Fair-Value Estimates of the Cost of Federal Credit Programs in 2013

Report
June 28, 2012

Subsequent estimates appear in Fair-Value Estimates of the Cost of Selected Federal Credit Programs for 2015 to 2024.

The federal government supports some private activities by providing credit assistance to individuals and businesses. Some of that assistance is in the form of direct loans, and some, in the form of guarantees of loans made by private financial institutions. Although about a hundred federal programs provide such assistance, just a few programs provide more than three-quarters of it: specifically, the programs offering student loans, single-family mortgage guarantees, and direct loans and loan guarantees for small businesses.

In this report, CBO provides an illustrative analysis of the federal government’s costs for those credit programs following two approaches:

  • The procedures currently used in the federal budget as prescribed by the Federal Credit Reform Act of 1990 (FCRA): Under those procedures, the lifetime costs of credit programs are recorded up front on an accrual basis. Those costs are measured by discounting the government’s future cash flows to a present value using the rates on U.S. Treasury securities with similar terms to maturity.
  • An alternative approach in which cost is based on an estimate of the market value of the federal government’s obligations—termed a fair-value approach.

Lawmakers have considered changing federal budgetary accounting to require a fair-value approach. If that approach was adopted, most programs that have budgetary savings under FCRA procedures would have a cost under a fair-value approach.

How Would the Federal Government’s Costs for the Credit Programs Differ Under the Two Approaches?

Using FCRA procedures, CBO estimates that new loans and loan guarantees issued in 2013, in the amount of $635 billion assumed for this analysis, would generate budgetary savings of $45 billion over their lifetime—thereby reducing the budget deficit. In contrast, using a fair-value approach, CBO estimates that those loans and guarantees would have a lifetime cost of $11 billion—thereby adding to the deficit. Much of the difference between those two amounts derives from the valuation of student loans: Under FCRA procedures, those loans generate very large budgetary savings per dollar lent compared with other federal credit assistance; under the fair-value approach, most of those savings disappear.

Why Would the Costs for Credit Programs Be Higher Under the Fair-Value Approach?

Costs for all credit programs would be higher under the fair-value approach because it accounts more fully than FCRA procedures do for the cost of the risk the government takes on when issuing loans or loan guarantees. In particular, the fair-value approach accounts for the cost of market risk, and FCRA procedures do not.

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. The government is exposed to market risk because when the economy is weak, borrowers default on their debt obligations more frequently, and recoveries from the borrowers are lower. When the government extends credit, the associated market risk of those obligations is effectively passed along to taxpayers, who, as investors, would view that risk as having a cost.

What Data Did CBO Use for Its Analysis?

To facilitate computation of the estimates for this analysis, CBO used its own projections of the volume of loans and cash flows for some programs and projections by the Office of Management and Budget (OMB) and other federal agencies for others. In particular, CBO used its own estimates for the Department of Education’s student loan programs and the Federal Housing Administration’s (FHA’s) single-family mortgage guarantee program, because those estimates are a routine part of its budget baseline projections. However, because CBO does not ordinarily project the detailed cash flows required to estimate the costs for most of the other, smaller federal credit programs, the agency relied on other federal agencies’ projections of those cash flows for the purpose of comparing the two methods of accounting.

Consequently, in the aggregate, the lending levels and costs described in this report are illustrative—in particular, they differ from those underlying CBO’s baseline estimates or its analysis of the President’s budget—but they provide a good basis for comparing the overall budgetary impact of the two ways of accounting for the costs of credit programs.