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Accounting for the Cost of Government Credit Assistance

By Ingo Walter, Seymour Milstein Professor of Finance, Corporate Governance and Ethics and Vice Dean of Faculty, & the Financial Economists Roundtable

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The Financial Economists Roundtable comprises 33 prominent financial economists, (including Profs. Ed Altman, Rob Engle, Martin Gruber, Kose John and Ingo Walter), who recently endorsed a statement that examines current government accounting rules used to calculate the budgetary costs of government credit programs. They conclude that the use of these rules systematically understates the cost of federal credit programs and leads to perverse incentives to employ financial guarantees. The current approach fails to capture all of the risks associated with federal credit programs that must ultimately be borne by taxpayers.

They propose adopting a discount rate that captures all the risks borne by taxpayers. This would eliminate two perverse incentives caused by application of the current rules: (1) credit and non-credit assistance would be made more comparable in the budgetary process; (2) the government would be able to buy and sell loans at market prices without significant budgetary effects, eliminating the current budgetary arbitrage opportunity in buying loans at market prices and booking them at higher values using the current accounting rules. Moreover, a more accurate assessment of the guarantees issued by Fannie Mae and Freddie Mac, now under government conservatorship, would facilitate their ultimate privatization. And the true budgetary implications of credit assistance would be more transparent to program administrators, policy makers and the public.

Read full statement