I want to commend james Capretta’s excellent article at RealClearPolicy, “How Congress Can Fix Its Trillion Dollar Accounting Error”, to your attention. It furnishes a description and history of the federal government’s role in lending. Here’s the meat of the article:
For instance, when the government issued guarantees for loans made by private sector banks, the federal budget would often show substantial initial savings from the issuance of the guarantees because the banks were required to pay up-front fees when loans were originated. The cost to the government of guaranteeing the loans was only recorded when payments were made to banks to cover losses associated with defaults. But these federal payments for loan defaults often took place many years after the loans originated and sometimes well beyond the five- or 10-year timeframe of the federal budget. Using cash accounting very often gave the misleading impression that issuing loan guarantees, even with lenient terms for the borrowers and the potential for large financial losses for the government, actually benefitted the federal budget.
By contrast, when the government lent money directly to borrowers, cash accounting made the transaction look artificially expensive. The government recorded the loan disbursement as an outlay and the repayments from borrowers as receipts, or negative outlays. For the many different types of loans with repayment periods beyond the timeframe of the budget, the initial outlay would far exceed the expected repayments occurring within the budget window, thus making the issuance of the direct loans look more expensive for the government than they really were.
FCRA was a major advance because it instituted accrual accounting for most credit programs. Under accrual accounting, the federal budget records the net subsidy cost of a direct loan or loan guarantee at the time the loan is originated based on the present value of all future financial flows from the transaction. Present value calculations use discount rates to assign a value in today’s terms to a receipt or a payment that is scheduled to occur in a future year. The purpose of accrual accounting is to capture the government’s all-in net exposure (or profit) after taking into account all of the disbursements and receipts. With accrual accounting, direct loan and loan guarantees get assessed using an identical methodology, which allows for a fairer comparison of the competing approaches. Further, using accrual accounting for credit programs allows for more useful comparisons with the budgetary costs of the government’s traditional spending programs.
The defect in the present system is that FCRA is required to use Treasury interest rates rather than market rates, effectively subsidizing lending. The broad effect of the reform would be to increase interest rates over substantial range of loans—everything for which there is a federal credit program. Today that includes almost all borrowing.
I think that the general thrust of that reform is good but don’t ignore the knock-on effects. Subsidized student loans allow individuals who otherwise couldn’t afford to go to college to do so but it also allows people to shoulder debts they can never repay and can’t discharge in bankruptcy. Subsidized home loans allow people who otherwise couldn’t afford to purchase a home to do so but it also raises the price of houses. The web of effects is so great I doubt they can be untangled. We don’t really know what effect requiring FCRA to use market rates would have. It could rectify the relationship between supply and demand. Or it could drive universities out of business. Or both.