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CBO: Federal Accounting Understates Cost of Credit Programs

Posted By Lachlan Markay On March 6, 2012 @ 4:36 pm In Featured,Ongoing Priorities,Scribe | Comments Disabled

According to the nonpartisan Congressional Budget Office (CBO), measurements of the budget impact of federal credit do not adequately address the risks involved, and may, in some cases, dramatically understate the costs of those programs.

Under the current system, federal accounting practices do not “fully incorporate the cost of market risk,” (emphasis in the original) explained CBO in a new report [1]. Market risk “arises from shifts in macroeconomic conditions, such as productivity and employment, and from changes in expectations about future macroeconomic conditions.”

The expected costs of federal loan and loan guarantee programs are calculated using a model that assumes a zero percent default rate for borrowers, and the insurance rate paid by the Treasury Department for lenders.

But as CBO explains, there is always a risk that the recipient of a federal loan will not be able to pay it back. While that is not technically a default, the shortfall must be made up either through increased taxes or reduced spending elsewhere in the budget. Hence the zero-default assumption skews the true value of government-issued or guaranteed loans.

An alternate method of measuring the costs of these programs known as “fair-value accounting” incorporates the inherent risks in lending, the overhead associated with doing so, and takes into account market interest rates. That provides a more accurate picture of the costs of federal lending programs, according to CBO.

In CBO’s view, a fair-value approach would provide a more comprehensive measure of the costs of federal credit programs to the government than what is currently reported because it would fully incorporate the cost of market risk. (Market risk is the component of financial risk that remains even after investors have diversified their portfolios as much as possible; it arises from shifts in macroeconomic conditions, such as productivity and employment, and from changes in expectations about future macroeconomic conditions.) Treasury rates, which are used for FCRA calculations, are lower than market-based rates primarily because Treasury debt is viewed as having no default risk. But if payments received from borrowers with federal loans fall short of what is owed, the shortfall must ultimately be made up either by raising taxes or by cutting other spending. (Additional federal borrowing can postpone but not avert the need to raise taxes or cut spending.)So, even though the government can fund its loans by issuing Treasury debt and thus does not seem to pay a price for market risk, taxpayers ultimately bear that risk through its potential impact on the federal budget.

CBO also gave some examples of the discrepancies that the two methods for measuring potential expenditures can create. “[T]he average subsidy for direct student loans made between 2010 and 2020 would be a negative 9 percent under FCRA accounting but a positive 12 percent on a fair-value basis,” the report explains.

In other words, current accounting methods would likely predict that this federal credit program would reduce federal expenditures by nine percent of the amount of those loans. A fair-value measure, on the other hand, would peg the cost of the program at an additional 12 percent above those costs. CBO director Douglas Elmendorf has previously stated [2] that FCRA accounting likely understated the cost of the program by about $28 billion.

Some lawmakers have flagged potential inaccuracies in federal accounting for federal lending programs such as the Energy Department’s loan guarantees to green energy companies.

Rep. Paul D. Ryan (R-WI), who chairs the House Budget Committee, asked Herb Allison [3], the official running the administration’s review of DOE’s Section 1705 loan guarantees, to include “an adjustment for market risk” in his accounting of the program’s costs. Doing so, Ryan said, “would show the full subsidy cost of DOE’s loan guarantees and permit a better assessment of the costs of subsidizing these private sector activities.”


Article printed from The Foundry: Conservative Policy News from The Heritage Foundation: http://blog.heritage.org

URL to article: http://blog.heritage.org/2012/03/06/cbo-federal-accounting-understates-cost-of-credit-programs/

URLs in this post:

[1] new report: http://www.cbo.gov/publication/43035

[2] previously stated: http://www.cbo.gov/ftpdocs/113xx/doc11343/03-15-Student_Loan_Letter.pdf

[3] asked Herb Allison: http://budget.house.gov/UploadedFiles/RyanLetterDOE11292011.pdf

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