After The Student Loan Bailout

Should President Biden's recent pay-for-votes forgiveness of student loans make you nervous if you own government-guaranteed securities?

Although it seems highly unlikely, the student loan giveaway could create a slippery slope that leads next to mortgage forgiveness for veterans or some other protected or politically favored class, or some other form of federal debt relief. 

In that event, what would happen to so-called government-guaranteed securities backed by VA mortgages if the president declared that some or all of those loans were forgiven? Why not FHA loans, that are made to many of the same people who have student loans, i.e., those who supposedly have trouble paying back their loans or getting them in the first place because they have marginal credit or can’t afford a large down payment.

It wasn’t very long ago that Fannie Mae and Freddie Mac, the twin secondary mortgage agencies, failed and were taken over by the government, leaving equity investors with shares worth next to nothing (both are currently trading at about 50 cents a share on the pink sheets).

Before they went bust during the global financial crisis, it was widely assumed that Fannie and Freddie were backed by the full faith and credit of the U.S. government, which turned out not to be the case (as that great legal scholar Felix Unger reminds us).

Assuredly, mortgages backed by the VA and FHA are different animals than those issued by Fannie and Freddie, but that doesn’t mean they’re invulnerable (they historically have high default rates). With interest rates on mortgages now north of 5% and a recession possibly looming, how long will it be before pressure grows on Biden to give the weakest homeowners a break?

Now it doesn't seem so far-fetched, does it? Today student loans, tomorrow home mortgages. How far do we want to take this? 

In the past we've heard some people say we should weaponize Treasury securities against our foreign adversaries, such as the Chinese, who own so much of our debt. Does this now become a little less of a fantasy and more of a possibility, as our relationship with Beijing continues to deteriorate and the president is in such a forgiving mood?

The actual dollar cost of Biden’s student loan giveaway has yet to be calculated, but it’s safe to say it’s a lot more than he and his defenders claim. Some analysts say the total cost will be about $1 trillion, which certainly seems reasonable. It could certainly add up to a lot more, if and when those saps who are still repaying their loans wake up and realize that they have indeed been duped and demand forgiveness, too, or simply stop paying.

Politicians love to play fast and loose with debt, as long as it isn’t owed to them. Since the global financial crisis of 2008, government officials and politicians on both the left and the right have heartily endorsed Modern Monetary Theory as a way to solve today’s economic problems by simply wishing them away. Have the government issue massive amounts of debt backed only partially by tax receipts, with the rest purchased by the Federal Reserve, and all will be well. Now they’re writing a new chapter of that theory, which involves simply erasing parts of that debt by the mere stroke of the chief executive’s pen.

One important thing missing from the MMT playbook is taxes. According to the theory, the government can continue to spend money and run massive deficits until inflation is created, at which point it should turn off the spigots and raise taxes and put everything back into equilibrium. But as we know, no or little tax increases are on the horizon, certainly not in an election year, despite federal debt of more than $30 trillion.

The current administration likes to blame inflation on everything but out-of-control government fiscal spending. Rather, Vladimir Putin, supply chains, greedy corporations, etc., are to blame. Fighting inflation, the president tells us, is the sole domain of the Federal Reserve, and he will do nothing to threaten its independence. Except he does want the Fed to use its bank regulatory powers to decide which industries get access to funds (solar energy, electric vehicles) and which don’t (oil and gas producers, gun manufacturers).

Which leads us into the next potential mine field. If things go wrong for companies in the most favored categories, will the government or the Fed step in with even more subsidies or some kind of debt relief?

These are the risks we run when the government plays favorites in an otherwise free economy. Hopefully, most of these scenarios will never come to pass, but as the student loan bailout should teach us, anything can happen.

George Yacik
INO.com Contributor

Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.