Accounting for the Cost of Government Credit Assistance
The Financial Economist's Roundtable (FER) believes that use of FCRA accounting rules to calculate the budgetary costs of federal credit programs has resulted in the systematic understatement of the cost of these programs. This distortion occurs because of the failure of FCRA rules to account for the full cost of all of the risks associated with providing such credit.
The apparent cost advantage of government credit assistance over private lenders is, in the opinion of the FER, primarily due to FCRA accounting rules, rather than to any inherent economic advantage of the government. Under FCRA rules the recorded budgetary costs of most federal credit programs are calculated by discounting to the present the projected expected cash flows over the life of the loan or guarantee using current, maturity-matched, Treasury interest rates as the discount factors. Use of Treasury rates as discount factors, however, fails to account for the costs of the risks associated with government credit assistance -- namely, market risk, prepayment risk, and liquidity risk. Those costs must ultimately be borne by taxpayers, just as they must be borne by the equity holders (owners) of private lenders that make private loans. Also, the government’s practice of using Treasury rates to discount risky cash flows would generally be precluded by private sector accounting practices. Thus, FCRA rules cause government accounting to be inconsistent both with basic economic valuation principles and with financial reporting by the private sector.
The FER believes that, to correct this undervaluation of costs, current FCRA rules should be amended to require an approach to cost estimation that fully recognizes the cost of risk in the government’s credit programs. This can be accomplished by the use of discount rates that capture all risks borne by taxpayers, and in particular by the use of discount rates consistent with market-based or fair value estimates of cost. This proposal, it should be noted, is consistent with Title 1 of HR 3581, the “Budget and Accounting Transparency Act of 2012,” now before the Congress, which would amend FCRA by mandating a fair-value approach to credit cost estimates.
Adoption of our proposed remedy would make the true budgetary implications of credit assistance more transparent to program administrators, policy makers and the public. It would also eliminate a number of perverse incentives caused by use of current FCRA rules. In particular, (1) credit and non-credit assistance would be made more comparable in the budgetary process; (2) the government would be able to buy and sell loans at market prices without significant budgetary effects, eliminating the current budgetary arbitrage opportunity in buying loans at market prices and booking them at higher FCRA values; and (3) the privatization of Fannie Mae and Freddie Mac would be facilitated. While the FER recognizes that adopting new procedures will entail additional administrative costs for the government, we believe that the potential benefits of improved cost estimates for government credit programs will significantly exceed the costs.
Lastly, the FER wants to emphasize that the focus of this statement is on the appropriate methodology to use when measuring and accounting for the costs associated with government credit programs. It does not deal with the potential benefits of these programs. Determining whether a particular government credit program is in the public interest requires a careful assessment of both costs and benefits. Nevertheless, a critical component of such analyses is to obtain an accurate measure of the budgetary cost associated with a government credit program, which adoption of our proposed remedy would accomplish.