Crony Capitalism
Mariah Andrade
February 16, 2022
PLCY 704- Economics and Public Policy
History of Crony Capitalism in the United States
Crony capitalism is defined as “an economic system in which individuals and businesses
with political connections and influence are favored (as through tax breaks, grants, and other
forms of government assistance) in ways seen as suppressing open competition in a free market.”
(Merriam-Webster, n.d.) connections. Normally when this is seen people will vote to have an
increase in government intervention. However, it can be seen that more government intervention
can make matters worse. “When people in government are given power to regulate, to spend
money, or to benefit some at the expense of others, cronyism is inevitable.” (Mercatus, 2018)
With that being said, it would be more effective to limit government intervention.
There are a few reasons why cronyism develops, including; rent-seeking, regulatory
capture and interest group politics. Rent-seeking is when the government is in a position to
award privileges such as tariffs, quotas, and monopoly licenses, businesses have an incentive to
devote resources to acquiring favors rather than providing what customers value.Regulatory
capture is when regulated industries are often able to form a concentrated interest and actively
tilt the regulatory process in their favor. Interest group politics refers to when success comes
from political connections rather than productive market activity.” (Mercatus, 2018)
The government enables crony capitalism through enhancing direct money transfers,
entry hindrance, direct price control mechanism and creating rules that influence complements
and substitutes. (Rubin, 2015) The first example of crony capitalism in America can be seen
when the government bailed out Wall Street and the AIG. “The triumphs of crony capitalism
took place on October 3, 2008. Capitol Hill approved the $700 billion TARP (Troubled Asset
Relief Program) bill to bail out Wall Street. This spasm of financial market intervention,
including multi trillion-dollar support lines provided to the big banks and financial companies by
the Federal Reserve, was but the latest brick in the foundation of a fundamentally anti-capitalist
régime known as “Too Big to Fail” (TBTF). (Stockman, 2013)
Crony capitalism was seen in the form of Government Sponsored Enterprises, known as
Fannie Mae and Freddie Mae. “The purpose of these GSEs is to create a secondary market for
mortgages to increase the flow of credit within the mortgage industry and reduce the risk for
investors.” (Herrick, 2015) Fannie Mae and Freddie Mae were established to try to bring
affordable financing options to the housing market with mortgage-backed securities. These loans
were sold to investors, increasing money for homes and lower interest rates. Because Fannie and
Freddie Mae were both privately owned and government-sponsored, it gave them an advantage
in the market and made them susceptible to crony capitalism.
Before the financial crisis, Fannie and Freddie Mae both benefited from the low-interest
rates, were able to ignore industry regulations, and were not bound by the SEC. This is what
gave them the distinction of too-big-to-fail. “The government further contributed to the
conditions of crony capitalism within Fannie and Freddie by using their influence over the GSEs
to pressure both organizations to lower loan standards and guarantee housing loans to
increasingly risky investors, including those with bad credit ratings, or incomes that could not
support mortgage payments.” (Herrick, 2015) These policies and the overconfidence of the
market projection led to the crisis in 2008 that put the housing market and economy at risk.
Crony capitalism was responsible for monopolizing Fannie and Freddie and maintaining the
monopolization. It has facilitated Fannie and Freddie in circumventing antitrust laws and
regulations, which resulted in negligent and risky behavior within these GSEs, and is at least, in
part, responsible for the 2009 crash of the mortgage industry and housing market” (Herrick,
2015)
In 2006, the U.S. housing market reached its highest, creating the U.S. housing bubble.
This was caused by an increase in housing prices, which was caused by an increase in demand
with limited supply. The prices increased along with the number of investors because of the idea
that they could make a lot of profit in a short amount of time. “However, shortly after the
housing industry’s peak in 2006, supply began to overtake market demand and by December
2008, the US home price index reported the largest price drop in history, declining 18.2% in just
under a year.” (Herrick, 2015) What started as a get-rich-quick scheme became an economic
crisis that affected the entire world. Mortgages became delinquent and many houses went into
foreclosure. This caused a decrease in housing securities and investments. “The government
reacted to the crisis by proposing a bailout of the U.S. housing market and allocated over $900
billion in federal funds to rescue the housing industry, $400 billion of which went to
government-sponsored enterprises Fannie Mae and Freddie Mac.”(Herrick, 2015)
Speculative Financing in the United States and the Economic Crisis
“When it comes to economics, speculation, or speculative trading, refers to the act of
conducting a financial transaction that has substantial risk of losing value but also holds the
expectation of a significant gain or other major value.” (Chen, 2022) Housing speculation had a
direct effect on the economy and led to the recession in 2008. “By driving up housing demand,
housing speculation may have boosted the supply side of the housing market during the boom.
The increased housing supply would then overhang the housing market and the local economy
during the bust.” (Gao, et al., 2020)
The overhang channel of supply and an increase in the housing speculation had a greater
increase in housing construction at the same time that turned into the construction sector bust
later down the line. Speculative financing also contributed to the housing crisis. During the U.S
housing boom, many people were buying more non-owner occupied houses as investments.
Supply overhang and the increase in the purchasing of homes led to the boom and bust of the
economy.
Many home buyers with low income were blamed for the housing crisis. This being that they
were accepting loans that they knew they could not afford to maintain.
Crony Capitalism and the Housing Market
The housing market crisis was fueled by lenders whose intent was to lend risky
mortgage-backed securities to other investors for a profit. So, lenders who were loaning money
to people would not be able to keep up with the payments. The lenders did not care whether or
not the loans could be repaid because they would profit from them before they were defaulted
with no consequences. Because financial institutions were controlling all sections of mortgage
securitization, it meant that the financial institutions would gain more of a profit by charging
more. Another way that financial institutions were cutting corners was that they were committing
fraud, “ such as overstating a borrower’s income and over-promising investors on the safety of
the MBS products they were being sold.” (Reserve Bank of Australia, 2022) This shows that the
investors and financial institutions were taking advantage of the situation for their own gains.
Interventions by the Fed
When big financial companies were going bankrupt the Fed bailed out AIG, and a few
weeks later, Congress passed the Troubled Asset Relief Program (“TARP”), which allocated
$700 billion to stabilizing the financial system.” (Weinburg, 2022) The goal of TARP was for the
government to buy mortgage-backed securities and bank stocks. By doing this, the government
gave the financial institutions the idea that they could take these risks and there would be no
consequences to their actions. This was basically enabling financial institutions and investors to
loan out the money to whomever in order to make a quick profit.
Biblical Perspective of Crony Capitalism
“Crony Capitalism confers benefits to some while harming others, and compare this to
Biblical commandments to treat people impartially and to love one’s neighbor, and how
government action that facilitates Crony Capitalism goes beyond its God-ordained role.”
(Haymond, 2016) The leaders with political power use their power to sway public policy in the
direction that favors their interests, while sacrificing others who do not have the same power. The
Bible mentions the unrighteousness in how the rich treat the poor, but that can be interpreted to
mean many other things, such as how the powerful treat the weak.
Chen, J. (2022, February 8). Speculation. Investopedia. Retrieved from
https://www.investopedia.com/terms/s/speculation.asp#:~:text=In%20the%20world
%20of%20finance,gain%20or%20other%20major%20value.
Gao, Z., Sockin, M., & Xiong, W. (2020, January 26). Housing speculation and its economic
consequences. VOX, CEPR Policy Portal. Retrieved from
https://voxeu.org/article/housing-speculation-and-its-economic-consequences
Haymond, J. (2016, April 7). Biblical Critique of Crony Capitalism. Cedarville University
DigitalCommons@Cedarville. Retrieved from
https://digitalcommons.cedarville.edu/cgi/viewcontent.cgi?
article=1184&context=business_administration_publications
Herrick, C. (2015, April 1). "Crony Capitalism and Its Effects on GSE’s within the US Housing
Industry". Brigham Young University Scholars Archive. Retrieved from
https://scholarsarchive.byu.edu/
Mercatus. (2018). Crony Capitalism: By-Product of Big Government.
https://www.mercatus.org/system/files/holcombe-crony-capitalism-sum-v1.pdf
Merriam-Webster. (n.d.). Crony capitalism definition & meaning. Merriam-Webster. Retrieved
June 9, 2022, from https://www.merriam-webster.com/dictionary/crony%20capitalism
Rubin, P. H. (2015). Crony capitalism. Supreme Court Economic Review, 23(1), 105–120.
https://doi.org/10.1086/686474
Stockman, David. The Great Deformation: The Corruption of Capitalism in America. New York:
Public Affairs, 2013. ISBN: 9781610395236.
