Barney Frank's Insane Muni Bond Guarantee

The Wall Street Journal shreds Barney Frank’s proposal to create an FDIC-like federal insurance program for municipal bonds.  It’s a devastating critique that is made all the easier by Frank’s crazy talk about the program costing the federal government nothing at all.

Politicians tend to like insuring assets because they can pretend insurance is free—they don’t have to borrow or raise taxes to pay for it.  By the time the bills come due, the politician may have moved onto greener pastures and the public will likely have forgotten the promises of free money. At best, the price of insurance simply gets passed onto future generations. 

The best—or worst—example of this process is the implicit guarantee of  Fannie Mae. For years politicians pretended that the implicit government guarantee was not only costless, it was actually saving Americans money by reducing their mortgage costs. When this scheme to provide “free” insurance for Fannie’s debt fell apart, the costs of bailing out Fannie wound up being more than all the mortgage cost savings.

Part of the reason these plans don’t work is that insurance affects behaviour. As the Journal points out, federal bond insurance would encourage catastrophic moral hazard: local politicians would rack up debt that taxpayers would be forced to make good on down the road.  Faced with the choice of cutting spending, raising local taxes or shifting the burden to the federal government, the choice would inevitably be to tap the insurance. Politicians would deny that this was irresponsible—after all they paid insurance premiums into the plan. Why shouldn’t they tap it?

As the Journal says, one Fannie Mae is enough. Let’s not create a nation of local disasters.

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