Bipartisan Policy Center Event on Implications of GSE Reform for the Federal Budget and National Debt
AT THE MARCH 19TH FORUM HOSTED BY THE BIPARTISAN POLICY CENTER, panelists discussed the impact that government-sponsored enterprises (GSEs) have on the federal budget and proposed GSE reform legislation.
The panelists included: Tim Rood, Moderator and Chairman of The Collingwood Group; Michael Bopp, Partner at Gibson, Dunn & Crutcher; Deborah Lucas, Sloan Distinguished Professor of Finance at the MIT Sloan School of Management; Ike Brannon, Senior Fellow at the George W. Bush Institute; and Jim Hearn, Fellow at the National Academy of Public Administration.
Opening Remarks
Bill Hoagland, senior vice president at the Bipartisan Policy Center, initiated the discussion by highlighting that the Office of Management and Budget (OMB) estimated that the government-sponsored enterprises (GSEs) could return $180 billion to the federal government, while the Congressional Budget Office (CBO) estimated that the net lifetime costs of GSEs will reach $20 billion in the next decade.
Panel Discussion
Rood called upon Lucas to explain the fundamental differences between the OMB and CBO accounting practices. Lucas cited CBO’s use of fair value accrual practices, which recognizes tax payers as equity holders in GSEs, rather than just investors. She continued that CBO asks how fair market value would treat liquidation of its existing assets, while OMB uses a cash-basis of accounting for Fannie Mae (Fannie) and Freddie Mac (Freddie).
The cash-basis model, Lucas explained, is “entirely backwards looking” and also “ignores the time value of money.” Additionally, it ignores the cost of market risk, she said. These issues with cash-basis accounting were recognized by Congress in the Federal Credit Reform Act (FCRA), Lucas stated. The Act uses Treasury rates for discounting projected cash flows, while fair value uses market rates. In summary, Lucas said, CBO’s fair value approach “is best for aligning economic reality with budgetary treatment.”
Bopp responded that he felt OMB “has been dealt a bit of a rhetorical blow.” The fact that CBO scores the GSEs as deficit-increasing is due in part to the fact that CBO does not recognize receipts from the Treasury, Bopp stated. OMB, on the other hand, finds treasury receipts and recognizes them.
Hearn referenced the Congressional Budget Act of 1974, which created the CBO and established the requirement that Congress must have a cost estimate available when moving legislation. The Supreme Court ruled against averaging OMB and CBO cost estimates. He added that “pointing out the issue of ‘which score do we use’ is not a huge issue because only CBO does [cost] estimates; OMB does not.”
Bopp agreed, stating that CBO is scoring legislation and “as a result, any impact legislation might have on transfer of income or cash from GSEs to Treasury is not going to score,” because it is a transfer within the government. He also added that the Third Amendment affects OMB’s scoring directly, specifically by impacting scores of legislation on the Hill and “depressing the value of those warrants.”
Lucas said that because the government puts capital into GSEs, it is “a bit of a red herring to think there is somehow a pile of value that the government is going to get out of selling these warrants.” This is an aside from the “main point” that GSEs cost the government money, she said.
Lucas continued that there is “no special magic” of GSEs; any large financial institution could guarantee home mortgages in a similar fashion, unless the government is offering an “underpriced guarantee.”
Brannon added that one of the reasons that the GSEs are generating so much cash is the implicit guarantee that the government is backing them up. “If you were to privatize them, what happens to that guarantee? There is still the notion that the government will come in again,” he said. “We are probably spending more on housing now than makes sense.”
Lucas stated that the decision would be on a broader basis as to what goes to the government and what goes to the private sector.
Brannon said that the U.S. has more housing stock and less capital invested in the economy because of housing policy, which can be measured “close to the trillions.”
Rood asked Hearn how the two accounting conventions are used. Hearn replied that people are interested in a score of legislation, but that the OMB would not be scoring legislation. It is the CBO’s job, he added, to tell Congress what the impact will be.
Rood then asked if the CBO and OMB talk to each other regarding where they stand. Hearn explained that the CBO and OMB have meetings on credit reform, as well as budget concepts and what should be in or out of the budget.
Brannon commented that GSEs “threw out” a lot of money last year, which is one of the reasons why the administration stated it was time to end austerity. He added that “we should be happy with how the CBO is doing its scoring.”
Rood then discussed that since the GSEs have become profitable, President Obama has not mentioned “winding down” recently. He asked if the President was trying to distance himself from the GSEs.
Bopp answered that there is more of a debate now about the role of the GSEs, and that it has not been concluded that they will be eliminated.
Rood asked the panelists what would happen if the GSEs stopped being profitable.
Lucas replied that in her opinion, the GSEs are not profitable because being cash flow positive is not how financial institutions should necessarily be evaluated. Lucas continued that cash flows are not a complete picture of the GSEs, and that these companies should be looked at the way the private sector and investors would look at them, which comes back to thinking in terms of fair value concepts.
Questions from the Audience
An audience member asked how eliminating GSEs would affect the U.S. government’s credit rating. Lucas answered that it would be unlikely to affect the credit rating, as it is understood that Fannie and Freddie are backed by the U.S. government, and therefore not a new liability. She added that Fannie and Freddie debt would not be categorized as official U.S. debt.
Another audience member asked what would happen if the Department of Housing and Urban Development (HUD) were to make mortgage loans directly, as the Department of Education makes student loans directly.
Hearn answered that it would depend on whether the mortgage loan would be treated under the Federal Credit Reform Act (FCRA). He continued that the federal government would displace all lenders if they were to provide loans, and that due to the Treasury rate it could be seen as making loans cheaply. Hearn explained that the federal government would not be a lender of last resort, they would be only lender, and that the Treasury rate would be higher if this were to happen.
It was asked if the CBOs analysis would change if good-faith estimates increase. Lucas explained that as good-faith estimates go up, the CBOs would predict that there would be more private competition, and the loan volume going to Fannie and Freddie would decline.
Hearn was asked if Congress can “work anything it wants” into the baseline. Hearn answered that the baseline reflects current law, and changes only if a new law is enacted.
An audience member asked what would happen on a budgetary basis if GSEs were put into a receivership.
Bopp replied that it would be “unthinkable,” and added that the OMB would score it in the next Presidential budget. He explained that if they were put into a receivership and then liquidated in an orderly way, there would be value created by the liquidation, and there would be enough generated through the ten year period to make up for any loss.
Lucas added that liquidation would not create value; it would transfer value to private investors in exchange for money.
An audience member commented on Basel III and Dodd-Frank, among other rules, requiring the building of capital, and asked if the capital currently on the U.S. government’s balance sheet should be off the balance sheet.
The panel agreed that they wanted the capital off the government’s balance sheet.
Rood continued that companies should be allowed to recapitalize themselves like AIG and the car industry did. Brannon added that if Fannie and Freddie are kept in the private sector, he did not know how to guard against regulatory capture other than selling the warrants. Rood replied that with intolerable uncertainty, it seemed as if “a lot of parties” are happy to have Fannie and Freddie included because it provides predictability and a level of certainty.
The audience member added that the private label market “disappeared,” and was a huge part of the financing industry. He continued that if the GSE finance market was going to change, the entire housing market would be open to question.
Bopp concluded that current lawsuits are focused on the Third Amendment, questioning whether it was a legal action for the federal government to change the terms in preferred purchase agreements. He added that the private sector felt like the federal government “pulled the rug out from under them,” destroying the value that many were encouraged to invest in.
For more information about this event, or to view a webcast, please click here.
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AT THE MARCH 19TH FORUM HOSTED BY THE BIPARTISAN POLICY CENTER, panelists discussed the impact that government-sponsored enterprises (GSEs) have on the federal budget and proposed GSE reform legislation.
The panelists included: Tim Rood, Moderator and Chairman of The Collingwood Group; Michael Bopp, Partner at Gibson, Dunn & Crutcher; Deborah Lucas, Sloan Distinguished Professor of Finance at the MIT Sloan School of Management; Ike Brannon, Senior Fellow at the George W. Bush Institute; and Jim Hearn, Fellow at the National Academy of Public Administration.
Opening Remarks
Bill Hoagland, senior vice president at the Bipartisan Policy Center, initiated the discussion by highlighting that the Office of Management and Budget (OMB) estimated that the government-sponsored enterprises (GSEs) could return $180 billion to the federal government, while the Congressional Budget Office (CBO) estimated that the net lifetime costs of GSEs will reach $20 billion in the next decade.
Panel Discussion
Rood called upon Lucas to explain the fundamental differences between the OMB and CBO accounting practices. Lucas cited CBO’s use of fair value accrual practices, which recognizes tax payers as equity holders in GSEs, rather than just investors. She continued that CBO asks how fair market value would treat liquidation of its existing assets, while OMB uses a cash-basis of accounting for Fannie Mae (Fannie) and Freddie Mac (Freddie).
The cash-basis model, Lucas explained, is “entirely backwards looking” and also “ignores the time value of money.” Additionally, it ignores the cost of market risk, she said. These issues with cash-basis accounting were recognized by Congress in the Federal Credit Reform Act (FCRA), Lucas stated. The Act uses Treasury rates for discounting projected cash flows, while fair value uses market rates. In summary, Lucas said, CBO’s fair value approach “is best for aligning economic reality with budgetary treatment.”
Bopp responded that he felt OMB “has been dealt a bit of a rhetorical blow.” The fact that CBO scores the GSEs as deficit-increasing is due in part to the fact that CBO does not recognize receipts from the Treasury, Bopp stated. OMB, on the other hand, finds treasury receipts and recognizes them.
Hearn referenced the Congressional Budget Act of 1974, which created the CBO and established the requirement that Congress must have a cost estimate available when moving legislation. The Supreme Court ruled against averaging OMB and CBO cost estimates. He added that “pointing out the issue of ‘which score do we use’ is not a huge issue because only CBO does [cost] estimates; OMB does not.”
Bopp agreed, stating that CBO is scoring legislation and “as a result, any impact legislation might have on transfer of income or cash from GSEs to Treasury is not going to score,” because it is a transfer within the government. He also added that the Third Amendment affects OMB’s scoring directly, specifically by impacting scores of legislation on the Hill and “depressing the value of those warrants.”
Lucas said that because the government puts capital into GSEs, it is “a bit of a red herring to think there is somehow a pile of value that the government is going to get out of selling these warrants.” This is an aside from the “main point” that GSEs cost the government money, she said.
Lucas continued that there is “no special magic” of GSEs; any large financial institution could guarantee home mortgages in a similar fashion, unless the government is offering an “underpriced guarantee.”
Brannon added that one of the reasons that the GSEs are generating so much cash is the implicit guarantee that the government is backing them up. “If you were to privatize them, what happens to that guarantee? There is still the notion that the government will come in again,” he said. “We are probably spending more on housing now than makes sense.”
Lucas stated that the decision would be on a broader basis as to what goes to the government and what goes to the private sector.
Brannon said that the U.S. has more housing stock and less capital invested in the economy because of housing policy, which can be measured “close to the trillions.”
Rood asked Hearn how the two accounting conventions are used. Hearn replied that people are interested in a score of legislation, but that the OMB would not be scoring legislation. It is the CBO’s job, he added, to tell Congress what the impact will be.
Rood then asked if the CBO and OMB talk to each other regarding where they stand. Hearn explained that the CBO and OMB have meetings on credit reform, as well as budget concepts and what should be in or out of the budget.
Brannon commented that GSEs “threw out” a lot of money last year, which is one of the reasons why the administration stated it was time to end austerity. He added that “we should be happy with how the CBO is doing its scoring.”
Rood then discussed that since the GSEs have become profitable, President Obama has not mentioned “winding down” recently. He asked if the President was trying to distance himself from the GSEs.
Bopp answered that there is more of a debate now about the role of the GSEs, and that it has not been concluded that they will be eliminated.
Rood asked the panelists what would happen if the GSEs stopped being profitable.
Lucas replied that in her opinion, the GSEs are not profitable because being cash flow positive is not how financial institutions should necessarily be evaluated. Lucas continued that cash flows are not a complete picture of the GSEs, and that these companies should be looked at the way the private sector and investors would look at them, which comes back to thinking in terms of fair value concepts.
Questions from the Audience
An audience member asked how eliminating GSEs would affect the U.S. government’s credit rating. Lucas answered that it would be unlikely to affect the credit rating, as it is understood that Fannie and Freddie are backed by the U.S. government, and therefore not a new liability. She added that Fannie and Freddie debt would not be categorized as official U.S. debt.
Another audience member asked what would happen if the Department of Housing and Urban Development (HUD) were to make mortgage loans directly, as the Department of Education makes student loans directly.
Hearn answered that it would depend on whether the mortgage loan would be treated under the Federal Credit Reform Act (FCRA). He continued that the federal government would displace all lenders if they were to provide loans, and that due to the Treasury rate it could be seen as making loans cheaply. Hearn explained that the federal government would not be a lender of last resort, they would be only lender, and that the Treasury rate would be higher if this were to happen.
It was asked if the CBOs analysis would change if good-faith estimates increase. Lucas explained that as good-faith estimates go up, the CBOs would predict that there would be more private competition, and the loan volume going to Fannie and Freddie would decline.
Hearn was asked if Congress can “work anything it wants” into the baseline. Hearn answered that the baseline reflects current law, and changes only if a new law is enacted.
An audience member asked what would happen on a budgetary basis if GSEs were put into a receivership.
Bopp replied that it would be “unthinkable,” and added that the OMB would score it in the next Presidential budget. He explained that if they were put into a receivership and then liquidated in an orderly way, there would be value created by the liquidation, and there would be enough generated through the ten year period to make up for any loss.
Lucas added that liquidation would not create value; it would transfer value to private investors in exchange for money.
An audience member commented on Basel III and Dodd-Frank, among other rules, requiring the building of capital, and asked if the capital currently on the U.S. government’s balance sheet should be off the balance sheet.
The panel agreed that they wanted the capital off the government’s balance sheet.
Rood continued that companies should be allowed to recapitalize themselves like AIG and the car industry did. Brannon added that if Fannie and Freddie are kept in the private sector, he did not know how to guard against regulatory capture other than selling the warrants. Rood replied that with intolerable uncertainty, it seemed as if “a lot of parties” are happy to have Fannie and Freddie included because it provides predictability and a level of certainty.
The audience member added that the private label market “disappeared,” and was a huge part of the financing industry. He continued that if the GSE finance market was going to change, the entire housing market would be open to question.
Bopp concluded that current lawsuits are focused on the Third Amendment, questioning whether it was a legal action for the federal government to change the terms in preferred purchase agreements. He added that the private sector felt like the federal government “pulled the rug out from under them,” destroying the value that many were encouraged to invest in.
For more information about this event, or to view a webcast, please click here.