Did good employees, really create a favorable impression of government? A response to Megan McArdle

Today the excellent columnist Megan McArdle blogged a theory about why Americans were more willing to trust government in the decades immediately following the New Deal, but became distrustful towards government afterwards. Her theory is that many high quality employees were pushed into government work by a comparative lack of good private sector jobs. When the economy improved, it was impractical for long-term government employees to quit, but, so the theory goes, their successors were less worthy.

This actually might explain why people were so much more willing to trust government in the 1950s and 1960s than they are now: that was the era when government really was staffed with the "best and the brightest" at senior levels. The subsequent brain drain into the private sector decreased the quality of services and planning, which in turn made people hostile to the idea of more services and planning.

I very much respect McArdle's analysis, but in this case, I think that Megan's theory may well be flawed in that it implies that the broadly favorable public impressions of government present immediately following the great depression, and the broadly unfavorable impressions of government from the 1960s onward are actually variations from the same norm of "America."

I would say that to the contrary, the impressions of the government in both cases are actually impressions based on the overall SIZE of the government and regulations in the life cycle of the population in each era. In effect these two divergent appraisals of government reflect "normal" attitudes, in two very different, but characteristic systems.

Before the New Deal, the US government was comparatively small, and the reduced size of government overall was actually characteristic of the English speaking nations as a whole. Even the British Empire in India or Sudan used a small number of governmental officials, and as such, had a small amount of bureaucracy in comparison to many governments in continental Europe, or their colonies.

When the government is small, it is fairly easy to see how it is serving a useful purpose.

By contrast, when the government is large, it is likely to be seen as much less as pure and true "public service".

Megan's theory would tend to suggest that if the government is only staffed with good enough people, the public will tend to have a good impression of it.

I would say that to the contrary, most of the reason that the government is disliked is not because anything about it is identifiably corrupt or incorrect, but is rather that the government is large, in people's way, and government officials are unfriendly compared to many of the people encountered in other professions, where the need to recruit new customers encourages a pleasant demeanor.

I would suggest that both the history of literature and economics backs up my theory.

Modern economics which tries to restrict the role of government absolutely as much as possible, is commonly called the "Austrian school." Many of its luminaries emigrated, or fled Austria to the United States with the rise of Hitler. In the United States, these theories did not immediately receive a friendly reception, but then, the US at the time was accustomed to a small government, while anyone who grew up and was educated in Austria was accustomed to a very large government indeed. "Classical" economics from a British standpoint never was as minimalistic about the theoretical role of government, but then there was historically, less government to react against.

The anti-government young adults that began to appear in the 1960's and 1970's were the first to have actually spent a lifetime under the "good government" of the New Deal, and the good government employees of Megan's example.

When we look at the history of literature, it is certainly true that books like the classic "Catch 22" began to appear in the 1960's, rather than in WW2, when the book was set, but this is not necessarily because nobody could have, or did write books of the sort before. Rather, it was in the 1960's when people had enough experience with the behaviors of bureaucracy that such a book began to seem broadly relevant to the public.

If we look elsewhere however, there are examples of books with a similar spirit appearing and being celebrated earlier. "The Good Soldier Svejk" by Jaroslav Hasek was published in 1923, and like the Austrian school of economics, The Good Soldier Svejk came out of the Austrian empire, post WW1. This book has had enormous cultural impact in the Czech world, and was recognized as being broadly culturally relevant. Not only did this book predate "Catch 22" but in fact, it inspired it. Thus in both economics and literature, we have American cultural developments reacting against government, being inspired by reactions to the Austro-Hungarian empire, which predated the US experience of expansive and meddlesome government.

I would expand on this theory to say that I suspect that the EXPECTATIONS around government did not just change in a way that affected the population, but the expectations that spring up around an expansive government very likely affected the expectations and behavior of government workers themselves.

To put it one way, it is more inspiring to be Batman, than to be the clerk that logs prisoner's possessions, or a parole officer. This example sounds exaggerated, but in fact, if you use another cultural example, the Andy Griffith Show, it is easier to see how government service now occupies a less clearly essential social role than in the past. Andy Griffith, the small town Sheriff in the show, might not have been Batman, but despite engaging in petty tasks like the clerk or parole officer, his role was more socially elevated, and more obviously essential.

We're not in Mayberry any more...

Having "good" employees certainly means having employees who are dutiful in minor or unpleasant tasks as well as inspiring ones, but inspiration still certainly matters, and many employees who are now considered to be "top notch" or who are intelligent, are not likely to be inspired by labor in the bowels of a modern government bureaucracy.

As a final point, but one which likely has great import for the future of bureaucratic government and capitalism alike, one of the factors which probably pushed motivated and intelligent people into the government back in the Great Depression, and likely will today in the "Great Recession" was the notion that capitalism had effectively failed. This notion, turns the self-evident evils of government bureaucracy, into "necessary evils", things that people do not like, but which they accept.

As indicated earlier, the annoyances and evils of big government were noticed in Austria and noticed by Czechs very early, but this did not mean that the bureaucracy was ever eliminated.

Libertarians can easily make a case for the benefits of the free market on average, but just as employees can turn down potentially increased benefits in the commercial labor market, for increased certainty in government employment, so the public can choose increased security in the size and scope of government. Unless the average person can believe that they can control their own personal economic risks adequately in the private sector, they will impose regulations and other aspects of the public sector on everyone else.

Why people should be ALLOWED to act like corporations, and why libertarians should not try to stop them.

Megan McArdle has returned to the subject of recourse, the ability to sue for debt after the security is returned, in mortgages.

"mortgages were issued under a tacit understanding that people do try very hard to pay their mortgages, even when it's hard.

And changing those mores would be expensive--not for banks, but for homeowners."

This portion of her article forms a question that should be possible to test economically, and if not, then it raises real questions about the viability and desirability of economically rationalized governmental policy.

Economists normally say that economic failures, as in the case of the Soviet Union, have a rational basis, more scientific in nature than a simple matter of misbehavior, or "sin". If social mores can truly overwhelm large economic incentives for decades at a time, then this throws a lot of economics, and the Western governmental policy built on economic ideas into question. If non-recourse mortgages are likely to actually produce notably worse mortgage terms, then there should be clear evidence of that between the US states which have recourse mortgages, and those which do not.

The history of the US would also seem to cast some doubt on the idea that social mores are so strong that they preclude sharp practice in contracts and deals. The "Yankee peddler" and horse trader were famed for their cunning back in the colonial period, just as the used car dealer is today, and it is not only professional sharp practice which has a long and well established history. The very earliest US government housing program, created with the Homestead Act saw ordinary Americans pushing the limits of legality not only to the limit, but often past it, with straw buyers and other dishonest tactics being commonly used to allow people to claim extra land.

So if economic incentives should produce differences in mortgage terms to the disadvantage of the inhabitants of non-recourse states, and if such differences are not in fact apparent, then why not? I think that several factors are likely to be decisive.

1.

As a practical matter, banks cannot generally go about making home mortgage loans where the loan is commonly for a sum notably larger than the value of the property. If the bank can't get most of their money back between previous payments and foreclosure, then this means either a catastrophic loss of value due to an overwhelming economic depression, or that the banks were inflating a real estate bubble, in contradiction of sensible business practice.

2.

Individual mortgage holders are not in fact likely to be able to benefit by allowing the bank to foreclose on their property. It isn't that difficult to see why this would be the case given the notable black mark on one's credit history, and given the fact that the payments that one makes on a normal mortgage cover not only interest, but capital, and these payments cannot be reclaimed in foreclosure. Tack on transaction costs, and it is obvious that this is not a good means of exploiting a bank under normal circumstances.

3.

Onerous documentation requirements on home mortgages do not make practical sense for one of the big reasons that business income taxes are not as economically efficient as personal income taxes. A commentator that McArdle quotes lists some of this sort of documentation.

The borrower had to give the lender a statement of cash flow and net worth every quarter?
The property value had to be above a minimum loan-to-value ratio?
The borrower had to maintain an income at some multiple of the monthly loan payment?
The borrower had to maintain a minimum net worth?
The borrower could not make significant changes to the property without lender consent?
Everything had to be personally guaranteed?

The simple fact of the matter is that businesses, and their income, losses and expenses are generally much more complicated than household incomes and budgets, and the economics of a business are likely to vary a lot more than the economics of a household.

Now having stated why I do not think that recourse mortgages are economically necessary, there is the question of where a libertarian, or to be frank even a simple capitalist should stand on the matter. There are two big reasons that I think that people who are libertarian, or who simply believe in capitalism should support non-recourse mortgages.

1.

It is not in the best interests of banks, much less the economy, for banks to be supporting real estate booms premised on false valuations. This doesn't really change whether or not mortgages are recourse, or non-recourse.

Just as things which are bad for an individual in the long run can seem tempting however, the policies which can harm an institution like a bank can seem tempting for a time. Recourse mortgages help to obscure the need for banks to ensure that mortgages are based on sound valuation. A loan officer could imagine that the actual value of a property is not really important, because the buyer can be chased down. This is not likely to be a sound practice, and it is unlikely to pay off, but the temptation is enhanced.

2.

Recourse mortgages are in practical terms, a much less market-based mechanism for loans in the housing market. Most housing foreclosures are not going to be driven by the calculating real-estate speculation of people trying to game the market.

For the majority of foreclosures, where the house buyer cannot afford to pay, making the buyer pay off the entire debt to the best of their ability is likely to involve fairly elaborate calculations of the buyer's ability to pay, by a government official. Just how much debt a person can afford to repay is not a strictly scientific calculation, and the arbitrary aspect of such calculations, encourages additional government intervention in the market, and additional government intervention in incomes.

3.

Recourse mortgages have the potential to create situations where a person is in substantial debt for something which they do not have. If the bank takes away a person's house, but a person is in debt for years or decades to pay for the house that they do not possess, this situation is, in the main, going to be regarded as being unfair by most of the public. The simple dynamic of paying for something that the bank has taken away is so simple a narrative that even when the home buyer behaved irresponsibly, the story will arouse sympathy with the buyer, and anger at the banking system and capitalism in general. A libertarian ideology is advocating minimal government intervention, and to succeed, such government intervention as takes place must seem as simple and as fair as possible.

A look at the counter-capitalist ideologies of today, and going back through the 20'th century is going to show that the great question has always been, do we rely on economics and non-governmental action to obtain what people need, or do we rely on values, mores, and the government. Economists have held that the market and voluntary transactions can fill more holes than many ideologies would claim. The question is, whether the same is true for mortgages, or are mores and detailed and elaborate government enforcement actions needed to hold down mortgage rates. Do you believe in the market?

Regarding Foreclosure Options

Megan McArdle has been commenting on foreclosure and she has made some excellent points, like "the perils of jingle mail", which is to say that returning a house does not, in many states, remove your obligation to pay for it.


With her article"Foreclosure Options" however, she turns to the desirability and ethics of recourse (a mortgage holder can sue you for debt after foreclosing on your property) versus non-recourse mortgages, and comes down heavily on the side of recourse mortgages, particularly in a moral sense.

But another question occurred to me. "Let's turn it around," I asked. "What if the bank decided that it wanted to exercise the same sort of option?"

"What do you mean?"

"What if the bank foreclosed on your house, even though you made the payments, because it figured it could make more money taking the house and selling it?" (Not a likely scenario, I know, but a useful thought experiment.)

I could tell from his face that he didn't think this would be fair. But assuming that the bank can get away with it, why would it be wrong for them to do this? (We were discussing morality, not practicality) If you get to decide when they get the house, and when they get the payments, why is it unfair when they exercise the same option?

There is an outstanding reason that giving a mortgage borrower an "option" to cease payment, and forfeit only the security of the real estate is NOT like giving the bank the option of foreclosing to aquire increased real estate value. When a mortgage borrower stops payment, they lose not only the property, but also all the accumulated equity they have acquired. The bank does not give any money back. The value of accumulated equity lost should be sufficient to compensate banks for their loss of "options" inside a mortgage contract.

The simple morality of mortgage loans aside, there are also sound macro-economic reasons to advocate no-recourse mortgage loans. Real estate bubbles are likely to have a significant and negative effect on the economy at large, affecting even people and businesses who act responsibly. Banks are unlikely to encounter large numbers of people giving up their mortgage equity unless there is a severe devaluation in the real estate market, and a bubble is the most likely cause of this. No-recourse mortgages provide an incentive for banks to discourage, rather than encourage notable real estate bubbles and misvaluations.

This incentive is important even though it is not likely that it will eliminate large market corrections on a multi-generational timescale, like the present economic downturn.


The majority of real estate bubbles and misvaluations take place on a local scale, and will take place at any point in the overall economic cycle. At this very time, there are still a few areas of the country like portions of North Dakota where bubbles are present, or are a risk. These many little bubbles will cumulatively inflict significant economic damage on a national economy over time, unless, and to the extent that they are suppressed. Banks are inevitably better equipped to appraise real estate and evaluate value than most members of the public, and non-recourse mortgages encourage banks to convey this information, or at a minimum, act on their own pricing information to forstall real estate bubbles built on borrowed money, rather than hide this information.