September 16, 2010
In September 2008, the federal government took control of Fannie Mae and Freddie Mac—two government sponsored enterprises (GSEs) that provide credit guarantees on more than half of the outstanding residential mortgages in the United States. Although they are not legally federal agencies, the government operates them to fulfill the public purpose of supporting the housing and mortgage markets. Therefore, CBO believes that it is appropriate to include the GSEs’ financial transactions in the federal budget.
In its August 2010 baseline projections, CBO included an estimated $53 billion in costs for new mortgage guarantees that Fannie Mae and Freddie Mac will make over the 2011–2020 period. That estimate was made using a so-called “fair-value” basis of accounting, which differs from the way most federal credit programs are reflected in the budget. In a letter sent today to Congressman Barney Frank, CBO discusses that estimate and compares it with the budgetary impact that would be estimated using the procedures specified in the Federal Credit Reform Act of 1990 (FCRA), which governs the accounting for most federal direct loans and loan guarantees. CBO estimates that on a FCRA basis, Fannie Mae’s and Freddie Mac’s new mortgage guarantees made over the 2011–2020 period would generate total budgetary savings of $44 billion.
Both types of estimates use an accrual basis of accounting (the estimates represent the lifetime cost of credit commitments at the time when a federal loan or guarantee is provided) and are based on the same projected cash flows—but the estimates are very different because they involve the use of different discount rates to convert the expected future cash flows into one number representing the present value of those transactions. FCRA estimates are based on Treasury rates (which are generally viewed as risk-free), whereas fair-value estimates employ discount rates that are adjusted to match the risk of the specific credit obligation. Because it fully accounts for such risk, the fair value of a federal loan guarantee represents the amount that would have to be paid to induce a private entity to assume that liability in an orderly market.
The fair-value approach thus provides a more comprehensive measure of cost because it recognizes the cost to taxpayers when the government assumes financial risk. FCRA accounting, by omitting part of the cost of risk, makes a federal direct loan or loan guarantee appear to be less costly than an economically equivalent grant program. However, using the fair-value approach to account for the budgetary cost of the GSEs has the drawback that it reduces the comparability of the GSEs’ cost with that of other federal mortgage guarantee programs, such as those operated by the Federal Housing Administration.
The Administration takes a different approach to showing the impact of Fannie Mae and Freddie Mac on the federal budget. It treats the GSEs as separate from the federal government, and records the cash transactions between those two GSEs and the federal government. That is, it shows the payments the government makes to those entities when it purchases preferred stock, less the dividends Fannie Mae and Freddie Mac pay to the government. CBO estimates that those cash transactions will result in net receipts to the government of $8 billion over the 2011–2020 period, reflecting additional costs for more cash infusions from the Treasury in the near term (2011 and 2012) and dividend payments from the GSEs to the Treasury that will exceed cash infusions in subsequent years. That budgetary treatment, however, does not reflect the governmental nature of the GSEs’ activities, nor does it capture the full cost of the risks associated with them.