“Fair-Value” Proposal Would Artificially Inflate Federal Lending Costs

Charles Lane argues in a Washington Post op-ed today that the official cost estimates of federal loan and loan guarantee programs should include a penalty based on the additional amount that private lenders would charge if they issued the loans and loan guarantees.  But this proposal, to adopt so-called “fair-value accounting,” would make federal credit programs appear to cost more than the government is expected to actually spend on these programs; it would overstate spending, deficits, and debt, as we explained earlier. Some advocates of fair-value accounting wrongly believe that current budget accounting ignores the fact that some borrowers (homeowners, students, and so on) default on their loans.  In reality, the Federal Credit Reform Act of 1990 already demands that budget estimates fully reflect the likelihood of borrower defaults, including the fact that defaults will likely rise during recessions. Some advocates, including Congressional Budget Office (CBO) Director Doug Elmendorf, also argue that even if current accounting methods perfectly represent the expected amount of money that the federal government will spend on these programs, they do not reflect the full “cost” for a different reason. Robert Reischauer, the highly respected former CBO director, explains what the proponents of “fair value accounting” are talking about and why he strongly opposes using that approach in the budget:

The accounting convention used since enactment of the Credit Reform Act of 1990 already reflects the risk that borrowers will default on their loans or loan guarantees. . . . [Fair-market accounting] proposes to place an additional budgetary cost on top of the actual cash flows . . . to reflect a cost to society that stems from the fact that, even if the cash flows turn out to be exactly as estimated, the possibility that the credit programs would cost more (or less) than estimated imposes a cost on a risk-averse public. . . .

A society’s aversion to risk may be an appropriate factor for policymakers to take into account in a cost-benefit assessment of any spending or tax proposal but adding a cost to the budget does not make sense. . . .  Inclusion of a risk aversion cost for credit programs would be inconsistent with the treatment of other programs in the budget (many of which have costs that are at least as uncertain as the costs of credit programs — for instance, many agriculture programs and Medicare) and would add a cost element from a traditional cost-benefit analysis without adding anything based on the corresponding benefit side of such an analysis.  It would also make budget accounting less straightforward and transparent.

[Fair-value accounting] represents a misguided attempt to mold budget accounting to facilitate a cost-benefit analysis, with the result that neither the budget nor the cost-benefit analysis would serve their intended purposes well.  [Emphasis added in bold]

Mr. Lane says, rightly, that policymakers should take into account the societal advantages and disadvantages of federal credit programs when voting on them.  They should do the same when voting on other federal programs and tax policy, as well.  But pretending that the government spends more on these programs than it actually does is the wrong way to accomplish that.