Bankers Once Went to Prison in the U.S.

Once upon a time in America, bank executives went to prison for white-collar crimes. During the Savings and Loan (S&L) debacle, between 1985 and 1995, there were over 1,000 felony convictions in cases designated as major by the U.S. Department of Justice.

In contrast, no senior bank executives faced prosecution for the widespread mortgage fraud that contributed to the 2008 financial apocalypse that precipitated the Great Recession. Not a single senior banker who had a hand in causing the financial crisis went to prison.  Rather than reining in Wall Street, President Obama and Congress restored the status quo ante, even when it meant ignoring a staggering white-collar crime spree.

Indeed, the Department of Justice did not prosecute a single major bank executive in the largest man-made economic catastrophe since the Great Depression. They went after the small fish, not the mortgage executives who created the toxic products or the senior bank executives who peddled them.

The S&L crisis was arguably the most catastrophic collapse of the banking industry since the Great Depression.  S&Ls were banks that for well over a century had specialized in making home mortgage loans.  Across the United States, more than 1,000 S&Ls had failed, nearly a third of the 3,234 savings and loan associations that existed in 1989.  It is estimated that by 2019, there were only 659 S&L institutions in the United States.

In 1979, the S&L industry was facing many problems.  Oil prices doubled, inflation was in double digits for the second time in five years, and the Federal Reserve decided to target the money supply to control inflation. This not only let interest rates rise, it also made them more volatile.

As inflation continued to soar, S&Ls, with their concentration in home loans, found themselves squeezed by an interest rate mismatch.  The 30-year mortgages on their books earned single-digit interest rates, but they either had to pay depositors double-digit rates or lose them to competitors. Overnight, long-term depositors turned short term.  Funding long-term assets like mortgages with short-term liabilities like deposits is a risky formula, and in a high-inflation environment, it quickly makes insolvency inevitable.

For sure there are several parallels between then and the failures of Silicon Valley Bank and other banks over the last several months.  Just as many S&Ls went bust because surging interest rates increased their costs as mortgages brought low fixed rates of interest, many of today’s banks face similar balance sheet problems.

The changing economic and financial environment ruined the “3-6-3” business model that had served thrift executives well for decades: pay 3 percent on savings deposits, charge 6 percent on mortgages, pocket the difference, and play golf at 3:00.

In 1982, lobbying from the S&L industry led Congress to permit them to make highly leveraged investments far removed from their original franchise to provide mortgage funding.  In response, the federal government also enacted statutory and regulatory changes that lowered the capital standards that apply to S&Ls.

For the first time, the government approved measures intended to increase S&L profits, as opposed to promoting home ownership.  The premise underlying the changes was that deregulation of markets could let the S&Ls grow out of their insolvency.  Instead, the crisis culminated in the collapse of hundreds of S&Ls, which cost taxpayers many billions of dollars and contributed to the recession of 1990-1991.

And some S&Ls contributed to the development of a Wild West attitude that led to outright fraud among insiders. Many S&Ls ended up defrauding their depositors and speculating on high-risk ventures, engaging in illegal land flips, engaging in accounting fictions, and other criminal activities.

The S&L crisis teaches at least one important lesson: There is no ending financial chicanery without holding senior bankers accountable for their wrongdoing.

Ford Motor Co. and Industrial Policy

The U.S. government is giving the Ford Motor Co. a $9.2 billion loan, by far the biggest infusion of taxpayer cash for a U.S. automaker since bailouts during the 2008 financial crisis, to build three battery factories in Kentucky and Tennessee.  Neither Ford nor the Energy Department (DOE), which provides loans at far lower interest rates than those available in the private market, have revealed details about the loan.

The U.S. is taking a page from Beijing’s playbook.  China has a top-down industrial policy, with serious government planning and support of target industries. China’s sustained industrial policy has yielded the world’s largest battery manufacturers.  Between 2009 and 2021, the Chinese government poured more than $130 billion of subsidies into the EV market, according to a report last year by the Center for Strategic and International Studies.  Today, more than 80 percent of lithium-ion battery cell manufacturing capacity is in China.

Simply put, industrial policy means that centralized agencies formulate national visions and programs to develop specific industries.  It has been a toxic phrase in American politics.

As Gary Becker, who won the Nobel Prize for Economics in 1992, said, “The best industrial policy is none at all.” It has long been associated with pork barrel politics, picking winners, and crony capitalism.  The political rhetoric has been that the free market works best and is closely associated with freedom and democracy. The history of the U.S. does not square with this perspective.

On the surface, Ford would seem an unlikely party to receive the largest loan ever extended by the Department’s Loans Programs Office.  Just last month, Ford touted having almost $29 billion of cash on its balance sheet and more than $46 billion in total liquidity.  It is worth nothing that one of the best known loans made by the DOE was $465 million to Tesla in 2010 to support manufacturing of the Model S.

Ford aims to close the gap with Tesla on electric vehicles, just as the U.S. aims to close a similar gap with China. Ford told investors early last year that it would put $50 billion into its EV manufacturing efforts. By the end of 2026, the company wants to make two million EVs a year.

Starting with Alexander Hamilton, the first Secretary of the Treasury, who outlined a strategy for promoting American manufacturing both to catch up with Britain and provide the material base for a powerful military.  Hamilton’s “Report on the Subject of Manufacturers” promoted the use of subsidies and tariffs.  Similar practices have been expressed in various forms throughout American history.

During the 19th and 20th centuries, the government played an active role in promoting economic growth, using policies such as high tariffs to protect strategic industries, federal land grants, and subsidies for infrastructure development. The federal government has sometimes backed failures, but it also has remarkable success stories, such as nuclear energy, computers, the Internet, and building the interstate highway system

These days, industrial policy is viewed more positively, spurred by bipartisan concerns about the competitive threat China poses.  U.S. programs are now underway to cover semiconductor production, development of critical technologies, to secure key domestic supplies and support industries that are considered strategically important.

For example, subsidies from the Inflation Reduction Act and Infrastructure Investment and Jobs Act are spread across the EV value chain and are carpet bombing the entire automobile industry.  There are tax credits for sourcing critical minerals within the U.S. or friendly countries, for manufacturing or assembling the batteries and EVs they go into, for the consumers who buy the vehicles, and even for anyone building the public chargers needed to keep those vehicles moving.

The debate over industrial policy will continue because it gets to the longstanding controversy over the role of the government in our economy.  One thing is clear: the rosy rhetoric about the U.S. not engaging in industrial policy is contradicted by the country’s history.