A new Congressional Budget Office (CBO) report compared the cost of three federal loan programs under standard accounting rules and a “fair-value” alternative, which imposes an added cost based on the extra amount that private lenders would charge if they issued the loans or loan guarantees. We view this report as a useful reminder that by making these programs appear to cost more than the government is expected to actually spend on them, fair-value accounting would distort budgeting, putting loan programs at an unfair disadvantage relative to other programs. (The key loan programs at risk are listed here.)
Fair-value accounting adds a penalty, on top of the regular cost estimate, based on the fact that private-sector investors are loss-averse: they dislike losses (in this case, the possibility of higher-than-expected loan defaults) more than they like gains (the possibility of lower-than-expected defaults). For the three programs it examined, CBO estimated that such a loss-aversion penalty would average $22 billion per year for federal student loans, $9 billion per year for single-family mortgages guaranteed by the Federal Housing Administration (FHA), and less than $2 billion per year for the Export-Import Bank’s loans, guarantees, and insurance.
With these loss-aversion penalties, the three programs would appear to lose rather than make money for the federal government. (CBO’s new estimates of these loss-aversion penalties is somewhat smaller than its estimates of last year.)
CBO currently thinks that adding loss-aversion penalties is a good idea, but former CBO Director Robert Reischauer shares our strong opposition. (Our short paper and in-depth analysis provide more details on the problems with fair-value accounting.) Whether one favors or opposes some or all federal credit programs, it is wrong in principle to add non-existent costs to the budget, which — as my colleague Paul Van de Water recently blogged — “would untether the budget from reality.”