Wherein I Argue with both the WaPo Editorial Page and CBO

June 4th, 2014 at 10:11 am

Let’s talk about fair-value accounting (FVA)!

Hey, where ya goin’?–get back here right now!!

This morning’s WaPo editorial page takes what I and my CBPP colleagues have long considered the wrong view about how the federal budget should account for its lending programs.  I take you through the weeds here, but the long and short of it is that the WaPo and others, including (importantly) CBO, argue that the federal budget should raise the risk premium on government loans in such a way that would reflect higher costs to the budget than is currently the case.

Here’s where the WaPo betrays a significant misunderstanding of the issues at stake here:

The policy rationale [for current accounting vs FVA] is that government, unlike banks, is relatively indifferent to credit risk; its social priorities, such as educating the populace and promoting homeownership, override getting every last dime back for the taxpayers. If you forced Congress to account for the market risks of its portfolio, that would limit its ability to spend on other worthy purposes.

Government’s “social priorities” have nothing to do with it.  Our current approach would be correct if we were underwriting pet rocks instead of education (and current rules would enforce the reflection of the relative default risks such a switch would entail).

What’s relevant here is the fact that private lenders face various disadvantages relative to the government and they reasonably want to be compensated for them, so they charge more for their loans.  They can’t borrow as cheaply as Uncle Sam, they can’t tax, they can’t print money, they won’t make loans unless they expect to make a profit on them, and so they’re more risk averse.  So they add a risk-premium to their interest rate.

This doesn’t make the government a riskless lender, of course.  The full likelihood of defaults or late payments and the probability of changes in interest rates need to be taken account of – as they already are.  But to charge the government for market risks it does not face is to create phantom costs, which in turn, invoke the need for phantom offsets.

I can see why the hawkish WaPo editorial page favor a move to FVA but I don’t get the CBO’s rationale.  And they are, of course, an extremely powerful voice in this debate.  In my earlier piece (see link above), I tried to empathize thusly:

The FVAers [including CBO] seem to think the current accounting methods give the government an unfair advantage over private lenders, and want to put them on equal footing.  They seem put out, for example, by the fact that our student loan program is scoring as a “negative subsidy”—it’s making money—right now, as the government is taking advantage of favorable spreads between its borrowing and lending costs.

Perhaps the FVAers want to artificially pump up the budgetary costs of the loans because they worry that a government that can lend more cheaply than the private sector will fail to impose enough discipline on its lending programs.  While I’m obviously opposed to the shift to FVA, that’s not an unreasonable concern.  I don’t want to see the government take advantage of its unique ability to lend at lower costs than private lenders such that it gets into all kinds of different markets.  Student loans are different, since they support an important public good.  But if this is the FVAer’s motivation, I kinda see where they’re coming from.

See…real fiscal empathy!  But that doesn’t make it right.

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12 comments in reply to "Wherein I Argue with both the WaPo Editorial Page and CBO"

  1. Smith says:

    (some typos corrected with apologies for length)

    I disagree with the use of the word “don’t” in the following statement:
    “I don’t want to see the government take advantage of its unique ability to lend at lower costs than private lenders such that it gets into all kinds of different markets.”

    The big three of non commercial lending are mortgages, student loans, and consumer debt and we’re into them up to our necks. We the people already finance the finance industry not only because they are too big to either fail or jail.

    http://www.cnbc.com/id/100946537 August 13, 2014
    “Nearly 90 percent of mortgages written today are backed by Fannie or Freddie.”
    (maybe it’s dropped to 89% since this was a year ago, extensive googling for more up to date figure left as an exercise for the reader)

    http://www.asa.org/policy/resources/stats/ of the trillion of student loans August 29, 2012
    “Roughly $864 billion is outstanding federal student loan debt while the remaining $150 billion is in private student loans(Source: Consumer Finance Protection Bureau)”
    sourced from http://files.consumerfinance.gov/f/201207_cfpb_Reports_Private-Student-Loans.pdf

    Lack of regulation in consumer loans was deemed so important a new agency was created with nearly 1,000 employees and 1/2 billion dollar budget.
    http://en.wikipedia.org/wiki/United_States_Consumer_Financial_Protection_Bureau

    Prior to 1978, individual states had for hundreds of years capped the interests banks could charge on consumer loans. The state limits still exist but the Supreme Court ruled in ’78 national banks were exempt, so now national banks predominate.
    http://en.wikipedia.org/wiki/First_National_Bank_of_Boston_v._Bellotti

    New legislation removed moral hazard of high risk loans, by effectively removing bankruptcy as a threat to unscrupulous lenders. This and previous legislation also contributed to run away tuition costs by not allowing student loans to be dischargeable.
    http://en.wikipedia.org/wiki/Bankruptcy_Abuse_Prevention_and_Consumer_Protection_Act

    The high water mark of government involvement in finance was post WWII VHA loans because an entire generation qualified for the program. Similarly the GI Bill covered so many because nearly every able bodied man served. In fact, it didn’t loan money, it outright granted tuition, providing enough to even attend Harvard (this before era of unnecessarily skyrocketing tuition) and with a stipend. And as indicated, since colonial times, debt on consumer loans was severely restricted. That limit as well the threat of bankruptcy wiping out loans gave lenders incentive not to entice people into onerous debt at usurious rates. Those controls are no longer in effect. The government needs to get more involved. But the financial industry opposes continuing Fannie and Freddie, and the 30 year mortgage, restoration of usury law and bankruptcy rights, and the already executed government takeover of government backed student loans.


  2. Jason Delisle says:

    This is rich. The CBPP says it doesn’t get CBO’s rationale for Fair Value, but it invoked that exact same rationale and cited the CBO when it was arguing against private investment accounts for Social Security.

    Read Jason Furman’s paper http://www.cbpp.org/files/6-2-05socsec.pdf on the topic. He explains that not risk-adjusting the returns on government investment is misleading accounting — it suggests a “free lunch” when there is none.

    Here is Furman writing for the CBPP invoking CBO’s rationale for fair value, verbatim: “The Congressional Budget Office discussed this matter in a report it issued several years ago, in which it examined the effect of having the U.S. Government shift some of its assets from Treasury bonds to stocks. CBO noted: ‘Government investment in private securities does not offer a free lunch: although it would increase the expected value of budgetary resources, it would do so at the cost of exposing the government, future taxpayers, and beneficiaries of federal programs to greater risk. If that risk was taken into account, the returns on private securities would be no greater than the returns on government securities'” (emphasis added).

    Jason Delisle
    New America


    • Peter K. says:

      It would increase risk to shift from Social Security to private accounts. There would be a cost. The CBO’s rationale doesn’t involve shifting anything to riskier investments. It’s just saying that the government’s budget accounting has the private sector as more credit worthy than it really is.

      It’s only data or evidence as far as I can tell is “For years, officials insisted the Federal Housing Administration would never need a bailout despite the brutal home price collapse; in 2013, the FHA absorbed $1.7 billion from the treasury.”

      So the government should act more like a private sector bank because of the massive lack of discipline and restraint in the private sector which resulted in the “brutal” housing bubble bust?

      Sometime I wish the government would act like a for-profit monopoly. Like after the “brutal” financial crisis it should have nationalized two-thirds of the financial sector and scored epic amounts of assets on the cheap. Then it should unilaterally raise taxes progressively on the top 10 to 1 percent and raise capital gains, estate, wealth and financial taxes so that’s it’s in the black. Budget discipline! Then engage in some infrastructure building and move back a little into the red because the private sector needs Treasuries as safe assets.


  3. Tom in MN says:

    Wouldn’t a proper fair value accounting of student loans result in a negative interest rate? That is, if we pay people to get educated we (the whole country) make out in the long run because of their greater productivity and additional taxes they pay? This is factoring in the risk that the person does not get educated if they can’t afford the loan and hence contributes less to the country.

    This is clearly different from a private loan where the company can’t claim to reap (at least directly) any of the gains from the person getting educated.


    • Robert Buttons says:

      That’s “blue sky” economics.You are ignoring opportunity costs and (falsely) assuming everyone benefits from college.


  4. Larry Signor says:

    I will take a clue from Dean Baker. The WaPo states there was a $1.7 billion bailout of the FHA in 2013 but they do not have the links to this data. Let us give them the benefit of the doubt. Federal spending in 2013 was 3,454 billion dollars. (http://www.cbo.gov/publication/44716) 1.7/3,454= 4.9218297625940938042848870874349e-4, or less than .0004 % of federal spending in 2013. Are you all worried yet? And as an aside, why shouldn’t the government have an advantage over private lenders? We, as a nation, should pay a premium to private lenders for financing our nation in a currency that we, the people, own? Just down home econ resists that idea. When r>g, some re-alignment may be necessary. Isn’t that where most of the economic discourse leads today?


    • Robert buttons says:

      I don’t think, “its only a small % of the total budget so we should waste it” is a valid argument.


      • Larry Signor says:

        Again, you provide no data for you opinion. How do we determine if the $1.7 billion was “waste(d)” and who are you quoting? As for your free market “mumbo jumbo”, there are very few Americans, including you, who have not benefited from some financial inter-mediation by the Federal Government. Not me! you say. You don’t eat meat, cheese, fish, vegetables, have a savings or checking account, drive on the Interstate Highway system, fly on an airplane, or poop in a federally financed sewage treatment system? Ever? Really??


  5. Robert Buttons says:

    We heard all the “riskless loan” mumbo jumbo with Fannie and Freddy

    In a free market economy, the govt should not be underwriting loans. period. problem solved.


  6. Alan says:

    The CBO method that Delisle has been pushing for years, now, is complete nonsense. Instead of looking at historical sales of federal student loan assets in valuing federal student loans, this method completely ignores this data, and uses high interest private loans to benchmark to.

    This violates the first rule of fair value accounting.

    What CBO is doing (and what Delisle refuses to defend) is tantamount to Exxon pointing to a guy selling biodiesel for $8/gallon (where Exxon sell its gas for $4), and using this as a justification for claiming a loss of $4 for every gallon it sells! It is, frankly, FRAUDULENT accounting that I would say makes Enron’s FVA shenanigans PALE in comparison.

    I would be ok with using Fair Value Accounting to value federal student loans, and would take income/loss estimates that flowed from it seriously if it was done according to accepted Fair Value Accounting methodology. This would mean using existing sales data of federal student loans as a benchmark, and using ACTUAL DEFAULT RECOVERY RATES to calculate risk.

    The fact is that the federal government has been MAKING, not losing money on defaults for years, and this is shown clearly in many years of White House Budget data. Jason has been using this FVA accounting gimmickry to hide this fact for years, and it has harmed millions of people, while providing camoflage for a structurally predatory, big-government monstrosity that Heritage, Cato, and other conservative groups pushing this accounting method used to fight against.

    Jason: You have run away from this criticism more times than I can count. That you have somehow managed to hold onto any shred of credibility on this issue is astonishing to me. That you would dishonor yourself repeatedly at this late date is beyond astonishing.


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