Fair Value for Federal Credit Programs: Start With Disclosure
By Roman Iwachiw, FI Consulting
The calls on Capitol Hill for fair value (FV) budgeting of federal credit programs resurfaced earlier this year with the Budget and Accounting Transparency Act of 2015 (S. 399/H.R. 119). Like bills introduced in past years, the Act calls for changing credit program budgeting from the current Federal Credit Reform Act of 1990 (FCRA) approach to a FV, or mark-to-market, approach. Like bills introduced in past years, FV legislation stalled.
The critical difference between FCRA and FV is this: While FCRA budgeting reflects expected credit losses, FV pricing also recognizes that there is uncertainty (i.e. risk) as to the ultimate amount and timing of these losses, and it incorporates this risk into budgetary costs.
FV legislation has well-argued philosophical and economic merits but it faces a fundamental challenge in that it would increase the government’s cost to issue loans and loan guarantees, leading to lower program volumes, higher appropriation requirements, or both. For example, CBO estimates that for fiscal years 2015-2024, a shift to FV would increase the cost of the Department of Education’s four largest student loan programs by $223 billion and FHA’s single-family mortgage program by $93 billion.*
Given the challenge in moving FV budgeting forward, advocates should consider redirecting their efforts. Rather than working to change budget rules, they can pursue an important secondary benefit of FV—increasing transparency into credit program risk. This could be accomplished by requiring that FV cost estimates be calculated and disclosed, as supplemental budget information, on agency financial statements, or elsewhere. For example, one could envision a disclosure embedded into the Federal Credit Supplement (note: I chose these programs at random and made up the numbers):
There is precedent for dual disclosure in the private sector, as the GSEs and many banks already offer their stakeholders both GAAP-compliant financial statements and a fair-value presentation of their balance sheet in footnotes. Transparency into risk could be strengthened even further by supplementing FV cost estimates with disclosures that show the potential for credit program outcomes to vary from FCRA estimates. Scenarios could be defined by a body such as OMB or by the credit agencies themselves. This is analogous to the stress testing required in the banking industry.
Whether FV is used for budgeting or simply for disclosure, the implementation is the same and it will pose challenges. Many Federal loans and guarantees would be valued using Level 3 inputs in the FAS 157 hierarchy, requiring that agencies enhance their modeling and data capabilities to quantify not just expected credit losses, but also the risk that losses will diverge from expectations. Even credit programs that can be valued using Level 2 inputs would need market data on similar financial instruments and methodologies to extrapolate those data to their own portfolios.
While the implementation challenges are real, CBO’s studies and the Troubled Asset Relief Program’s successful experience with FV demonstrate that they are not insurmountable. In addition, the challenges come with corresponding benefits. FV will not only improve the risk information available to policymakers and the public, but the process of putting it in place will give credit agency leadership new and valuable insights into their programs.
* Damien Moore and Mitchell Remy, “Fair Value Estimates of the Cost of Federal Credit Programs for 2015 to 2024.”