Why are we making Uncle Sam a trillion-dollar lender?

By Douglas Holtz-Eakin
July 28, 2011

By Douglas Holtz-Eakin
The opinions expressed are his own.

America is on a path to fiscal disaster.  The skyrocketing national debt will continue to force the Nation to make fundamental decisions about what the government will and will not do, and how to share budget resources across competing programs.  Too bad Congressional budget rules give misleading signals on the best path forward.

In spite of the impending crisis, in just the past two years Congress and the President have committed the United States government to lend directly more than a trillion dollars of student, home and other loans.  That is over a trillion dollars of new borrowing at a time when debt threatens the foundations of the U.S. economy.  More startling, the borrowing was done in the name of deficit reduction.

How could this be?

Budget law requires the Congressional Budget Office (CBO) to assume that loans made directly by the government earn huge profits, with virtually no risk that such estimates could be wrong.  As a former CBO Director, it is easy for me to point out that most of the governments financial transactions are fraught with risk – the support of Fannie Mae and Freddie Mac being the prime examples that came back to haunt the taxpayer.  So it is a paper fantasy that the federal government will surely recoup more money than it lends out.  If a bank were to use the same accounting, the Securities and Exchange Commission would charge them with overstating their earnings and throw the book at them.  Congress gets to call these phantom profits “savings.”

CBO understands the pitfalls ,and has told Congress that in the two largest federal lending programs – federal direct student lending and housing loans made by the Federal Housing Authority (FHA) – the estimates ignore real-world risks and put taxpayers on the hook for huge inevitable future shortfalls. Worse yet, Congress spends the fictional “savings” the day legislation is passed, while leaving unsuspecting taxpayers to pick up the tab down the road.

The rules – specifically the Federal Credit Reform Act – need to be changed so that the budget reflects the risks associated with federal lending.  If those rules were in place, Congress would not have an incentive to explode the federal balance sheet and would have an incentive to pare back taxpayer burdens.

Consider student loans.  Armed with a CBO projection of $68 billion in taxpayer “savings” from establishing the Department of Education as a student loan monopoly, Congress and the President drastically increased the government’s role in delivering student aid. Secretary of Education Arne Duncan has a tough enough job as head of U.S. education efforts.  Why ask him to also be a banker? Nobody could perform both roles well.

It gets worse.  Congress and the President turned around and spent the so-called “savings” that have no guarantee of materializing.  Worse yet, they knew it as they did it.  Months before the legislation was passed, Republican Senator Judd Gregg asked CBO to project the savings if the real world risks of owning such a large volume of loans were considered.  In response, CBO told Congress that the official score was overly optimistic by $28 billion.

Bottom line: The Secretary of Education is now one of the top financial executives in the U.S., and Congress spent nearly all of the over-estimated “savings” on the President’s health care reform and unaffordable education entitlements.  This one piece of legislation will add more than a trillion dollars of risky loans to the national balance sheet by 2017, and all in the name of fiscal responsibility.  Backed by unsuspecting taxpayers, the federal government is now the last American institution with a financial incentive to make more and more loans, irrespective of whether individuals can pay them back.

The same rules for estimating loan costs mean that any attempt to rein in federal lending – even if done to protect individuals from overborrowing – would be portrayed as “costing” federal revenue.  In light of the threat to this Nation of the debt, these incentives are untenable.

In April, the S&P rating agency cited the potential for losses on federal loans as a “material fiscal risk” to the creditworthiness of the United States. Accordingly, any serious effort to reform our growing debt must include a change in rules so that the budget reflects the risks associated with federal lending.  Accurate budgeting will reflect the real costs to taxpayers, and thereby remove the incentive for Congress to make a bad situation even worse.

 

5 comments

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Government now accounts for 40% of US GDP! Also, our National debt represents 25%+ of total world debt and will soon (this year) exceed 100% of GDP! Big government is the problem, not the answer! We have a moral obligation to shrink the size of our government! Not likely when 40% of us either work for government, are retired for government of living off gov! I call that one big FAT conflict of interest when voting for more government!

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[...] is passed.  For example, CBO says that federal direct student loan program ”savings” were over-stated by $28 billion in risks that CBO is not permitted to consider and that $1T in risky loans would pile up by 2017. [...]

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