GOVERNMENT CREDIT SHOULD INCORPORATE MARKET RISK
September 1, 2004
The Congressional Budget Office (CBO) suggests that government lending policy could be improved by using commercial interest rates because they incorporate market risk.
The federal government reduces the price and increases the availability of credit for particular uses by guaranteeing private loans or making loans directly. The amount of these obligations is substantial:
- In fiscal year 2003, the government guaranteed $365 billion in new loans at an estimated cost of $4.2 billion -- or $1.15 per $100 guaranteed (a subsidy rate of 1.15 percent).
- More than two-thirds of all loans were for home mortgages, though loan guarantees to companies in the airline, steel, oil and gas industries are also common.
- Last year, all outstanding federal direct and guaranteed loans had a total value of $1.4 trillion -- nearly two-thirds more than the value a decade ago.
Currently, the government uses risk-free Treasury interest rates to measure the cost of federal credit programs. However, the CBO finds that this form of discounting fails to capture the costs that market risk impose on government:
- As a result, the government systematically underestimates the costs of both direct and guaranteed loans, potentially biasing the allocation of budgetary resources.
- Switching to risk-adjusted discount rates, which are used by private financial institutions, will improve the comparability of budgetary costs for credit and other programs.
Source: "Estimating the Value of Subsidies for Federal Loans and Loan Guarantees," Congressional Budget Office, August 2004.
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