As shown in figure 1, since the 2008 financial crisis, the amount  of federal direct loans and loan guarantees outstanding has nearly  doubled from $1.5 trillion at the end of fiscal year 2008 to $2.9 trillion at  the end of fiscal year 2014. Subsidy Cost Estimates and Reestimates

FCRA requires agencies to estimate the cost to the government of  extending or guaranteeing credit. This cost, referred to as subsidy cost,  equals the net present value of estimated cash flows from the  government minus estimated cash flows to the government over the life of  the loan and excluding administrative costs. The data used for budgetary subsidy cost estimates are generally  updated—or reestimated—annually after the end of the fiscal year to  reflect actual loan performance and to incorporate any changes in  assumptions about future loan performance. The  financing account, which is nonbudgetary, is used to (1) collect the  subsidy cost from the program account, (2) borrow from the Department  of the Treasury (Treasury) to provide financing for loan disbursements,  and (3) record the cash flows between the government and the borrower  or lender associated with direct loans or loan guarantees over the life of  the loan. These cash flows include loan disbursements, default payments  to lenders, loan repayments, interest payments, recoveries on defaulted  loans, and fee collections. In addition, FCRA requires that the rate of interest charged  on financing account transactions with Treasury be the same as the final  discount rate used to calculate the net present value of cash flows when  estimating the subsidy cost of a credit program. As a result,  the discount rate reflects the federal government’s actual borrowing cost  and incorporates into the subsidy cost calculation an agency’s cost of  financing its lending. Some have suggested  revising FCRA to include in the subsidy cost an additional estimated cost  related to certain market risk. This suggestion has been referred to as the  fair value approach and centers around the debate that beyond the cash  flows associated with the direct loan or loan guarantee, which are  recognized under FCRA, costs are imposed on taxpayers who would, in a  similarly risky private market transaction, require compensation for  bearing the aggregate risk associated with making the loan. Based  on our analyses of these factors related to reestimate data for the fiscal  years 2001 through 2014 cohorts, we did not identify any overall  consistent trends in under- or overestimates of subsidy costs across  federal credit programs government-wide. Specifically, although  both direct loan and loan guarantee programs government-wide had  overall lifetime upward reestimates for the cohorts over the 14-year period  of our analysis, the reestimates fluctuated significantly from year to year. These reestimates could generally be explained by specific events  affecting a few large programs. Chief among these changes affecting the cost were downward  adjustments to long-term housing price and interest rate assumptions  stemming from the mortgage and financial crises in the late 2000s. More  specifically, the fair value approach would (1) add noncash costs into the  budgeting process, which is based on cash costs; (2) be inconsistent with  the budget treatment of similarly risky programs; (3) lack transparency  with respect to inclusion of a noncash cost in budget totals; (4) involve  significant implementation issues; and (5) be complicated by comparisons  to GAAP fair value. Consequently, we  do not support the fair value approach to estimate subsidy costs for the  budget and believe the current FCRA methodology is more appropriate,  as it represents the best estimate of the direct cost to the government and  is consistent with current budgetary practices .Other experts we  interviewed, as well as OMB, opposed the fair value approach. Aggregate Risk Premium  In private financial markets, taxpayers as  investors with diversified portfolios would still  demand compensation for bearing the risk  that the macroeconomy—the national or  global economy as a whole—may falter. This  risk—referred to as aggregate risk (which  represents a portion of overall market risk)— arises from the possibility of significant  economic downturns, when even a well- diversified portfolio of financial investments  will experience a reduction in value. To incorporate the cost of bearing this aggregate risk into budget costs for  loans, the fair value approach adds an aggregate risk premium to the  discount rate used in FCRA calculations, which is determined based on  interest rates on Treasury securities. The debate  over the fair value approach rests on whether the cost associated with  aggregate risk should be considered in the subsidy cost of credit  programs for the budget of the federal government. Reflecting a different concern, some proponents of the fair value  approach to budgeting for federal credit programs, cited as motivation the  perceived over-reliance on federal credit as a policy tool and the desire to  correct any bias toward underestimated costs under FCRA. Some  proponents of the fair value approach told us that adopting the fair value  approach would help address concerns about the over-reliance on federal  credit programs by raising the subsidy cost of credit programs, likely  resulting in fewer loans being made. In contrast,  proponents of the FCRA methodology stated that to the extent that  agencies were underestimating subsidy costs under FCRA, this would be  more appropriately addressed through improvements in the subsidy  estimation process rather than application of the fair value approach. Fair Value Approach Subsidy Cost Estimates Are Not Consistent with Long-standing Federal Budgeting Practices, Involve Significant Implementation Challenges, and Should Not Be Included in the Budget

While fair value approach estimates may provide useful information for  evaluating the costs against the benefits of credit programs, the additional  market risk recognized under that approach do not reflect additional  estimated cash costs beyond those recognized by FCRA. Because of these issues, we do not support the fair value approach to  estimate credit program subsidy costs for the budget and believe that the  current FCRA methodology is more appropriate for this purpose. Agency Comments

We provided a draft of this report to CBO and OMB for their review and  comment. To evaluate implications of using subsidy cost estimates developed under  the fair value approach for the budget and to determine whether we  believe such concepts should be incorporated into subsidy cost estimates  for the budget, we reviewed literature related to the Federal Credit  Reform Act of 1990 (FCRA), the budget, and the fair value approach. We conducted semistructured interviews with 30  experts to achieve a variety of expertise and viewpoints. Budget Issues: Budgetary Treatment of Federal Credit Programs.
Why GAO Did This Study

Federal direct loans and loan guarantees outstanding have nearly doubled from $1.5 trillion at the end of fiscal year 2008 to $2.9 trillion at the end of fiscal year 2014. For the past several years, concerns have been raised by some experts both in and out of the federal government that FCRA may understate credit program subsidy costs. Some of these experts have suggested that FCRA be modified with an approach—referred to as the fair value approach—to include certain market risk not currently considered under FCRA.
GAO was asked to examine the budgetary treatment of the cost of federal credit programs. This report addresses (1) whether trends exist in subsidy cost reestimates and what factors, if any, help explain any significant trends in reestimates and (2) the implications of using the fair value approach to estimate subsidy costs in the budget and whether GAO believes such concepts should be incorporated into subsidy cost estimates for the budget.
GAO analyzed reestimate data from fiscal years 2001 to 2014 as reported in the President's Budgets and conducted interviews with 30 experts.

What GAO Found

The Federal Credit Reform Act of 1990 (FCRA) requires agencies to estimate the cost to the government of extending or guaranteeing credit. This cost, referred to as subsidy cost, equals the net present value of estimated cash flows from the government (e.g., loan disbursements and claim payments to lenders) minus estimated cash flows to the government (e.g., loan repayments, interest payments, fees, and recoveries on defaulted loans) over the life of the loan, excluding administrative costs. Discount rates that reflect the federal government's cost of financing are used to determine the net present value of estimated cash flows. Agencies generally update—or reestimate—subsidy costs annually to reflect both actual loan performance and changes in expected future loan performance.
Based on GAO's analyses of credit program reestimates for direct loans and loan guarantees obligated or committed from fiscal years 2001 through 2014 and considering various factors to identify trends, GAO did not identify any overall consistent trends in under- or overestimates of subsidy costs across federal credit programs government-wide. Overall, both direct loan and loan guarantee programs government-wide underestimated costs by $3.1 billion and $39.0 billion, respectively, over the 14-year period. These amounts represent less than 1 percent of the amounts disbursed or guaranteed during the period. Annual reestimates fluctuated from year to year, indicating both under- and overestimates of subsidy costs. Further, significant lifetime reestimates could generally be explained by specific events affecting a few large programs. For example, the Department of Housing and Urban Development's Mutual Mortgage Insurance Program reported underestimating costs over this period because of a variety of factors, including long-term housing prices and interest rate changes stemming from the mortgage and financial crises in the late 2000s.
While subsidy cost estimates under the fair value approach may provide useful information to decision makers for evaluating the costs against the benefits of credit programs, GAO does not support the use of the fair value approach to estimate subsidy costs for the budget. Proponents of the fair value approach have asserted that beyond the cash flows associated with a direct loan or loan guarantee, costs are imposed on taxpayers who would, in a similarly risky private market transaction, require compensation for bearing the risk associated with making the loan or guarantee. Taxpayers as investors with diversified portfolios would still demand compensation, or a premium, for bearing the risk that the macroeconomy—the national or global economy—may falter. This risk—referred to as aggregate risk (a portion of overall market risk)—arises from the possibility of significant economic downturns, when even a well-diversified portfolio of financial investments will decrease in value. To incorporate the cost of bearing aggregate risk into subsidy cost estimates for the budget, the fair value approach adds an aggregate risk premium to the discount rate used in FCRA calculations, which is based on interest rates of Treasury securities. Including the aggregate risk premium incorporates a noncash cost into the subsidy cost estimate. The actual cash flows to and from the federal government associated with a credit program are the same under the fair value approach and FCRA. The debate over the fair value approach rests on whether the cost associated with aggregate risk should be considered in the subsidy cost estimates for the budget of the federal government.
Reflecting a different concern, some proponents of the fair value approach cited as motivation the perceived overreliance on federal credit programs as a policy tool and the desire to correct any bias toward underestimates of costs under FCRA. Raising the subsidy cost would likely result in fewer loans being made. In contrast, some proponents of FCRA stated that any overreliance on credit programs should be addressed as a policy decision, and that to the extent that agencies were underestimating subsidy costs under FCRA, improvements in the subsidy estimation process should be pursued.
The additional market risk recognized under the fair value approach does not reflect additional cash costs beyond those already recognized by FCRA. The introduction of market risk into subsidy costs under the fair value approach would (1) be inconsistent with long-standing federal budgeting practices primarily based on cash outlays; (2) be inconsistent with the budgetary treatment of similarly risky programs; (3) introduce transparency and verification issues with respect to inclusion of a noncash cost in budget totals; and (4) involve significant implementation issues, such as the need for additional agency resources. Consequently, GAO does not support the use of the fair value approach to estimate subsidy costs for the budget and believes the current FCRA methodology is more appropriate for this purpose as it represents the best estimate of the direct cost to the government and is consistent with current budgetary practices.

What GAO Recommends

GAO supports maintaining the current FCRA method for estimating credit subsidy cost for the budget and therefore is not making any recommendations. The Congressional Budget Office and the Office of Management and Budget provided technical comments on a draft of this report, which have been incorporated as appropriate.