How government makes things worse

Ethanol and Subprime

What do ethanol and the subprime mortgage meltdown have in common? Each is a
good reminder of that most powerful of unwritten decrees, the Law of Unintended
Consequences - and of the all-too-frequent tendency of solutions imposed by the
state to exacerbate the harms they were meant to solve.

Take ethanol, the much-hyped biofuel made (primarily) from corn. Ethanol has
been touted as a weapon in the fashionable crusade against climate change,
because when mixed with gasoline, it modestly reduces emissions of carbon
dioxide. Reasoning that if a little ethanol is good, a lot must be better,
Congress and the Bush administration recently mandated a sextupling of ethanol
production, from the 6 billion gallons produced last year to 36 billion by
2022.

But now comes word that expanding ethanol use is likely to mean not less CO2 in
the atmosphere, but more. Instead of reducing greenhouse gas emissions from
gasoline by 20 percent - the estimate Congress relied on in requiring the huge
increase in production - ethanol use will cause such emissions to nearly double
over the next 30 years.

The problem, laid out in two new studies in the journal Science, is that it
takes a lot of land to grow biofuel feedstocks such as corn, and as forests or
grasslands are cleared for crops, large amounts of CO2 are released. Diverting
land in this fashion also eliminates "carbon sinks," which absorb atmospheric
CO2. Bottom line: The government's ethanol mandate will generate a "carbon
debt" that will take decades, maybe centuries, to pay off.

Actually, that's not quite the bottom line. Jacking up ethanol production
causes other problems, too. Deforestation. Loss of biodiversity. Depletion of
aquifers. More ethanol even means more hunger: As more of the US corn crop goes
for ethanol, the price of corn has been soaring, a calamity for Third World
countries in which corn is a major dietary staple.

Senator Charles Grassley of Iowa bloviates that "everything about ethanol is
good, good, good," but it plainly isn't, isn't, isn't. The fate of ethanol,
including how much of it is produced, should be determined by the decentralized
process of free exchange - by the voluntary interactions of countless consumers
and producers, buyers and sellers, each acting according to his best judgment
and in his own best interest. Instead, Congress and the president, convinced as
always that they know best, imposed a single, inflexible, ham-fisted directive
from above. The result is that the carbon dioxide they aimed to reduce will be
increased, and many people will suffer unnecessary misfortune.

The subprime mortgage collapse is another tale of unintended consequences.

The crisis has its roots in the Community Reinvestment Act of 1977, a
Carter-era law that purported to prevent "redlining" - denying mortgages to
black borrowers - by pressuring banks to make home loans in "low- and
moderate-income neighborhoods." Under the act, banks were to be graded on their
attentiveness to the "credit needs" of "predominantly minority neighborhoods."
The higher a bank's rating, the more likely that regulators would say yes when
the bank sought to open a new branch or undertake a merger or acquisition.

But to earn high ratings, banks were forced to make increasingly risky loans to
borrowers who wouldn't qualify for a mortgage under normal standards of
creditworthiness. The Community Reinvestment Act, made even more stringent
during the Clinton administration, trapped lenders in a Catch-22.

"If they comply," wrote Loyola College economist Thomas DiLorenzo, "they know
they will have to suffer from more loan defaults. If they don't comply, they
face financial penalties . . . which can cost a large corporation like Bank of
America billions of dollars."

Banks nationwide thus ended up making more and more subprime loans and agreeing
to dangerously lax underwriting standards - no down payment, no verification of
income, interest-only payment plans, weak credit history. If they tried to
compensate for the higher risks they were taking by charging higher interest
rates, they were accused of unfairly steering borrowers into "predatory" loans
they couldn't afford.

Trapped in a no-win situation entirely of the government's making, lenders
could only hope that home prices would continue to rise, staving off the
inevitable collapse. But once the housing bubble burst, there was no escape.
Mortgage lenders have been bankrupted, thousands of subprime homeowners have
been foreclosed on, and countless would-be borrowers can no longer get credit.
The financial fallout has hurt investors around the world. And all of it thanks
to the government, which was sure it understood the credit industry better than
the free market did, and confidently created the conditions that made disaster
unavoidable.

"No man's life, liberty, or property is safe," warned Mark Twain, "while
Congress is in session." Mark Twain was a humorist, but that was no joke.

Jeff Jacoby's e-mail address is jacoby@globe.com