Through the FDIC, the federal government handled the transition of each one. No depositors lost money. California, Georgia, Florida, Illinois and Minnesota have each had more than twenty failures in the past decade (Note #3).

In many cases, the FDIC stepped into a failed bank at closing time on Friday evening, closed the institution and fired the management. Over the weekend they did a thorough accounting of the bank’s assets and liabilities, packaged and sold the bank’s performing loans to another bank which re-opened the following Monday under a new name. Nothing to worry about here, folks. Go on about your business. The FDIC has proved itself an efficient and prudent risk supervisor.

The government manages the risk of natural disasters. Insurance companies are reluctant to cover damage from “acts of God.” Homeowner’s insurance does not cover flooding, for example (Note #4). If they did, it would be prohibitively expensive. Instead, the government insures flood damage through the National Flood Insurance Program (Note #5). Because the program is subject to much political influence, it lacks fiscal prudence. The program’s greatest expenses are recurrent repairs to structures in areas that are prone to flooding, but the program can not charge the premiums reflecting those increased risks. An independent agency with a long-term outlook would act less rashly.

Employee risks are managed by state and federal government agencies which deploy government funds to pay unemployment claims. For employees injured on the job, private insurers are reluctant to pay for replacement wages for an injured employee. Even after medical bills are paid, the employee may need retraining after the injury – an additional expense that private insurers want to avoid. Furthermore, employers wanted to avoid the risk of being sued by their employees for unsafe working conditions. Many states have Workmen’s Compensation programs that are either government agencies or independent agencies set up by law (Note #6).

The federal government manages health risks. It plays a large role in the health insurance market and in the health delivery market through the Medicare, Medicaid and tax subsidy programs. The federal government pays almost half of all health care costs in the U.S. through these programs (Note #7).  In 2017, this amounted to 8% of the entire GDP of the country.

In summary, the federal government is already heavily involved in insuring risk. Private industry has taken the gravy and dumped the risks that they don’t want to insure on the government. If the government assumed some of the lucrative insurance products, it would help offset the costs of these other risks. Let’s get government in the capitalism business. Let an independent government agency start offering some competitive financial insurance products and see if they can attract some market share.

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Notes:

1. Federal Housing Finance Agency encloses several formerly independent government finance agencies
2. History of the Federal Deposit Insurance Corporation
3. The map of bank failures is from the FDIC site
4. Homeowner’s insurance and the distinction between flooding caused by wind (may be insured) and that caused by rain (not insured). Allstate
5. National Flood Insurance Program
6. Workmen’s Compensation Insurance