How CBO Produces Fair-Value Estimates of the Cost of Federal Credit Programs: A Primer

The federal government supports some private activities—such as home ownership, postsecondary education, and certain commercial ventures—through credit assistance offered to individuals and businesses. Some of that assistance is in the form of federal direct loans, and some is through federal guarantees of loans made by private financial institutions. Although the costs of most federal activities are recorded in the budget on a cash basis (showing the balance of inflows and outflows when those flows occur), the lifetime costs of federal credit programs are recorded up front on an accrual basis. That budgetary treatment applies both to direct loans (for which most of the cash outflows occur up front, when loans are disbursed) and to loan guarantees (for which cash flows both to and from the government occur gradually over the life of the commitments).

The cost of providing credit assistance is an important consideration for policymakers as they allocate spending among programs and choose between credit assistance and other forms of aid such as federal grants—but assessing cost is not a simple matter. Indeed, it is more difficult to measure the cost of credit assistance than to assess the costs of other forms of aid because, for credit assistance, the measurement of cost must account for future cash flows of uncertain amounts that can continue for many years.

In this primer and other reports, CBO discusses two approaches that are used to estimate the cost to the federal government of credit programs:

• The accounting procedures currently used in the federal budget, as prescribed by the Federal Credit Reform Act of 1990 (FCRA), and
• An alternative approach in which costs are estimated on the basis of the market value of the federal government’s obligations—termed a fair-value approach.

A common method for estimating the fair value of a direct loan or loan guarantee is to discount the projected cash flows to the present using market-based discount rates. The present value expresses the flows of current and future income or payments in terms of a single number. That number, in turn, depends on the discount rate, or rate of interest, that is used to translate future cash flows into current dollars. For FCRA estimates, the discount rates used are the projected yields on Treasury securities of varying maturities. The fair-value estimates employ discounting methods that are consistent with the way the loan or loan guarantee would be priced in a competitive market. The difference between the FCRA and fair-value discount rates can be interpreted as a risk premium—the additional compensation that investors would require to bear the risk associated with federal credit. In general, the cost of a direct loan or a loan guarantee reported in the federal budget under FCRA procedures would be lower than the fair-value cost that private institutions would assign to similar credit assistance on the basis of market prices.

FCRA estimates reflect the average budgetary effects of programs that provide credit assistance. Combining FCRA estimates with projections of average spending and revenues produces deficit projections that in the long run reflect the average cash flows to and from the government. However, average budgetary effects sometimes are not the most useful measure of cost. By taking into account how the public assesses financial risks as expressed through market prices, fair-value estimates can help policymakers understand trade-offs between some types of policies.