Take An Integrated View of Mission, Cost, and Risk in Federal Credit Portfolios
BY JOSH MEIKRANTZ, FI CONSULTING
Federal credit agencies expend resources—in the form of costs and risk— in order to achieve policy missions. While agencies measure program credit costs and performance against mission, typically these efforts are undertaken independently and risk is not considered at all. Government credit agencies should assess costs, mission, and risk jointly, in a manner analogous to the risk-return frameworks made by private financial institutions. Developing an integrated view will increase transparency, improve allocation of budgetary resources, and give credit program managers better insight into what they’re buying. It will also make comparisons across different credit programs more meaningful.
In this post we describe the current state of cost, mission, and risk measurement in US government credit programs and put forward a simple, illustrative, approach to integrate these concepts within the existing Federal budget reporting framework. We propose two metrics: “Cost / Mission” and “Stress Cost / Mission”, that would provide a more holistic view of credit program performance than current measures.
Cost. Federal credit agencies calculate credit program costs using a net present value of cash flows approach, consistent with the Federal Credit Reform Act of 1990 (FCRA). Costs are reported in the Federal budget and in agency financial statements, and are expressed both in dollars and as a percentage of outstanding credit (credit subsidy rate). FCRA ensures that cost metrics are defined identically across agencies, enabling direct comparison across programs. For example, the credit subsidy costs of VA’s housing guarantee program (estimated to be 0.25% of total credit obligations for the 2017 cohort) can be compared to those of FHA’s MMI program (-3.7% for the 2017 cohort). Comparisons can also be made over time.
Mission. Most agencies measure and report their programs’ performance against their policy missions, however the quality of these metrics varies widely. Mission metrics are inherently challenging to define and implement. Authorizing statutes tend to express credit program missions in the form of high-level goals, or not at all. Translating even a well-stated mission into tangible metrics is difficult and collecting supporting data can be even harder. As agency priorities shift missions can be redefined, making previous performance metrics irrelevant. For credit programs, mission metrics often focus on program outputs, for example lending volumes (or proxies thereof), rather than on policy outcomes. Some agencies have made progress, but it is uneven.
Table 1 provides some examples of metrics used by agencies to assess credit program performance.
Risk. FCRA’s approach to credit program costs does not take into account risk— the potential for actual credit losses to vary from expectations. Very few credit agencies quantify risk and even fewer disclose it. In a prior blog post, we proposed that agencies consider dual reporting, using Fair Value cost measurement as a means to better understand and disclose risk. We also suggested that agencies deepen their understanding of risk even further by estimating and disclosing “stress path” subsidy rates that illustrate credit program costs under adverse economic scenarios. Defining these adverse scenarios centrally and applying them government-wide would allow for meaningful comparison of risk across programs and agencies, similar to DFAST/CCAR stress tests in banking.
Developing an Integrated View
An integrated view of cost, mission, and risk will provide benefits that include greater transparency and better information to support resource allocation. While enabling this will require work– mainly to develop risk metrics and to advance credit programs’ mission metrics to the level of relative maturity found in FCRA costing– a framework that can support integrated reporting of these three metrics already exists: the Federal Credit Supplement.
In Figure 1, we present a simple addition to the structure of the Credit Supplement to support integrated reporting. The key metrics are:
- Cost/Mission – the subsidy cost per unit of mission achieved
- Stress Cost/Mission — the subsidy cost per unit of mission achieved, in an adverse scenario
All else equal, policy makers should seek to minimize these ratios in order to deliver as much mission as possible for given cost and risk levels. In addition, to the extent that mission metrics can be harmonized across similar types of programs, for example in housing, integrated presentation will allow policymakers to compare programs in meaningful ways.
Note that the subsidy rates, mission, and risk metrics are illustrative only.
Figure 1 – Adding mission and risk metrics to the Federal Credit Supplement; “Cost/Mission” and “Stress Cost/Mission”