[Joint House and Senate Hearing, 114 Congress]
[From the U.S. Government Publishing Office]
S. Hrg. 114-83
THE ECONOMIC EXPOSURE OF FEDERAL CREDIT PROGRAMS
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HEARING
BEFORE THE
JOINT ECONOMIC COMMITTEE
CONGRESS OF THE UNITED STATES
ONE HUNDRED FOURTEENTH CONGRESS
FIRST SESSION
__________
JUNE 17, 2015
__________
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JOINT ECONOMIC COMMITTEE
[Created pursuant to Sec. 5(a) of Public Law 304, 79th Congress]
SENATE HOUSE OF REPRESENTATIVES
Daniel Coats, Indiana, Chairman Kevin Brady, Texas, Vice Chairman
Mike Lee, Utah Justin Amash, Michigan
Tom Cotton, Arkansas Erik Paulsen, Minnesota
Ben Sasse, Nebraska Richard L. Hanna, New York
Ted Cruz, Texas David Schweikert, Arizona
Bill Cassidy, M.D., Louisiana Glenn Grothman, Wisconsin
Amy Klobuchar, Minnesota Carolyn B. Maloney, New York,
Robert P. Casey, Jr., Pennsylvania Ranking
Martin Heinrich, New Mexico John Delaney, Maryland
Gary C. Peters, Michigan Alma S. Adams, Ph.D., North
Carolina
Donald S. Beyer, Jr., Virginia
Viraj M. Mirani, Executive Director
Harry Gural, Democratic Staff Director
C O N T E N T S
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Opening Statements of Members
Hon. Daniel Coats, Chairman, a U.S. Senator from Indiana......... 1
Hon. Carolyn B. Maloney, Ranking Member, a U.S. Representative
from New York.................................................. 3
Hon. Mike Lee, a U.S. Senator from Utah.......................... 5
Witnesses
Dr. Douglas Holtz-Eakin, President, American Action Forum,
Washington, DC................................................. 7
Mr. Jason Delisle, Director, Federal Education Budget Project,
New America, Washington, DC.................................... 8
Mr. Douglas Elliott, Fellow, Brookings Institution, Washington,
DC............................................................. 10
Dr. Paul Van de Water, Senior Fellow, Center on Budget and Policy
Priorities, Washington, DC..................................... 12
Submissions for the Record
Prepared statement of Hon. Daniel Coats.......................... 28
Letter dated June 16, 2015, from the National Education
Association to Representative Maloney.......................... 29
Letter dated June 16, 2015, from the National Association of Home
Builders to Senator Coats and Representative Maloney........... 31
Letters for the record submitted by Representative Maloney....... 34
Prepared statement of Hon. Carolyn B. Maloney.................... 51
Prepared statement of Dr. Douglas Holtz-Eakin.................... 53
Prepared statement of Mr. Jason Delisle.......................... 60
Prepared statement of Mr. Douglas Elliott........................ 71
Prepared statement of Dr. Paul Van de Water...................... 82
Questions for the Record submitted by Senator Mike Lee and
responses from Dr. Douglas Holtz-Eakin and Mr. Douglas Elliott. 84
Question for the Record submitted by Senator Bill Cassidy and
response from Dr. Douglas Holtz-Eakin.......................... 90
Questions for the Record submitted by Congresswoman Alma Adams
and responses from Dr. Paul Van de Water and Mr. Douglas
Elliott........................................................ 92
Letter dated June 17, 2015, from Deborah Lucas to Chairman Coats,
Ranking Member Maloney, and Members of the JEC................. 94
THE ECONOMIC EXPOSURE OF FEDERAL CREDIT PROGRAMS
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WEDNESDAY, JUNE 17, 2015
Congress of the United States,
Joint Economic Committee,
Washington, DC.
The Committee met, pursuant to call, at 10:00 a.m. in Room
216 of the Hart Senate Office Building, the Honorable Dan
Coats, Chairman, and Mike Lee, presiding.
Representatives present: Schweikert, Grothman, Carolyn B.
Maloney of New York, Delaney, Adams, and Beyer.
Senators present: Coats, Lee, Cotton, Sasse, Klobuchar, and
Heinrich.
Staff present: Connie Foster, Harry Gural, Colleen Healy,
David Logan, Viraj Mirani, Barry Nolan, Leslie Phillips, Sue
Sweet, Jim Whitney, and Phoebe Wong.
OPENING STATEMENT OF HON. DANIEL COATS, CHAIRMAN, A U.S.
SENATOR FROM INDIANA
Chairman Coats. The Committee will come to order.
The Committee today will examine the economic exposure of
Federal credit programs. I would like to thank our witnesses
for being here. We will be introducing them shortly.
As I begin, I want to thank Senator Mike Lee for agreeing
to spearhead this program. He helped with us in terms of
putting all this together and inviting the witnesses. He will
be here very shortly.
I have a conflict and have to be on the Senate floor. I
apologize to the witnesses and my Committee members here that I
have to do this, but I will put it in the capable hands of
Senator Lee to conduct this hearing.
He has played a leading role in raising attention to this
issue. As I have indicated, he and his staff have helped us in
putting together the hearing, including identifying some of our
witnesses.
Today we will examine why accounting for our federal assets
matters, and why inaccurate monitoring can bring economic harm
to borrowers who pay higher interest rates to cover the
defaults of others, private lenders who are frozen out of the
markets they seek to serve, and taxpayers who may be exposed to
unqualified losses.
During my prior service in the Senate, I was one of the nay
votes for the Omnibus Budget Reconciliation Act of 1990.
Twenty-five years later, I never imagined that I would be
chairing a hearing to debate the impact of accounting rules
passed back then.
This situation reminds me of an old Yogi Berra quote, ``The
future ain't what it used to be.'' The 1990 Reconciliation law
included the Federal Credit Reform Act, accounting rules
crafted in reaction to the rocky credit history of the 1980s.
The Resolution Trust Corporation held the assets of failed
savings and loans and put the Federal Government in the loan-
workout business. Sadly, fraudulent student loans made during
the decade, that decade, led to a 20 percent student-loan
default rate and a loss equal to almost 10 percent of
outstanding loans.
Cash accounting for all these asset changes within a budget
year presented a volatile picture of the Federal budget that
properly represented spending trends. Since then, the Federal
Government has followed the rules of FCRA, recording an annual
present-value adjusted, quote, ``subsidy cost'' to account for
losses it may incur in the future charged against loans it has
made directly, as well as guarantees it provided for loans made
by others.
It took 10 years to refine the complicated net present
value calculations used for FCRA, but by 2002 government
accountants calculated that the federal portfolio of $1.3 to
$1.4 trillion in loans and guarantees generated annual subsidy
costs in the range of $5 to $12 billion.
This brings us to the financial crisis of 2008 which
ballooned the government's loan assets. FCRA's accounting rules
converted loan subsidy costs into deficit reducers. Since 2008,
government accountants have booked nearly $200 billion in
annual subsidy gains while the amount of federal loans and
guarantees has more than doubled.
As a result, it is clear that the more credit market
exposure the government takes on, the more that expectations of
future revenue rise under the current accounting rules without
equal accounting for higher risk.
At the end of September 2014, loans made or fully
guaranteed by the Federal Government totaled over $2.9
trillion. This includes $1.1 trillion in student loans. The
Federal Reserve reported that nonmortgage consumer debt totaled
$3.3 trillion as of September 30, 2014, giving the Federal
Government a one-third share of the U.S. consumer loan market.
Add that to the 70 percent of the mortgage market that the
Federal Government holds through direct loan guarantees and
Fannie Mae and Freddie Mac, and the Federal Government is the
largest consumer lender in the country.
A lot has changed in those 25 years. So today we must ask
ourselves: Do accounting rules passed 25 years ago reflect the
complexity of today's financial world?
I would now like to recognize Ranking Member Maloney for
her opening statement, and just before I do I want to hand over
this gavel. When I first got a gavel in my hand I thought, wow,
I can get something done here.
So, Mike, be careful. Don't take us past the jurisdiction
of the Committee. It would be tempting, but I am putting this
in very capable hands. And thank you for heading up this
hearing. But first, let us hear from Senator--I mean,
Congresswoman Maloney.
And then after you give your opening statement I would ask
you to introduce the witnesses and take care of the hearing.
Senator Lee [presiding]. Right.
[The prepared statement of Chairman Coats appears in the
Submissions for the Record on page 28.]
OPENING STATEMENT OF HON. CAROLYN B. MALONEY, RANKING MEMBER, A
U.S. REPRESENTATIVE FROM NEW YORK
Representative Maloney. Thank you so much, Chairman Coats,
for holding this hearing. And I thank all of our panelists for
being here today.
In this morning's hearing we will compare two systems for
budgeting federal credit programs. The first, the Federal
Credit Reform Act of 1990--so-called FCRA--was signed into law
by George H. W. Bush in 1990. It has proven a reliable tool for
budgeting federal credit programs.
The second, so-called ``Fair Value Accounting,'' is a
program supported by some of my colleagues in the Republican
Party that will make federal credit programs seem more
expensive. If implemented, this system will necessitate cutting
loan programs, or raising interest rates. In my mind, there is
nothing fair about ``Fair Value Accounting.''
At its root, today's hearing is about two vastly different
philosophical approaches to government. My Republican friends
believe that the Federal Government, in this case federal
lending programs, should operate just like the private sector.
But the Federal Government is not the private sector. The
principal motivation of the private sector is to maximize
profit.
The principal role of government is to provide services
that the private sector cannot or will not provide. These
differences are especially clear in federal lending programs.
Private institutions make loans that they think will be the
most profitable. But the United States Government sees things
differently.
For example, it lends to a group of individuals with little
or no income and no credit history. They are known as ``college
students.'' And there are more than 20 million of them in the
United States today.
The vast majority of student loans are issued or guaranteed
by the Federal Government. Why does the government take on this
risk? Because it helps millions of Americans go to college who
might otherwise not be able to afford to go.
It also benefits the rest of us by creating a more educated
workforce. A better workforce will make our country more
competitive, and will make our economy stronger and our country
stronger. This is a social good not recognized by private
lenders.
I want to turn to the specific question of how we measure
the cost of Federal Government loan programs. How these
programs are accounted for and how their budget impact is
assessed will affect the broader deficit outlook in choices we
make as policymakers.
The current procedure under the Federal Credit Reform Act
appropriately calculates the lifetime costs of federal credit
programs, reflecting both the risk of default and the
government's cost of borrowing.
FCRA has been very accurate. OMB found that in the more
than 20 years that FCRA has been in place, the initial cost
estimates of all credit programs differed from their actual
costs by less than one percent of their face value. As they
say: If it ain't broke, don't fix it.
But today we are apparently trying to fix a system that
already works very well. It is part of a broader ideological
initiative. In tax policy Republicans are trying to change the
rules of the game by instituting so-called ``dynamic scoring.''
This would make tax cuts seem less expensive than they really
are.
In federal credit policy, Republicans are trying to change
the rules of the game using an accounting system that will make
programs like student loans look more expensive. The result of
this so-called fair value accounting will be cuts in federal
loan programs. For example, less money available for students
at higher interest rates.
Under fair value accounting, the cost of federal credit
programs, which are funded by the purchase of low-interest
Treasury Securities, would be evaluated as if they were forced
to borrow with an additional risk premium demanded by the
private sector.
As the Center on Budget and Policy Priorities put it, fair
value budgeting requires that the budget, quote, ``reflect
amounts that the Treasury would never actually pay anyone,''
end quote. It will make federal lending programs appear more
costly than they really are.
Millions of Americans have something to lose if proponents
of this accounting system have their way. I regret that we
don't have any of their representatives on the panel today.
However, Chairman Coats and I have received letters from a
number of organizations that strongly oppose the fair value
accounting system. I have a stack of them here (indicating),
and I have a letter with me right now from the National
Education Association which states, and I quote:
``NEA opposes the use of fair value accounting in federal
credit programs, especially student loan programs, because it
would artificially raise their costs and make them appear to be
more expensive to the Federal Government than they really
are.'' End quote.
I ask unanimous consent to place this letter into the
record.
Senator Lee. Without objection.
[The letter appears in the Submissions for the Record on
page 29.]
A letter from the National Association of Home Builders
states, and I quote, ``Fair value accounting would artificially
raise the rates on home loans.'' And I would also like to enter
that letter into the record.
[The letter appears in the Submissions for the Record on
page 31.]
Other organizations also oppose using fair value accounting
for budgeting purposes: The National Association of Realtors,
the National Association of Independent Colleges and
Universities, The Retired Enlisted Association, The National
Rural Electric Cooperative Association, The Student Aid
Alliance, The National Multifamily Housing Council, and many,
many others, and I would like to place these letters that I
just mentioned into the record.
[The letters appear in the Submissions for the Record on
page 34.]
Representative Maloney. In conclusion, I ask that we listen
to both sides of the debate today, but that ultimately we not
let ideology trump reality. Fair value budgeting would distort
the budget process, undercut federal credit programs, and
ultimately deprive millions of Americans of the financial
support that they need to get an education, buy a home, or
start or operate a small business.
I look forward to our discussion today, and I thank each of
the witnesses for appearing before the Committee. And I yield
back. Thank you.
[The prepared statement of Representative Maloney appears
in the Submissions for the Record on page 51.]
OPENING STATEMENT OF HON. MIKE LEE, A U.S. SENATOR FROM UTAH
Senator Lee. Thank you, Representative Maloney, and the
documents you have submitted will be submitted into the record,
without objection.
I want to thank Chairman Coats for calling this hearing,
and also for his insightful remarks, and for the remarks that
we have heard so far from Representative Maloney.
From the early days of our Republic, we have had an ongoing
debate about the role to be played by the Federal Government
within the credit market. The provision of credit to the states
and its assumption by the newly formed Federal Government was a
topic of great debate and discussion during the drafting of the
Constitution in 1787 and during the early Congresses formed
pursuant to that document.
Provision of credit by the Federal Government has a
somewhat more recent history. As Mr. Elliott, who is one of our
witnesses today, noted in his book ``Uncle Sam In Pinstripes,''
the provision of federal credit began in the way we are
discussing today in the early part of the 20th Century. It
began with farm programs under President Theodore Roosevelt.
These programs have ballooned over the past century. Today
we frequently hear about $18 trillion in total outstanding
public debt. It is far less common to hear about the $3
trillion in Federal Government loan exposure that Journalist
Michael Grunwald identified earlier this year.
This federal credit system has grown over the years at
times responding to perceived political needs, and at other
times responding to political pressure from special interests,
natural mission creep, and bureaucratic ambitions.
This has left us with a system that no one would design. We
have a housing finance system that leans almost entirely on
federal backstops in the FHA and VA.
We have a student loan program administered almost entirely
by the Federal Government, a program that notably took
considerable writedowns over recent weeks.
We have the Export-Import Bank that was founded before
exporters could easily fly across the ocean to visit customers,
and now exists largely to facilitate deals between large
corporations and large banks, while leaving the taxpayer on the
hook.
From TARP to farm programs, the Federal Credit System is
hard to think of as a system at all, except for one feature. If
things go wrong, the Federal Government is on the hook. If
things go wrong, the taxpayer ends up with the bill.
It is critically important that Congress debate the wisdom
of such a system's existence at all, including the
Constitutional and prudential justifications for the provision
of federal credit.
Today we look to start that debate by discussing something
much simpler than this larger discussion. Namely, we are
looking to find valid means to analyze costs, compare
management structures, and establish a general rubric to make
apples-to-apples comparisons.
We hope to be able to both compare different credit
programs against each other, and compare credit programs
relative to spending, tax, or regulatory programs designed to
accomplish similar goals.
Getting on the same page on these questions will be a key
step in the process of reforming these programs.
So I thank the Chairman again for this opportunity and I
look forward to the testimony that we are going to hear from
each of our witnesses.
And with that, I would like to introduce our witnesses
before we hear from them. We will start on this end of the
table and then move over.
Dr. Douglas Holtz-Eakin is the President of the American
Action Forum, and most recently was a commissioner on the
Congressionally chartered Financial Crisis Inquiry Commission.
During 2001 to 2002, he was the Chief Economist of the
President's Council of Economic Advisers. From 2003 to 2005,
Dr. Holtz-Eakin was the sixth director of the Congressional
Budget Office. From 2007 to 2008, he was Director of Domestic
and Economic Policy for the John McCain Presidential Campaign.
And following the 2008 election, Dr. Holtz-Eakin was the
President of DHE Consulting. Dr. Holtz-Eakin received his B.A.
from Denison University, and his Ph.D. from Princeton
University.
Jason Delisle is the Director of the Federal Education
Budget Project, which is part of the Educational Policy Program
at New America. Mr. Delisle is a leading expert on the federal
student loan program, and federal financing for higher
education. Before joining New America in 2007, Mr. Delisle was
a senior analyst on the Republican staff of the United States
Senate Budget Committee. Prior to that position, he served as a
legislative aide in the office of Representative Thomas Petri.
Mr. Delisle holds a Masters Degree in Public Policy from George
Washington University, and a Bachelor's Degree from Lawrence
University in Appleton, Wisconsin.
Douglas Elliott, a Fellow in Economic Studies at the
Brookings Institution, is a member of the Initiative on
Business and Public Policy. A financial institutions investment
banker for two decades, principally at J.P.Morgan, he was the
founder and principal researcher for the Center on Federal
Financial Institutions, a think tank devoted to the analysis of
federal lending and insurance activities. He recently wrote the
book, ``Uncle Sam In Pinstripes,'' evaluating the U.S. federal
credit programs, the only comprehensive review of the Federal
Government's credit activities to be written in the last
quarter century. Mr. Elliott graduated from Harvard College
magna cum laude with an A.B. in Sociology in 1981, and in 1984
he graduated from Duke University with an M.A. in Computer
Science.
Last but not least, Paul Van de Water is a Senior Fellow at
the Center on Budget and Policy Priorities where he specializes
in Medicare, Social Security, and health coverage issues. He is
also Director of the Center's Policy Futures Initiative.
Previously he was Vice President for Health Policy at the
National Academy of Social Insurance. Van de Water worked for
over 18 years at the Congressional Budget Office. From 1994 to
1999, he was Assistant Director for Budget Analysis.
So with that, why don't we hear from the witnesses. Let's
hear from all of you. If you can try to keep your remarks
within about five minutes, then we will proceed to questions
from there. And we will start with you, Dr. Holtz-Eakin.
STATEMENT OF DOUGLAS HOLTZ-EAKIN, Ph.D., PRESIDENT, AMERICAN
ACTION FORUM, WASHINGTON, DC
Dr. Holtz-Eakin. Thank you, Senator Lee, Ranking Member
Maloney, and Members of the Committee, for the chance to be
here today.
As has been emphasized in your remarks and Chairman Coats'
remarks before that, there is an enormous commitment of
taxpayer resources to federal loans and loan guarantees. If you
look at the tables put out most recently by the Office of
Management and Budget, there are $3.3 trillion since 2014 in
such loans and loan guarantees outstanding. And in light of the
magnitude of this commitment of resources, I applaud the
Committee for looking into this. I think it is an extremely
important topic to understand.
I will be brief. I will just make three basic points.
Point number one is that the 1990 Federal Credit Reform Act
was actually an enormous step forward in that it leveled the
playing field between direct federal lending and the guarantee
of private loans by the Federal Government. Both have the same
economic function; they provide the same credit flow to the
ultimate consumer; and they are both backed by the taxpayer and
are a commitment of the taxpayers' resources.
However, having said that, the Federal Credit Reform Act
does have a glaring hole. If you look in the OMB tables, those
$3.3 trillion in loans and loan guarantees are assumed to make
a profit, a profit, of $22.3 billion, and not be perceived as a
cost to the taxpayer.
That is counter to anyone's intuition and reveals the flaw
with the Federal Credit Reform Act, which is it omits an
important source of risk--the market risks that are associated
with credit activities.
That omission of market risk causes FCRA to underestimate
the true cost of credit evaluated in that fashion. And it is
important when Congress is making decisions to not only have a
firm handle on the benefits of credit programs, but also their
actual cost to the taxpayers with all kinds of risks involved.
The big difference between FCRA and fair value accounting
is fair value accounting incorporates this market risk. It
recognizes that as the economy fluctuates there is a tendency
for loan failures to bunch during downturns, and that risk
should be involved in the calculation of potential losses and
any credit activity.
It also recognizes that the taxpayer has to come up with
the money to cover those losses at a time when money is
especially valuable. During downturns, Americans are less
affluent and they do not want to have to cover these losses. So
fair value accounting gets that into the mix.
The second reason it is pretty obvious that something needs
to be done is it should not be the case that if you take a loan
in the private sector and simply drag it across the line
between the private sector and government, it should somehow
become more valuable or less risky instantaneously because of
the label on it. And that is exactly what happens under FCRA.
And indeed we have seen examples of this in recent
legislation where we have used a government takeover of a
private loan portfolio to finance government activities. That
is a pure budget gimmick and one of the main reasons I think it
is important to examine fair value accounting.
And the third point is that fair value accounting is not
some untested theoretical proposition. When I was the Director
of the Congressional Budget Office, we undertook numerous
studies of what important federal backstops would look like
under fair value accounting. We looked at the Pension Guaranty
Corporation. We looked at the Student Loan Program. We looked
at the then-Chrysler bailout from the 1980s. We looked at the
guarantees for Air West during 2001-2002. We looked at Fannie
Mae and Freddie Mac. And in each case, you would see a clear
pattern: things that looked like they were profitable with the
government became a cost to the taxpayer; things that were
costly to the taxpayer were underestimated and needed to be
revised upward.
Since then, we have actually seen fair value accounting,
both in resources given to the Housing GSEs, Fannie Mae and
Freddie Mac, and for accounting for the TARP program and the
budgeting of that intervention.
So this is not something that is untested. This is not
something that could not be done, and doing it would give a
fair presentation of the commitment of taxpayer backstop to the
credit programs, and I would encourage the Congress to move
forward with it.
Thank you.
[The prepared statement of Dr. Douglas Holtz-Eakin appears
in the Submissions for the Record on page 53.]
Senator Lee. Mr. Delisle.
STATEMENT OF MR. JASON DELISLE, DIRECTOR, FEDERAL EDUCATION
BUDGET PROJECT, NEW AMERICA, WASHINGTON, DC
Mr. Delisle. Thank you, Senator Lee, Ranking Member
Maloney, and Members of the Committee. I am glad to have the
opportunity to testify about the cost of federal credit
programs and the Federal Student Loan Program in particular.
The Federal Government's direct loan program plays a vital
role in our postsecondary education system and our national
economy. It guarantees access to credit at favorable terms for
millions of Americans who pursue credentials that range from
short-term certificates to graduate professional degrees.
And despite the recent backlash against student debt, a
government loan is a perfectly logical tool to support
postsecondary education. Loans allow students to move some of
the future earnings that they would gain from an education to
the present, and to finance the education itself.
Moreover, a robust private market for student lending is
unlikely to develop because of information asymmetries and poor
economies of scale. And a private market would likely make
credit most readily available to those who need it least. It
would also restrict credit availability in times of economic
stress, the point at which demand for higher education surges.
So while the case for a government student loan program is
strong, so too is the case for knowing what it costs. One point
helps make that clear.
The student loan program is quickly set to become the
largest government loan program. With $1.2 trillion in debt
outstanding, it is on the verge of eclipsing mortgage
guarantees made through the Federal Housing Administration.
Yet despite the need for reliable information about what
this program costs, Congress has actually prevented the
nonpartisan Congressional Budget Office from doing just that.
As a result, we have the highly unusual situation of the
Congress asking CBO to provide it with the best estimate of
what the budget agency believes the program costs, while
dictating what information the CBO must use to construct its
estimate.
In the early 1990s, Congress made important changes to the
way federal loan programs are treated in the budget with the
enactment of the Federal Credit Reform Act, or FCRA. That law
put federal loan programs on an accrual basis and was a big
improvement over measuring loans on a cash-in/cash-out basis.
But what lawmakers also included was a provision in the law
that systematically understates the cost of government loan
programs. And I am using the words of the Congressional Budget
Office there.
They mandated that budget analysts, including the CBO,
discount risky cash flows associated with a loan at a risk-free
rate--the interest rates on U.S. Treasury securities. Thus, the
average expected cash flows for government loans are treated as
if they were financially indistinguishable from those of the
U.S. Treasury with the same expected performance.
The CBO has argued that that approach does not provide a
comprehensive measure of what federal credit programs actually
cost the government. Indeed, FCRA suggests that the government
can earn a profit on student loans even though it provides them
at terms much more generous than taxpayers would offer
voluntarily.
FCRA's risk-free discounting can also make it appear,
albeit erroneously, that when the government purchases loans at
market prices it immediately records a financial gain. Worse
still, the riskier the loan that the government buys, the
larger the immediate financial gain.
The Center on Budget and Policy Priorities warned in 2005
that those dubious results created a, quote, ``supposed free
lunch,'' unquote. And in response argued fervently that
expected returns on risky assets must be risk-adjusted, citing
the CBO and many economists.
But as I am sure you will hear today, the CBBP now says
that view was, quote, ``mistaken.'' The economists at the CBBP
cited in 2005, including the CBO, have not, however, changed
their position.
A better accounting approach, one endorsed by the
Congressional Budget Office and many financial economists,
would discount loan cash flows using a market-based rate, one
that is higher than a U.S. Treasury rate. That approach
incorporates a cost for bearing market risk, also called ``fair
value accounting.''
So at first glance, the support for fair value accounting
would suggest that Congress should amend FCRA and require that
budget estimates for loan programs use a market-based discount
rate. But I would recommend a different approach.
Requiring that cost estimates use a specific type of
discount rate, a U.S. Treasury rate, or a market-based rate for
that matter, is a highly unusual intrusion on the discretion
Congress affords the CBO.
When the CBO develops estimates for other federal programs
like the Pell Grant Program, Congress does not require it to
assume a certain rate of inflation or student enrollment
growth; the CBO uses whatever it believes is most appropriate.
In that regard, Congress should simply amend the language
of FCRA to give budget agencies the freedom to use the discount
rate they deem will result in the best estimate. This will
surely result in fair value accounting because the CBO already
supports that. And that is a great result because it will be an
accounting decision that is free of Congressional and partisan
interference.
That concludes my testimony today. I look forward to
questions that you may have.
[The prepared statement of Mr. Jason Delisle appears in the
Submissions for the Record on page 60.]
Senator Lee. Thank you, sir. Mr. Elliott.
STATEMENT OF MR. DOUGLAS ELLIOTT, FELLOW, BROOKINGS
INSTITUTION, WASHINGTON, DC
Mr. Elliott. Thank you, Senator. And thank you all for the
opportunity to testify today on an area of great interest to
me.
Senator Lee was kind enough to describe my background. I
founded the Center on Federal Financial Institutions and worked
at it as a volunteer for three years because I do believe that
this is a very important and underlooked area, and he was kind
enough to mention my book as well.
Given the political nature of so much of the discussion,
let me note that I am as close to a political neutral as you
will find on this topic. I do not belong to a political party.
I have served in no administration. And I am a moderate on the
political spectrum. So you can factor that in as you listen to
me.
In my book I made a number of recommendations for improving
the effectiveness and efficiency of the federal credit program.
I would like to repeat a few of them here.
Specifically, we should target borrowers more carefully,
take more account of the relative risks of different loans, use
the same budget rules for all federal credit programs, use
risk-based discount rates for federal budget purposes,
formalize the process of initiating new federal credit
programs, create a federal bank to administer all of these
programs, focus more on optimizing the allocation of money
between these various programs, spread best practices across
the programs more effectively, and improve the compensation and
training of federal financial workers.
Now given your interests and the time constraints, I will
focus on risk-based discount rates.
Accounting systems such as the federal budget are tools
that should be designed to meet specific needs and should
differ depending on those needs. There is not a ``right'' moral
answer. These are tools.
Our current budget approach for federal credit programs
ignores the variability of potential results. Given how
strongly the budget numbers drive decision making, we are
effectively acting as if Congress and the taxpayers do not care
about risk--which I do not believe to be the case. Instead, I
believe subsidy costs in the federal budget should reflect this
uncertainty for several reasons, which mostly come down to how
they are likely to change the decision making.
First, it is important that federal credit programs be
structured to minimize risks where possible, while still
achieving the overall objectives. This is less likely to happen
when the budget numbers that drive them ignore risk.
Second, the benefit to borrowers of government loans is
higher for risky loans, since these would be priced higher by
the private lenders but are not usually priced higher by the
government. Ignoring that risk for federal budgeting has
distorting effects on the choices that Members of Congress
make. In particular, there will be a tendency to direct scarce
federal dollars to sectors where there is more uncertainty in
the outcomes since those borrowers will find the federal loans
more valuable. They will lobby harder for them, and they are
more likely to apply for and to accept such loans, choosing
them over private alternatives.
Third, risk-based pricing, one of my other recommendations,
is considerably more likely to be implemented if the budget
appropriately reflects risk as a cost. The situation today in
which a loan with a wide range of potential outcomes is treated
as costing the same as a relatively certain loan discourages
political decisions that take account of such risk.
Now there are reasonable counterarguments to moving to
risk-based discount rates, although I do not personally find
them compelling. The principal one is that the U.S. Government
can spread any unexpected losses over a very wide tax base and
many years of time, and therefore does not need to worry about
the variability of outcomes. However, the way in which federal
credit losses are ultimately offset is by increasing taxes or
decreasing federal expenditures. And it seems very unlikely--
sorry, it seems very likely that taxpayers would prefer less
risk of a big tax increase to more risk of one, even if the
latter were offset by a potential on the other side for
unusually good performance and future tax reductions.
This is especially likely since, as Douglas referred to,
credit losses are concentrated in those years when the economy
is particularly bad and taxpayers are unlikely to feel capable
of comfortably bearing the resulting tax increases.
There are also various technical arguments about
maintaining the consistency of federal credit programs with
other programs, and of dealing with swings in estimated costs.
These are reasonable concerns, but they are outweighed by the
fact that Congress uses the initial subsidy estimates as by far
the most important figure on which to make decisions. As long
as these are the critical numbers, I believe it is important to
incorporate risk appropriately into them in order to improve
the quality of decisions. Thank you very much for your time and
consideration.
[The prepared statement of Mr. Douglas Elliott appears in
the Submissions for the Record on page 71.]
Senator Lee. Thank you, Mr. Elliott. Mr. Van de Water.
STATEMENT OF PAUL VAN de WATER, SENIOR FELLOW, CENTER ON BUDGET
AND POLICY PRIORITIES, WASHINGTON, DC
Dr. Van de Water. Senator Lee, Ranking Member Maloney,
Members of the Committee, thank you for the opportunity to
appear here today. The current method of accounting for federal
credit programs, as you have heard, fully records on a present-
value basis all of the cash flows into and out of the Treasury.
And that fully reflects the risk of default.
In contrast, fair value accounting would add an extra
amount to the budgetary cost based on the fact that loan assets
are less valuable to the private sector than to the government
for several reasons: Businesses must make a profit. They cannot
put themselves at the head of the line when collecting a debt.
They borrow at higher interest rates than the government. And
private-sector investors are risk-averse. That is, they dislike
losses, in this case higher than expected loan defaults, more
than they like equally likely gains, lower defaults. But none
of those factors that affect private-sector lenders represents
an actual cost that the government incurs when it makes loans.
Fair value accounting is misguided for four reasons.
First of all, the budget should reflect only the Federal
Government's actual income and outgo, that is, funds that the
Treasury actually receives or disburses. Including in the
budget a cost for risk that the government does not actually
pay would overstate spending, deficits, and debt, making the
federal budget a less accurate depiction of the Nation's fiscal
position.
Second, fair value accounting would treat different federal
programs inconsistently because it would not impose a risk
version penalty on noncredit programs, many of which have costs
that are at least as uncertain and variable as those of credit
programs. Regardless of one's position on whether a particular
credit program is worthwhile or not, the budget should put
credit programs and other programs on a level playing field.
Fair value accounting would tilt the playing field against
credit programs, thereby distorting the process of setting
priorities.
Third, even if one thought that the Federal Government
should be risk averse on behalf of its citizens, as advocates
contend, fair value accounting presents an incomplete and
misleading picture of federal credit programs. Federal loan
programs do not necessarily increase financial risks for U.S.
citizens overall. If the cost of a loan program turns out to be
higher than originally estimated, taxpayers will indeed
eventually have to cover the higher costs. But students,
farmers, homeowners, or other borrowers will have received more
help. Fair value accounting considers only the first half of
this equation.
Fourth and finally, cost estimates by themselves are not
designed to assess whether a federal program is worthwhile, and
they should not be expected to do so. Deciding whether a
federal program or project is worth undertaking or expanding
entails evaluating many factors in addition to its cost to the
government, and risk is indeed one of those.
Doug Elliott suggested that leaving risk out of a cost
estimate suggests that the government does not care about risk.
I would have to disagree with my friend Doug on that topic.
There are a lot of things that get left out of cost estimates
that are extremely important. As an example, building a bridge
in a lightly populated area is likely to be less valuable and
may not be worth doing compared to resurfacing a heavily
traveled highway in the Northeast corridor. A bill's cost
estimate is never going to reflect all of these different
factors, and trying to do so is a vain effort.
My conclusion is the same as that of former CBO Director
Robert Reischauer who says that fair value accounting, quote,
``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.'' Thank you.
[The prepared statement of Dr. Paul Van De Water appears in
the Submissions for the Record on page 82.]
Senator Lee. Thank you very much. Thanks to each of you for
your testimony.
Well it seems to me that if we are using accounting methods
that do not accurately reflect reality, then the fundamental
problem here is that we are lying to ourselves. We are fooling
ourselves. And we are fooling ourselves with regard to a very
large sum of money.
Dr. Holtz-Eakin, are we making these decisions under flawed
accounting rules without a good idea of the relevant tradeoffs?
That is, if we are analyzing these incorrectly, do we really
have the ability accurately to ascertain whether some other
program, or no action at all, might be preferable?
Dr. Holtz-Eakin. I do not believe so. I think that, you
know, fair value accounting would affect a lot of different
aspects of the operation of the government. It would affect the
analysis of new programs. It would affect the re-estimates that
occur each year. It would affect the balance sheet
presentation. But the most important thing it would affect
would be the decision making by the Congress about the relative
costs of programs.
Now the Congress has the right to determine the value of
programs. That is what it does. But it should be presented with
an accurate measure of the costs so that they can make good
decisions, and they are not right now.
Senator Lee. And if we are not doing that, then we are
fooling ourselves. We are not getting accurate information, or
we are presented information saying this is worth it, this is
making money, when in fact it is not; we are not making logical
decisions.
Dr. Holtz-Eakin. I think the most important point that Dr.
Delisle made was that the Congress has precluded the CBO or
anyone else from giving a fair representation of the expected
cost of the programs. That is not in your interest.
Senator Lee. And, Mr. Delisle, we are not really talking
here about changing programs; we are talking about analyzing
them accurately? Is that correct?
Mr. Delisle. Right. So we are talking about the cost, and
usually in these debates we hear a lot about the benefits of
the programs. Fair value is completely agnostic to the benefits
of the program. You can have a government program that costs
money and provides benefits to people. I think that fact is
actually quite intuitive.
It is credit reform that flips that upside down and
suggests that you can provide benefits to people and also earn
a net return, which does not really make much sense.
Senator Lee. And I would ask both of you, what are the
risks to the taxpayer when we pretend that programs raise money
for the government while CBO finds that they lose money under
fair value? What kind of risk does that present?
Dr. Holtz-Eakin. There are hypothetical answers to that,
but I will give you a real one. We did an estimate of the
taxpayer cost of the implicit subsidy in guarantee to Fannie
Mae and Freddie Mac. We did it back in 2003 or 2004, when I was
CBO Director. That number was about $20 billion a year, or $200
billion.
It was painfully close to what the taxpayer ultimately had
to shell out in the crisis for the housing GSEs. That is the
risk you run. You will not budget for real costs that will
happen in very bad moments.
Mr. Delisle. Well I would--the sort of, the flaws in the
Federal Credit Reform Act actually make the entire world of
finance appear as a gigantic arbitrage opportunity for the
Federal Government. To show you how distorting that is, you
have heard that Greece has a bit of a debt problem. And the
market is charging them quite a high interest rate on their
bonds. Under FCRA, if the Federal Government purchased Greece's
debt, it would book an immediate profit.
I cannot imagine many members of the Committee suggesting
that that looks right to them.
Senator Lee. Maybe we should look into that, though?
[Laughter.]
Mr. Elliott, on the net, examining all federal programs in
the aggregate, and all costs and benefits of these programs,
does the academic literature indicate that during normal
economic times that federal credit programs are net negative,
or a net positive, for the economy?
Mr. Elliott. We do not know, is the short answer. One
reason we do not know is there are many judgment calls that
have to be made.
I think there are certain programs--student loan programs,
for example--where it is very clear that there is a market
imperfection that really cannot be solved other than by having
a very significant federal role.
In programs like that there is no question in my mind that,
at least properly run, provide a significant economic benefit.
Many of the other programs, it's harder to say. In many ways
they are more redistributional than anything else. It is
choosing which segments of the population to help, and Congress
many have valid reasons for helping them, or they may not.
Senator Lee. Thank you. Okay, I see my time has expired.
Ranking Member Maloney.
Representative Maloney. Thank you.
Mr. Van de Water, changing to fair value budgeting would
have far-reaching consequences for students, and Veterans, and
home buyers, and small businesses who benefit from our various
federal credit programs. Fair value budgeting would not
actually make federal credit programs more costly, but it would
certainly make them all appear more costly than they really
are.
It would do this by assuming banks and governments are
somehow alike, and assigning to government credit programs the
same costs of lending as those faced in the private sector.
So would increased phantom costs resulting from fair value
accounting be passed along to borrowers in the form of higher
interest rates and fees?
Dr. Van de Water. We can only speculate as to what the
result would be, but certainly by increasing the cost of credit
programs relative to those of noncredit programs, it would
change the incentives, exactly as Doug Elliott has just said,
in a way that would make it highly likely that the Congress
would either reduce the scope of the lending programs, or
change the terms--that is, increase the interest rates, charge
higher origination fees, whatever, in ways to make the programs
less generous.
So I think it is clear that changing the accounting method
would be likely to have real impacts on borrowers.
Representative Maloney. As the cost of these federal credit
programs appear to increase, would the federal deficit also
increase?
Dr. Van de Water. That is one of the complications that
this introduces. The problem, as I see it, with fair value
accounting is that it introduces a cost in the budget which is
not actually a cash-dollar cost that the government ever
incurs.
The good thing about our current accounting system is that
we actually have a benchmark at the end of the day for figuring
out whether things actually worked out the way we estimated.
Namely, we can observe the cash flows.
But if one starts adding a cost--in this case a cost for
risk--which is not a cash cost, we lose that ability to track
the budget to what actually happens.
And the proposals for fair value accounting, depending on
the proposal, make various adjustments to make sure the books
balance in the end even when you have added this imaginary
cost.
Representative Maloney. And would higher apparent costs for
federal credit programs disadvantage them relative to other
federal programs? And if so, how?
Dr. Van de Water. That is exactly right. As the other
witnesses have indicated, the essence of fair value accounting
is to add to the estimated cost of federal credit programs an
additional item, a risk premium, a risk penalty, to reflect the
fact that there is uncertainty in what the disbursements of the
credit programs will actually be.
But the same thing is true for many, many other federal
spending programs as well. In advance, we do not know exactly
what they are going to cost, and we do not know precisely in
what years they will be incurred.
So by adding a risk penalty for credit programs but not for
other federal programs, we are thereby putting the credit
programs at a disadvantage.
Representative Maloney. Thank you.
Mr. Delisle, there are more than 20 million college
students now in the United States, and many of them rely on
student loans provided by or guaranteed by the Federal
Government.
Fair value accounting would likely mean that student loan
programs will shrink and/or that interest rates will go up. How
would you defend fair value accounting to a large meeting of
college students?
Mr. Delisle. Well, I would say, like I said at the
beginning of my testimony, there is a strong rationale for
having a federal student loan program. And it is important to
provide subsidized credit to them. I am a hundred percent for
that.
But what the program costs should be agnostic to what we
think the benefits are. Right? Cost/benefit analysis is two
parts. You have got to get the costs right, and you have got to
get the benefits right. They are two different things.
Representative Maloney. And Mr. Elliott, we have received--
I went through a whole stack of letters from organizations,
stakeholders in our country that were basically opposing fair
value accounting. To name a few: the National Education
Association, the National Association of Home Builders. The
Retired Enlisted Association, The National Rural Electric
Cooperative Association, The Student Aid Alliance. Many other
very active associations, including the National Association of
Realtors, have gone on record against fair value.
And if you were advising a Member of Congress on this
issue, how would you recommend that he or she explain the issue
to these organizations?
Mr. Elliott. I think I would argue along the same lines
that Jason just did, which is essentially we want Congress to
be making decisions based on the best possible cost numbers,
the best possible benefit numbers.
I am not at all surprised that a set of borrowers basically
would prefer us to use lower discount rates on the theory that
that will not give us any incentive to increase the rates. So
there is nothing we can say to them that will change their
position.
Representative Maloney. Well my time has expired.
Senator Lee. Okay. Next we will recognize Mr. Delaney; then
after Mr. Delaney, Mr. Schweikert, and then we will proceed
from there.
Representative Delaney. Thank you. I want to thank all the
witnesses for being here today and sharing their testimony.
Mr. Elliott, you mentioned a concept that I thought was
very interesting, which is creating a bank within the
government and consolidating all the lending activities out of
that bank, which I would love to follow up with you more on
that. That seems to be a pretty interesting idea. You could
have consolidated accounting, and credit, and portfolio
management, and all those kinds of things, and it would make
these programs inherently less sloppy, right, because there
would be more rigor around how they are managed.
From an accounting standpoint, if that bank had its assets
effectively mark-to-market, which is in some ways what this
does, would you suggest that its liabilities also be mark-to-
market? Because my experience with financial institutions, if
you mark one side of the balance sheet you have to mark the
other side, as well.
How should we think about--a lot of this discussion is
about marking the assets to market to provide greater
transparency. Are they priced right? How do they compare to the
market? Et cetera. Would we then also have to mark the
liabilities to market?
Mr. Elliott. So two parts. First, thank you for your
positive comments about the idea of a single federal credit
bank. I do think there are--there is great potential there for
improved efficiency, which----
Representative Delaney. Right. And we will follow up on
that later.
Mr. Elliott. In terms of the question, what the Federal
Credit Reform Act does is it looks at both the positive and
negative cash flows out from this point in time forward.
Representative Delaney. Yes.
Mr. Elliott. All those, whether positive or negative, at
any point are discounted back at the same discount rate.
Representative Delaney. Right.
Mr. Elliott. So your question then would have to be, to get
to what you are calling the liability side, is we would have to
decide how were we funding those.
Representative Delaney. Yes.
Mr. Elliott. Which we do not do in the budget. We do not
say this part is from borrowing; that is from a three-year
borrowing; that is from a seven-year borrowing----
Representative Delaney. But you could, right? If you ran it
as a bank, you could basically have a relationship with the
Treasury Department and issue different series of notes to the
Treasury that they would buy. And you would have a whole
liability stack.
Mr. Elliott. You know, it is an interesting point and not
one I have seriously considered, to be honest, because it is
not--it is so far different from how we budget now I have just
not given it thought.
Representative Delaney. Because I just think when we talk
about mark-to-market accounting, which is basically where we
are going in this discussion, it is like people talk about that
with banks all the time. They say the banks should mark your
assets to market, which most banks do not mark their loans to
market.
But in reality, they then should mark their liabilities to
market, right? And banks have much better liabilities than
nonbanks do. So those liabilities would mark up, and you would
mark the assets down, and you would kind of end up in the same
place.
So I think it is important if we think about mark-to-market
accounting for the assets that we also have to have some
framework for thinking about it for the liabilities so that you
do not overcorrect so much. Because in fact the government
borrows at a much better rate than your average AAA borrower.
And so in fact the government's liabilities are worth more,
right? So just when you would mark these assets down, you would
be marking the liabilities up.
But I think there might be a better way to get at some of
the issues that I agree with you on as to whether we are
pricing these things right, whether we really understand the
cost. And Mr. Holtz-Eakin, or Dr. Holtz-Eakin, maybe you could
comment on this.
I have talked about a proposal where, rather than changing
the accounting we simply require the government on a regular
basis to sell off 10 percent of all its exposure in all these
credit programs. Right? So you take all the credit programs,
Ex-Im, housing programs, things we do for small businesses, go
down the list and say on some regular basis you have to sell
off 10 percent of your exposure to the market.
And then we see how the market prices it, right? And that
to me--because using accounting to figure out if things are
priced right is theoretical and it is based on assumptions, and
people can always play with assumptions. But when you actually
have to sell a piece to the market, you are actually getting
real transparency. And that information in some programs should
maybe dictate how they are priced, but other programs we just
should know it.
We should say, hey, we are making loans to startup energy
companies that would sell it for 20 cents on the dollar. That
is a huge subsidy. Should we be using that money elsewhere?
Would you comment on that proposal?
Dr. Holtz-Eakin. I think that is quite useful. In terms of
the two things that are going to be affected, the first is, as
you mentioned, the mark-to-market on the balance sheet. I am
actually less concerned about that.
Representative Delaney. Yes.
Dr. Holtz-Eakin. I am much more concerned about the income
statement, making sure we get that cost right.
Representative Delaney. Yes.
Dr. Holtz-Eakin. One of the practical difficulties people
always ask is, how do I get the right market risk to do the
discounting?
Representative Delaney. If you sell a piece, you know.
Dr. Holtz-Eakin. This gives you some information.
Representative Delaney. Right.
Dr. Holtz-Eakin. And I think it is something that is worth
exploring.
Representative Delaney. I talked to the chairman of the
Financial Services Committee, House Chairman Hensarling, about
this, because there is a big debate with Ex-Im right now. Folks
at Ex-Im say they're priced to the market.
Dr. Holtz-Eakin. Right.
Representative Delaney. All these other people come in and
say they're undercutting the market. My point is, well we
should just make them sell off part of their balance sheet
every year and then we will know. Right? If people pay par,
they are pricing it right. If they pay at a big discount, then
there is a big subsidy. And then we can decide, are we okay
with that?
Dr. Holtz-Eakin. Right. And you are going to get a maturity
strip----
Representative Delaney. Right.
Dr. Holtz-Eakin [continuing]. So you can get the estimates
right.
Representative Delaney. You would have to do it in a
logical way. So that is something I also think should be put on
the table in this discussion as you all think about this.
Thank you.
Senator Lee. Okay. We are now going to go to Senator
Klobuchar, and then to Mr. Schweikert.
Senator Klobuchar. Thank you, Congressman. I appreciate it.
Thank you to all our witnesses. It is great to see some of
you back--Dr. Holtz-Eakin--and to be back here at the Joint
Economic Committee on this important hearing.
I thought I would start out with veterans' housing. Since
2001, the VA has helped 3.75 million Veterans buy their own
homes.
Mr. Van de Water, how would changing to the fair value or
added-cost accounting method affect the VA's Home Loan Program,
in your view?
Dr. Van de Water. Senator, the general effect of fair value
accounting is to increase the estimated cost of credit programs
compared to the way that cost is recorded under the current
accounting mechanism.
And while we cannot be sure exactly how Congress would
respond to that change with regard to any particular program,
including veterans, I think it is highly likely that if the
program were to appear more expensive that it would fare less
well in the annual competition for resources, and therefore, it
is likely, although not entirely certain, that the Veterans
Housing Programs would become smaller, or that the loan terms
would be changed in a way to reduce the subsidies for
borrowers.
Senator Klobuchar. Okay. Thank you. Mr. Elliott, Minnesota
cares a lot about infrastructure. We are the State that had
that bridge collapse six blocks from my house, killing 13
people. And as you know, we have some issues with
infrastructure, everything from bridges, roads, rail, and I am
a fan of doing something about it, and I support a lot of the
work that Congressman Delaney and others have been doing in
this area.
How would switching from the current financing system using
the 30-year Treasury rate with credit premium to the fair value
or added-cost accounting affect investment in infrastructure,
in your view? Are there other funding mechanisms that we should
examine?
Mr. Elliott. Currently, in my view, we understate the cost
of all the programs, and therefore Congress would be looking at
higher costs to do the same thing using the current approach.
As would Paul, I cannot say what Congress might then choose to
do in terms of that. Presumably higher costs might make them do
less, but who knows.
In terms of other ways of doing it, there are of course
things like public-private partnerships, but I honestly will
confess I am not an expert on those.
Senator Klobuchar. Perhaps, Mr. Delaney, you could ask him.
No, there's a lot--Senator Warner will actually be putting our
bill out today, a bipartisan bill similar to some of the work
that Congressman Delaney has done. And so that is part of the
answer, but clearly not the only answer.
I just wanted to end on the Ex-Im Bank. We have 170
Minnesota businesses that have been helped by the Ex-Im Bank
just in one year alone. I visit all 87 counties in my State
every year, and I often visit these small businesses. The topic
usually isn't even Ex-Im, but then I find out that they are
exporting. We are such a big export State, we have 17 Fortune
500 companies, and it has spawned a lot of the smaller
companies that export. But they literally have no expert on
Kazakhstan or something, and they use the Ex-Im Bank to help
them, and help them with financing.
Mr. Van de Water, does the current system under the Fair
Credit Reporting Act of 1990 reflect the costs of the Ex-Im
Bank to the taxpayers? And how would the funds returned to the
American taxpayer be accounted for under the new rules?
Dr. Van de Water. Yes, Senator. The current accounting
mechanism fully reflects all of the cash that goes into or out
of the Treasury. So in that sense, the current accounting
mechanism does reflect the full cost of the Export-Import Bank
and other credit programs.
The difference is that fair value accounting would add to
that cost, to the recorded cost, an additional sum to reflect
risk, which is not an actual cash cost to the Treasury or to
taxpayers.
Senator Klobuchar. Okay. Does anyone want to add anything,
or disagree?
Mr. Elliott. If I could just add one thing, briefly.
Senator Klobuchar. Yes.
Mr. Elliott. One of the issues we sometimes lose sight of
is both potential approaches are simply ways of trying to
summarize a long series of future cash outflows and inflows.
The human mind is not capable of dealing with it, if we were to
tell you it was X amount this year, X amount this year, you
could not usefully do that.
So we have to bring it to a value in today's dollars. These
are both reasonable ways of doing it, but what we are arguing
about is what would be the effects of doing it one way or
another in terms of how you would make your decisions.
Senator Klobuchar. Right. Okay. Well I will just make one
last shameless pitch for the Ex-Im Bank, which is not the
subject of this hearing but, as has been pointed out, could be
affected by the way we do accounting and may affect taxpayers
and those involved. And that is that we have 80 developed
nations across the world that have similar financing
authorities, and we would be the only one that didn't.
We have China having major financing opportunities for
their businesses, and I just hope we find a way in the next few
weeks not to shut the Ex-Im Bank down. You are nodding your
head, Dr. Holtz-Eakin. Do you agree with me?
Dr. Holtz-Eakin. Perhaps to the chagrin of my fellow
conservatives, I am compelled by a theoretical argument that it
shouldn't exist. I think if you look at the data, you can make
the case that Ex-Im should be reformed in some fairly dramatic
ways; that its exposure cap might actually be restricted until
we saw the moment where actual exporters could not get
financing, and then we would know we need it. But I don't know
how you can decide in the absence of that evidence that it
shouldn't be around.
Senator Klobuchar. Very good. That's a perfect end to my
questions. Thank you everyone.
Senator Lee. Okay. Congressman Schweikert, and then we will
go to Congressman Beyer.
Representative Schweikert. Thank you, Senator Lee.
First off, Mr. Delaney, thank you. That is actually a
creative idea. You know, part of the discussion here for many
of us who are sort of fixated on sort of price theory is what's
the actual pricing of the value of both the credit risk, the
programmatic risk, and how do you discover that? To the
Democrat witness, all those years in those finance classes, I
need to go back and get my money back from those professors
because I have now heard things I have never heard before.
One of my personal fixations here, Mr. Chairman and Dr.
Holtz-Eakin, I would love--because I think you have actually
written parts about this--is what is the actual value of credit
programs? And how do you actually value the risk profile of
them?
Because we seem to have a setup today with the massive
amounts of--most Americans have no concept the amount the
Federal Government is on the hook for. I mean, what was it, the
Politico article last year, or several months ago, ``The Real
Bank of America'' was in the trillions, and trillions, and
trillions, and trillions, and trillions of dollars that we were
on the hook for.
You would do more than just the fair value accounting.
Wouldn't you ultimately try to develop a risk pricing model for
these programs? How would you go about doing that?
Dr. Holtz-Eakin. So a couple of things. First, I would echo
what my friend, Mr. Delisle, says again and again, which is be
very clear about what is a cost and what is a benefit. So when
you say what is the value of a credit program, that sounds like
the benefit to those who are served by it. There may be some
empirical evidence, but that is also a judgment call in the end
of the policymakers.
If you are going to measure costs, step number two is to
first of all quantify all the costs that are actually present
in the economic environment. And in this instance, for credit
programs it is out there in markets. We can find out. We can do
price discovery the way Mr. Delaney suggests, or use other
techniques, but, you know, take comprehensive measures----
Representative Schweikert. If----
Dr. Holtz-Eakin. Let me finish with one more thing, because
this is the important point. And the point that Mr. Van de
Water made earlier was, look, other programs have costs as
well. Social Security has some risks. Medicare has some risk.
We are not quantifying that.
That actually makes the major point, which is: You cannot
pretend the Federal Government is a riskless entity. All it
does is transmit the risk in the economic environment through
it back to the taxpayers who are subject to those risks to
begin with.
So measure them comprehensively. Trace them back to the
taxpayer, because that is ultimately who is going to pay.
Representative Schweikert. You may have actually nailed it.
Forgive me if I mispronounce. Is it Deso?
Mr. Delisle. De-lyle.
Representative Schweikert. Delisle. I would not have even
gotten close.
Mr. Delisle. That's all right.
Representative Schweikert. All right. So a bifurcation of
this argument is in some ways that I almost am hearing that I
don't want to know the real pricing because it may take away my
policy optionality over here because we might not do this.
How do I mentally get my fellow Members of Congress to sort
of bifurcate this thing? We need to know the real cost of what
we are doing, and then on this side deal with the policy side
of it? Because when many of us start to really dig into the
unfunded liabilities, it is stunning. We are seeing some in
academia saying we are well over a couple hundred trillion in
the 75-year window of unfunded liabilities. Yet, if you were to
share that with fellow Members of Congress they would just
stare at you.
How do we do that education?
Mr. Delisle. You do it exactly the same way you do it for
every other federal program, which is, you say to the
nonpartisan Congressional Budget Office: Do your best. Tell me
what you think it costs. But don't tell me what you think we
should do after you've given us that information; we will
handle that.
Loans are different because it is the only place that I
know of where Congress has told the CBO to use a certain set of
assumptions in its estimate. So the CBO can't do that. And that
is why we are here today.
If there were no provision requiring the CBO to use a
certain kind of discount rate in its estimate, we would not be
here. Mr. Schweikert. So, Doctor----
Dr. Holtz-Eakin. If I could add something, there is another
big difference between these credit programs and those other,
quote, ``unfunded liabilities.''
Credit programs are a contract. You have to honor it. Once
that loan is issued, that is a loan contract and the taxpayer
is on the hook.
The so-called, quote, ``unfunded liabilities'' are not
liabilities; they are programmatic decisions made by Congress
and can be changed. There is settled law on that fact. And the
term ``unfunded'' I dislike intensely because it suggests the
only need is to fund them, and there is not enough taxes out
there to do that.
So this is about the decision making for the structure of
those programs.
Representative Schweikert. Well the simple reality--I have
been here five years, and I think I have never been able to
have a rational vote on mandatory spending. And in four years,
76 percent of all of our spending will be programmatic.
So it is the clash of math and policy, and it is collapsing
very fast around us.
With that, Mr. Chairman, I will yield back.
Senator Lee. Mr. Beyer.
Representative Beyer. Thank you, Senator.
Mr. Elliott, if the current FCRA regulation takes the
present value of the long-term cash flow out and the long-term
cash flow in, doesn't this already reflect the likelihood of
default of some of these loans? And doesn't this methodology
then already build the risk into the portfolio?
On top of that, how do you--how do you answer the objection
over the past two decades that FCRA has proven to be extremely
accurate in projecting the actual cash flow of all these
federal credit loan programs?
Mr. Elliott. There is a confusion with the term ``risk.''
If you mean ``risk'' the potential for losing, the expectation
of losing money--that is, some loans will not pay you back--
FCRA does a good job of taking that into account.
What we are talking about here is, when you enter into a
program some of them--there is a high likelihood you will end
up where you expect to be. And there are other programs with a
much wider range of possibilities.
And so the question is: Do you as a Member of Congress want
a budget number to reflect the difference between very certain
results and very uncertain results? Or do you not?
Representative Beyer. It seems to me that one of the issues
here is that we are trying to compare the Federal Government's
credit to that of a major financial institution, a bank, a
profit-making institution. And clearly we are involved in this
as a federal government because we are making loans that banks
would not make--student loans being the best example.
And we are doing that because we have a larger social
purpose.
So, Dr. Van de Water sort of reminds me of the asymmetric
warfare, that fair value takes societal costs but not societal
benefits. It is like the dynamic scoring, which my dear friend
Congressman Delaney has written about very well in various op
eds in The Post, that dynamic scoring takes in all the benefits
of a tax cut but absolutely none of the benefits of investing
in education, and health care, and housing, and the like.
I got an e-mail from the University of Virginia that asked:
Would a move to fair value accounting capture both the values
of pursuing higher education and the monetary and nonmonetary
positive externalities of having a highly educated populace
that has access to federal student loans?
Dr. Van de Water. Well the answer to that is, of course
not. And we wouldn't expect that a federal budget cost estimate
would include things like that because many of those things are
benefits to the individual students. They are extremely
important benefits. Some of them have carryover benefits for
the economy as a whole.
But that is a perfect example, that there are a lot of
costs and benefits that are never going to show up in a cost
estimate that are essential for the Congress to evaluate in
deciding whether to go ahead with a program, or to expand it.
But for accounting, I have been arguing that we should retain
as a benchmark cash actually going into and out of the
government.
And you should not expect a cost estimate to contain
anything beyond that.
Representative Beyer. And my suggestion is, when you have
risk, things that cannot be assessed down the line, that can
also be offset by the societal benefits that we are also
choosing not to mention.
Dr. Van de Water. Exactly. Because while a loan program, a
student loan program, for example, increases risks for
taxpayers, it is reducing the risks for the student borrowers.
And at the same time, if the defaults turn out to be higher
than expected, it means, as I said in my testimony, that
taxpayers will be bearing a higher cost, but it also means that
the student borrowers will be receiving a higher benefit.
Those are both very important facts, but neither one of
them belongs in the cost estimate, in my view.
Representative Beyer. Thank you. Mr. Delisle, one slightly
tongue-in-cheek question, which is: Why would we ever buy Greek
debt? And then the more serious one is:
Given that we don't have a profit motive as the government
in our federal credit, the market risk premium represents an
opportunity cost that is not tied to cash flow. Doesn't the
cash flow make much more sense than an opportunity cost that
may never be realized? Especially when the historical data
suggests that in fact we are doing just fine?
Mr. Delisle. Do you believe that the average expected cash
flow, as CBO estimates it from a student loan, is guaranteed to
occur exactly the way they project it to occur? If so, FCRA is
your model.
If you do not think average expected cash flows are
guaranteed to occur the way they are estimated, then fair value
is your model.
In terms of why would we ever buy Greek debt? FCRA tells
you there is absolutely no budget reason not to do so.
Representative Beyer. Except that we have the larger social
purposes. We have put these things in place because we are
trying to build a better America, a better economy. I am not
sure that buying Greek debt is on that list.
Mr. Delisle. But it does not cost you anything. FCRA says
you make money doing it, immediately. So why wouldn't you do
it, if you make money and you help out--you solve a financial
crisis. There is no budgetary reason not to do it. But I am
very delighted that you are having problems with sort of the
notion that there is no budget reason not to do that.
But I should say, on the issue of measuring the benefits,
you are holding fair value accounting to a higher standard than
all the other ways we do cost estimates. None of them--not cash
accounting, not FCRA--none of them factor in the benefits.
When you do the estimate for a highway project, it does not
include the value of the benefits. None of the approaches do.
So this isn't a flaw with fair value. You are simply asking
more of fair value than you are asking of any of the other
accounting methods.
Representative Beyer. Thank you. Mr. Chairman, thank you.
Senator Lee. Senator Cotton.
Senator Cotton. Thank you. I apologize if we've been over
this ground. I am just coming from presiding over the Senate.
I would like to start, Dr. Holtz-Eakin, with you. Could you
outline any real challenges or risks to simply using fair value
accounting as one source of knowledge, even if it is not
mandated for use, even if it is not something that we put in
the statute but it is something that informs our policy
judgments?
Dr. Holtz-Eakin. I see no downside to that. Indeed, some of
that happens now. We have seen CBO put out estimates of the
budgetary impact of various credit programs under both FCRA
accounting and what they would look like under fair value, so
that Congress has some notion--the Ex-Im Bank being a notable
example.
Senator Cotton. Okay. Tell you what, why don't we just go
down the panel and hear responses to that.
Mr. Delisle. I'm sorry? The question again was?
Senator Cotton. So is there any risk or drawback of using
fair value accounting as at least one source of information to
inform policy judgments, even if we don't amend FCRA and make
that the method of accounting?
Mr. Delisle. Well I think that the risks in using fair
value are the same as they are in using other accounting
methods; that, you know, the information you know today ends up
not being perfect, and so something changes in the future to
make your original estimate different, or off. Those exist in
all the forms.
I should point out though that there has been some
conversation about how the Federal Government is different from
private entities. I think that that is a perfectly valid
argument if the Federal Government had its own money. It
doesn't have its own money. It has our money, and it has to use
our value for the price of risk. That's only fair. And where do
we go to assess our collective value for risk? We look at the
market prices. Because you have a massive voting system on what
something is worth, and I think that is the appropriate place
to go to figure out what these loans actually cost.
Senator Cotton. Could I ask you to say more about the
conversation you cited about the differences between the
Federal Government and businesses? I hear that, and I hear my
thinking that says, yes, the Federal Government is different.
It is not a for-profit enterprise. Therefore, it makes
decisions not based on market or financial signals, but on
political decisions oftentimes. And frequently, whereas market-
based institutions pick winners and losers which is in the
nature of a capitalist society, the government tends to pick
losers. Because if they were winners, they would have gotten
financing in the private marketplace.
So could you say a little bit more about that?
Mr. Delisle. So my first response is, nonprofit credit
unions are nonprofit. They also can borrow at a very low rate
because they have a government guarantee on their deposits.
Even they don't make loans at terms as generous as the Federal
Government because they don't think it is worth it. So there is
clearly something more going on than your profit motive. I also
think that, you know, the same could be true for pension funds,
right? Pensions funds are nonprofit. But they assign a value to
assets at the market price. And I think that is the fairest
value, regardless of your intentions and your motivations.
Senator Cotton. All right. Mr. Elliott, any real risk of at
least using fair value accounting as a way to inform our
decision making?
Mr. Elliott. I think it would be a step forward, very
clearly. The one risk is, there is an argument that having two
sets of numbers makes it a little harder for people to-- there
is a danger of talking past each other. But I would still
rather have the extra information.
Senator Cotton. Okay.
Dr. Van de Water. I see no objection to providing
additional information of that sort.
Senator Cotton. It sort of sounds like we are all in
agreement, it is worthwhile and should inform our policymaking.
Okay. Thank you all. Thank you.
Senator Lee. I want to thank our Committee members, and I
want to thank our witnesses especially for coming and providing
the insightful testimony.
Your testimony has been very helpful. The hearing record
will remain open for three business days for those members who
may wish to submit questions for the record.
We will be adjourned.
(Whereupon, at 11:20 a.m., Wednesday, June 17, 2015, the
hearing was adjourned.)
SUBMISSIONS FOR THE RECORD
Prepared Statement of Hon. Dan Coats, Chairman, Joint Economic
Committee
The committee will come to order.
The committee today will examine the economic exposure of federal
credit programs. I'd like to thank our witnesses for being here.
Today, we will examine why accounting for our federal assets
matters, and why inaccurate monitoring could bring harm to:
Borrowers who pay higher interest rates to cover the
defaults of others;
Private lenders who are frozen out of markets they seek
to serve; and,
Taxpayers, who may be exposed to unquantified losses.
During my prior service in the Senate, I was one of the ``Nay''
votes for the Omnibus Budget Reconciliation Act of 1990. Twenty-five
years later, I never imagined that I would be chairing a hearing to
debate the impact of accounting rules passed back then. This situation
reminds me of an old Yogi Berra quote, ``The future ain't what it used
to be.''
The 1990 reconciliation law included the Federal Credit Reform Act,
accounting rules crafted in reaction to the rocky credit history of the
1980s. The Resolution Trust Corporation held the assets of failed
savings & loans and put the federal government in the ``loan workout''
business. Sadly, fraudulent student loans made during the decade led to
a 20% student loan default rate and a loss equal to almost 10% of
outstanding loans. Cash accounting for all these asset changes within a
budget year presented a volatile picture of the federal budget that
properly represents spending trends.
Since then, the federal government has followed the rules of FCRA,
recording an annual present-value adjusted ``subsidy cost'' to account
for losses it may incur in the future charged against loans it has made
directly, as well as guarantees it provided for loans made by others.
It took 10 years to refine the complicated net present value
calculations used for FCRA, but by 2002, government accountants
calculated that the federal portfolio of $1.3-1.4 trillion in loans and
guarantees generated annual subsidy costs in the range of $5 to $12
billion, no small chunk of change.
This brings us to the financial crisis of 2008, which ballooned the
government's loan assets. FCRA's accounting rules converted loan
subsidy costs into deficit reducers. Since 2008, government accountants
have booked nearly $200 billion in annual subsidy gains while the
amount of federal loans and guarantees has more than doubled. As a
result, it is clear that the more credit market exposure the government
takes on, the more that expectations of future revenue rise under
current accounting rules, without equal accounting for higher risk.
At the end of September 2014, loans made or fully guaranteed by the
federal government totaled over $2.9 trillion. This includes $1.1
trillion in student loans. Additionally, the Federal Reserve reported
that nonmortgage consumer debt totaled $3.3 trillion as of September
30, 2014, giving the federal government a one-third share of the U.S.
consumer loan market.
Add to that the 70 percent of the mortgage market that the federal
government holds through direct loans, guarantees, and Fannie Mae and
Freddie Mac, and the federal government is the largest consumer lender
in the United States.
A lot has changed in twenty-five years. So today, we must ask
ourselves, do accounting rules passed twenty-five years ago reflect the
complexity of today's financial world?
I'd now like to recognize Ranking Member Maloney for her opening
statement.
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Prepared Statement of Hon. Carolyn B. Maloney, Ranking Member, Joint
Economic Committee
Thank you Chairman Coats for holding today's hearing.
In this morning's hearing, we will compare two systems for
budgeting federal credit programs.
The first, the Federal Credit Reform Act of 1990 (FCRA), was signed
into law by George H.W. Bush in 1990. It has proven a reliable tool for
budgeting federal credit programs.
The second, so-called ``fair value'' accounting, is a program
supported by some of my colleagues in the Republican Party that will
make federal credit programs seem more expensive. If implemented, this
system will necessitate cutting loan programs or raising interest
rates.
In my mind, there is nothing fair about ``fair value'' accounting.
At its root, today's hearing is about two vastly different
philosophical approaches to government.
My Republican friends believe that the federal government--in this
case federal lending programs--should operate just like the private
sector.
But the federal government is not the private sector.
The principal motivation of the private sector is to maximize
profit.
The principal goal of government is to provide services that the
private sector cannot or will not provide.
These differences are especially clear in federal lending programs.
Private institutions make loans that they think will be the most
profitable.
But the United States government sees thing differently.
For example, it lends to a group of individuals with little or no
income and no credit history. They are known as ``college students,''
and there are more than 20 million of them in the United States today.
The vast majority of student loans are issued by or guaranteed by the
government.
Why does the government take on this risk? Because it helps
millions of Americans go to college who might otherwise not be able to
afford to go. It also benefits the rest of us by creating a more
educated workforce. A better workforce will make our country more
competitive and our economy stronger.
This is a social good not recognized by private lenders.
I want to turn to the specific question of how we measure the costs
of federal government loan programs.
How these programs are accounted for--and how their budget impact
is assessed--will affect the broader deficit outlook and choices we
make as policymakers.
The current procedure under the Federal Credit Reform Act
appropriately calculates the lifetime cost of federal credit programs
reflecting both the risk of default and the government's cost of
borrowing.
FCRA has been very accurate. OMB found that since in the more than
20 years FCRA has been in place, the initial cost estimates of all
credit programs differed from their actual cost by less than one
percent.
As they say--if it ain't broke, don't fix it.
But today we're apparently trying to ``fix'' a system that already
works well.
It is part of a broader ideological initiative.
In tax policy, Republicans are trying to change the rules of the
game by instituting so-called ``dynamic scoring.'' This would make tax
cuts seem less expensive than they really are.
In federal credit policy, Republicans are trying to change the
rules of the game using an accounting system that will make programs
like student loans look more expensive.
The result of this so-called ``fair value'' accounting will be cuts
in federal loans programs--for example, less money available for
students at higher rates.
Under ``fair value'' accounting, the cost of federal credit
programs, which are funded by the purchase of low-interest Treasury
securities, would be evaluated as if these governments were forced to
borrow with an additional ``risk premium'' demanded by the private
market.
As the Center on Budget and Policy Priorities put it, fair value
budgeting requires that the budget ``reflect amounts that the Treasury
would never actually pay anyone.''
It will make federal lending programs appear more costly than they
really are.
Millions of Americans have something to lose if proponents of this
accounting system have their way. I regret that we don't have any of
their representatives on this panel today.
However, Chairman Coats and I have received letters from a number
of organizations strongly opposed to ``fair value'' accounting.
A letter from the National Education Association states that,
quote: ``NEA opposes the use of fair value accounting in federal credit
programs, especially student loan programs, because it would
artificially raise their costs and make them appear to be more
expensive to the federal government than they really are.''
I ask unanimous consent to enter this letter into the record.
A letter from the National Association of Homebuilders states that
``fair value accounting'' would artificially raise the rates on home
loans. I also would like to enter that letter into the record.
Other noted organizations also oppose using ``fair value
accounting'' for budgeting purposes:
The National Association of Realtors
The National Association of Independent Colleges and
Universities
The Retired Enlisted Association
The National Rural Electric Cooperative Association
The Student Aid Alliance
The National Multifamily Housing Council
And many others . . .
I would like to place letters from several of these organizations
into the record.
In conclusion, I ask that we listen to both sides of the debate
today--but that, ultimately, we not let ideology trump reality.
Fair value budgeting would distort the budget process, undercut
federal credit programs, and, ultimately, deprive millions of Americans
of the financial support they need to get an education, buy a home, or
start or operate a small business.
I look forward to our discussion this morning and thank each of the
witnesses for appearing before the Committee.
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