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Fair Value Accounting for Federal Credit Programs 1 (March 2012)

handle is hein.congrec/cbo10662 and id is 1 raw text is: ISSUE BRIEF MARCH 2012 Fair-Value Accounting for Federal Credit Programs The federal government supports some private activities-such as home ownership, postsecondary education, and certain commercial ventures-through credit assistance offered to individuals and businesses. Some of that assistance is in the form of direct federal loans, and some is through federal guarantees of loans made by private financial institutions. At the end of fiscal year 2011, about $2.7 trillion was outstanding in such federal direct loans and loan guarantees.' The cost of pro- viding credit assistance is an important consideration for policymakers as they allocate spending among programs and choose between credit assistance and other forms of aid such as federal grants-but assessing cost is not a sim- ple matter. Indeed, it is more difficult to measure the cost of credit assistance than to assess the costs of other forms of aid because the measurement of the cost of credit assis- tance must account for future cash flows of uncertain amounts that can continue for many years. According to the rules for budgetary accounting pre- scribed in the Federal Credit Reform Act of 1990 (FCRA, incorporated as title V of the Congressional Budget Act of 1974), the estimated lifetime cost of a new loan or loan guarantee is recorded in the budget in the year in which the loan is disbursed.2 That lifetime cost is generally described as the subsidy provided by the loan or loan 1. The figures for federal credit outstanding and new lending activity cited in this document exclude the activities of Fannie Mae and Freddie Mac, even though the government placed the two entities into conservatorship in 2008 (as discussed later). The figures also exclude purchases by the Treasury of securities issued by Fannie Mae and Freddie Mac, the financial assets acquired through the Troubled Asset Relief Program, amounts committed to the Inter- national Monetary Fund, and certain other transactions that involve credit assistance but that generally are not considered direct federal loans or loan guarantees. Consolidation loans offered by the Department of Education are counted toward credit outstanding but excluded from new lending activity because the Congressional Budget Office considers those loans extensions of the original loans. 2. Section 504(d) of FCRA, 2 U.S.C. § 661c (d) (2006). guarantee. It is measured by discounting all of the expected future cash flows associated with the loan or loan guarantee-including the amounts disbursed, prin- cipal repaid, interest received, fees charged, and net losses that accrue from defaults-to a present value at the date the loan is disbursed. A present value is a single number that expresses a flow of current and future income, or payments, in terms of a lump sum received, or paid, today; the present value depends on the rate of interest, known as the discount rate, that is used to translate future cash flows into current dollars.3 FCRA-based cost estimates, however, do not provide a comprehensive measure of what federal credit programs actually cost the government and, by extension, taxpay- ers. Under FCRAs rules, the present value of expected future cash flows is calculated by discounting them using the rates on U.S. Treasury securities with similar terms to maturity. Because that procedure does not fully account for the cost of the risk the government takes on when issuing loans or loan guarantees, it makes the reported cost of federal direct loans and loan guarantees in the fed- eral budget lower than the cost that private institutions would assign to similar credit assistance based on market prices. Specifically, private institutions would generally calculate the present value of expected future cash flows by discounting those flows using the rates of return on private loans (or securities) with similar risks and maturi- ties. Because the rates of return on private loans exceed Treasury rates, the discounted value of expected loan repayments is smaller under this alternative approach, which implies a larger cost of issuing a loan. (Similar rea- soning implies that the private cost of a loan guarantee would be higher than its cost as estimated under FCRA.) 3. For example, if an investment that will yield $100 one year in the future is discounted at 5 percent, its value today is $95. 4. See Congressional Budget Office, FeJeral LoanGuarantees for the Construction ofNuclear Pouer Piants, Appendix C (August 2011).

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