Hidden Spending: The Politics of Federal Credit Programs

Hidden Spending

Hidden Spending

The Politics of Federal Credit Programs

Dennis S. Ippolito

The University of North Carolina Press

Chapel Hill and London

© 1984 The University of North Carolina Press

All rights reserved

Manufactured in the United States of America

Library of Congress Cataloging in Publication Data

Ippolito, Dennis S.

  Hidden spending.

  Includes bibliographical references and index.

  1. Government lending—United States. 2. Loans—

United States—Government guaranty. I. Title.

HJ8119.165   1984    336.3    84-3652

ISBN 0-8078-1614-0

ISBN 0-8078-4121-8 pbk.

THIS BOOK WAS DIGITALLY MANUFACTURED.

For Nancy Elizabeth

Contents

Preface

Chapter 1

Spending, Credit, and the Budget

Chapter 2

Components of Federal Credit Activity

Chapter 3

Accounting for Federal Credit

Chapter 4

Credit without Controls

Chapter 5

The Credit Budget—Information versus Enforcement

Chapter 6

The Reagan Initiatives

Chapter 7

Controlling Federal Credit

Notes

Index

List of Tables

1.1 The Growth of Budget Outlays, Fiscal Years 1955–1982 6

1.2 Outstanding Federal Loans, Fiscal Years 1970–1982 6

1.3 Gross versus Net Lending, Fiscal Years 1980–1982 9

1.4 Unified and Actual Budget Deficits, Fiscal Years 1974–1982 10

1.5 Federal Participation in Domestic Credit Markets 11

1.6 Average Loan Terms and Comparable Market Interest Rates, Direct Loan Programs, by Agency, 1982 14

1.7 Average Loan Terms, Selected Loan Guarantee Programs, by Agency, 1981 14

2.1 Budget Shares, Defense versus Payments for Individuals, Fiscal Years 1955–1983 20

2.2 Human Resources Spending, Fiscal Years 1970–1985 21

2.3 Direct Loan Obligations and Loan Guarantee Commitments, by Function, Fiscal Years 1950–1982 24

2.4 Major Loan Guarantee Programs, Fiscal Year 1982 27

2.5 Major Direct Loan Programs, Fiscal Year 1982 35

3.1 Federal Financing Bank Holdings, Outstanding Agency Debt, Fiscal Years 1975–1983 57

3.2 Outstanding Federal Financing Bank Holdings, Agency Debt, Loan Assets, Direct Loans, Fiscal Years 1976–1983 57

3.3 FmHA Lending, Budget Balances, and CBO Sales to the FFB, Fiscal Years 1974–1983 60

3.4 Outlay and Deficit Understatements Caused by FFB Financing, Fiscal Years 1974–1983 62

4.1 Credit Legislation Enactments, by Functional Category, 1965–1982 66

4.2 Outstanding Credit Advanced by Government-Sponsored Enterprises, 1970–1982 68

4.3 Current and Previous Off-Budget Agencies 69

5.1 Net Federal Credit and Federal Credit Control, Fiscal Year 1981 Estimates 94

5.2 Appropriations Bill Limitations, Fiscal Year 1981 Estimates 95

5.3 Outstanding Federal Credit and Net Federal Credit, Fiscal Years 1979–1981 96

5.4 House Budget Committee Credit Budget Recommendations, Fiscal Year 1981 99

5.5 Federal Credit Outstanding, Fiscal Years 1979–1981 103

5.6 Direct Loans—Credit Budget versus Program Activity, Fiscal Year 1981 103

5.7 Loan Guarantees—Credit Budget versus Program Activity, Fiscal Year 1981 104

6.1 Reagan Administration and Congressional Spending and Credit Budget Aggregates, Fiscal Years 1981–1986 108

6.2 Estimated and Actual Changes in New Lending, by Agency, Fiscal Years 1980–1982 111

6.3 Reagan Administration Proposed Reductions in Credit Programs, Fiscal Years 1984–1988 116

6.4 Action Required to Effect Major Program Reductions, Reagan Fiscal 1984 Credit Budget 117

6.5 Estimated Outlay Impact of Reagan Credit Budget Proposals, Fiscal Years 1984–1988 119

6.6 Reagan Administration and Congressional Credit Budgets, by Function, Fiscal Year 1983 124

7.1 Interest Subsidy Values, Selected Direct Loan Programs, 1983 141

List of Figures

1.1 Net Federal Credit, Fiscal Years 1972–1988 8

2.1 Composition of the Spending Budget, Fiscal Years 1980–1985 22

2.2 Composition of Federal Spending and Federal Lending, Fiscal Year 1982 25

2.3 Total Guarantees Outstanding for Actuarially Sound Programs and for Programs for Marginal Borrowers 30

2.4 Federal Aid to Students for Higher Education, Fiscal Years 1971–1983 32

3.1 Net Lending and Loans Outstanding of the Federal Financing Bank, Fiscal Years 1974–1983 55

3.2 Direct Loan Disbursements, Farmers Home Administration, Fiscal Years 1951–1985 59

Preface

Each year, federal agencies distribute tens of billions of dollars in direct loans and guaranteed loans through a variety of credit assistance programs. There is disagreement about the effectiveness of many of these programs. There is also a good deal of uncertainty, and even growing apprehension, about their economic impact. While this book discusses the programmatic and macro-economic issues associated with federal credit activity, its focus is on the political implications of credit.

The budgetary treatment of federal credit programs has exacerbated spending-control problems in Congress and the executive branch. Since the volume and, more important, the subsidy costs of federal credit assistance are not accurately reflected in the unified budget, credit programs are not forced to compete with direct spending or even with tax preferences. When pressures develop to control budget totals, as has been the case in recent years, credit programs offer a loophole. Substantial amounts of financial assistance can be distributed to a wide range of borrowers with little or no direct budgetary costs.

The loophole is deliberate. The budgetary distortions and evasions relating to federal credit accounting are the products of design, not accident. They have been used to shelter programs that otherwise could not compete successfully for scarce resources. They have served to protect credit programs from critical oversight. They have, until recently, frustrated attempts to direct congressional attention toward the growth and impact of credit policy.

In the absence of external controls, such as constitutional limits, fiscal discipline is heavily dependent upon appropriate norms and procedures. In practical terms, this means—at a minimum—comprehensive budgets and centralized spending control. Credit programs have eroded the comprehensiveness of the federal budget and weakened still further centralized control over spending. Under these conditions the prospects for fiscal responsibility are dim. This is especially true in Congress, which has typically found it difficult to resist spending pressures.

For much of our history the fiscal test applied to political institutions was simple. Budgets should, under normal conditions, be balanced. Deficits should, if unavoidable, be temporary. The norm of the balanced budget reflected certain beliefs about government and the economy, but it was influenced to a considerably greater degree by political assumptions. So long as spending had to be financed directly and immediately by taxation, the political benefits of spending would be offset by the political costs of taxation. Given the public's natural antipathy toward taxes, balanced budgets meant limited budgets.

This norm, however, no longer applies to the federal government. The federal budget has become an instrument of economic management. Whether it is balanced—which has occurred only four times in the past thirty years—is not considered a test of political virtue or economic desirability. There is, then, a different fiscal test, with budgets evaluated for their economic impact. As is now quite apparent, this impact is much too uncertain to guide political decision making. Cutting the nexus between spending and taxation, and not substituting a clear-cut standard for evaluating fiscal decisions, simply biases the political process toward increased spending and deficits.

A similar bias affects credit programs. It is not possible to predict the economic effects of credit programs or credit budgets with great confidence. Political judgments about credit programs, therefore, are insulated from macroeconomic constraints. Credit programs may, of course, sometimes be preferable to direct spending. But without a consensus on economic impact (which does not exist and is unlikely to develop) or information about budgetary costs (which could be made available), credit is likely to be chosen for budgetary rather than programmatic reasons. Moreover, the only constraint is occasional disquiet when credit totals grow very rapidly and interest rates increase.

This book, then, examines the relationship between fiscal realities and the political process. It will, I hope, illuminate that relationship and improve our understanding of not only credit programs but also fiscal decision making.

I have incurred many debts during the course of this study and would like to acknowledge at least some of them. Leslie Lenkowsky provided truly indispensable assistance. Professor Aaron Wildavsky contributed encouragement and insight as part of a comprehensive critique. A second, anonymous reviewer permitted me to benefit from a formidable expertise about credit programs. Karen Bussell was an integral and invaluable part of this project from beginning to end.

Hidden Spending

Chapter 1

Spending, Credit, and the Budget

Political controversies over the size, composition, and economic effects of the federal budget have greatly intensified over the past decade. Despite presidential and congressional efforts to restrain spending, budget growth has been rapid and seemingly uncontrollable, and deficits have reached unprecedented levels. Pressures to reduce spending growth and deficits have heightened the competition between budget priorities, particularly between defense and social welfare spending.

While the travails of the official budget have received a good deal of critical attention, direct spending and the fiscal policies necessary to finance this spending are only part of the current fiscal dilemma. Since the early 1970s, federal credit programs have proliferated and expanded dramatically and now represent an important, though largely hidden, form of government spending.¹ These programs are a principal component of federal policy in a number of areas—housing, agriculture, education, and international affairs—and have important economic consequences as well.

In fiscal 1972 the amount of federal and federally assisted credit outstanding was approximately $200 billion.² Ten years later, the total was well over $500 billion, and one of every eight dollars extended by federal agencies was in the form of a direct loan or loan guarantee.³ There are perhaps as many as 350 direct loan and loan guarantee programs.⁴ Funds advanced through these and other federal sources account for more than one-fifth of the total funds advanced in U.S. credit markets.⁵

Both the Carter and Reagan administrations have attempted to bring federal credit activities under the umbrella of broader budget control efforts. In his fiscal 1981 budget, President Carter initiated a credit budget designed to focus greater attention on the use and economic impact of federal credit programs.⁶ Two years later, the Reagan administration announced that rigorous control over Federal credit programs ... is an important part of the President's budget reform plan.⁷ Congress has also begun to address problems of credit control and to explore means of integrating credit into the budget process.

Like spending programs, however, federal credit programs are inherently difficult to control, for they provide well-defined and substantial benefits to important constituencies. The desire for fiscal restraint thus collides with political pressures to maintain and even to expand individual programs. And unlike the spending budget, the costs of many credit programs are diffused and largely hidden. As one critic has pointed out, credit programs permit government to claim that wonder of wonders—something for nothing, or almost nothing.⁸ The claim is spurious, but it presents an extraordinary test of the fiscal responsibility of political institutions.

How Spending Is Hidden

The economic impact of federal credit programs extends to the allocation of credit, the composition of the economy, and, ultimately, the productivity and economic growth of the nation. The expansion of federal credit activity, however, is not reflected in the spending and deficit totals in annual federal budgets.

Most direct loans, which require immediate commitments of funds, are charged to off-budget agencies, while the budgetary consequences of guaranteed loans become apparent only in the case of default, when agencies must actually provide funds to repay lenders holding the guarantees.⁹ Loan guarantees are by far the single largest category of federal credit activity, with the government's contingent liability exceeding $550 billion.¹⁰ A wide range of borrowers thus receives assistance with little or no direct spending and, hence, no apparent budgetary costs.

There are other, less obvious, dimensions to the hidden costs of federal credit activities. All credit programs include subsidies, since borrowers receive assistance at lower interest rates or under more favorable conditions than would be available in private credit markets. Indeed, the element of subsidy is the principal reason for utilizing government rather than private credit. Lower interest rates, longer loan maturities, and related forms of favored treatment lower the costs of borrowing. The effective result is a cash grant to the borrower.

The precise cost of such subsidies, however, is often difficult to calculate and, in any case, is usually not translated into direct spending. When direct loans, for example, are extended at rates below prevailing market conditions (or even the interest rates the government pays to finance its own borrowing), their true costs are not reflected in the actual cash transactions, even when these transactions are handled by on-budget agencies.

The obscuring of costs is even more evident with loan guarantees. Federal guarantees typically allow borrowers to obtain funds at lower rates by eliminating the risk to lenders. They also affect the allocation and supply of credit. Loan guarantees thus have direct costs for nonassisted borrowers, in addition to direct benefits for assisted borrowers, but these costs are not reflected in budget outlays.

Guaranteed loans for individuals (such as students), corporations (such as Chrysler), and governments (such as New York City) or direct loans for housing, agriculture, and other purposes share a salient characteristic. They allow the federal government to extend financial assistance while minimizing or even eliminating budgetary costs. Subsidies in the form of direct grants would often serve essentially the same purposes as credit programs, but would have the disadvantage (for political officeholders) of driving up budget totals. Hidden spending allows legislators and executive branch officials to capitalize on the political benefits of distributing assistance while they escape the political costs of raising and financing budgets.

The Growth of Credit Activity

Since the mid-1970s the spending side of the federal budget has risen sharply, from less than $365 billion in fiscal 1976 to over $725 billion in fiscal 1982. Spending growth for this period averaged over 13 percent annually, well above the rate of spending increase during the preceding two decades (see Table 1.1). Spending has also continued to outpace economic growth, rising from an average level of less than 21 percent of gross national product during the 1970s to approximately 23 percent in fiscal years 1980–82.

While the spending budget illustrates the substantial, and growing, impact of federal fiscal activities on the economy, the inclusion of credit activities provides a much fuller and more accurate representation of this relationship. The expansion of federal credit activity has paralleled the remarkable rise in federal spending. By some measures, it has actually been more dramatic.

Measuring Credit Activity

There are various ways to measure federal credit activity. One of the more meaningful is the level of outstanding, or unpaid, loans at the end of a fiscal year. In 1970 this total stood at less than $180 billion, and it rose modestly over the next several years. The growth in credit programs then began to accelerate, resulting in annual increases that averaged almost 13 percent in the level of outstanding direct loans and loan guarantees between 1976 and 1982 (see Table 1.2).

The rapid growth in outstanding loan balances presages problems in the area of government liabilities. The Congressional Budget Office has estimated that perhaps 95 percent of outstanding loans will ultimately be repaid, but this is admittedly based upon experience with older, established loan programs.¹¹ Data on defaults for many of the newer programs are limited and inconclusive, but there are indications that default rates may be substantially higher than those experienced in the past. In addition, some of these programs differ from traditional ones in that they are not protected by government claims on marketable property.

Table 1.1 The Growth of Budget Outlays, Fiscal Years 1955–1982

Source: Budget of the United States Government, Fiscal Year 1984 (Washington, D.C.: Government Printing Office, 1983), p. 9–55.

Table 1.2 Outstanding Federal Loans, Fiscal Years 1970–1982 (in billions of dollars)

As shown in Figure 1.1, the volume of net federal credit extended each year—new direct loans and loan guarantees minus repayments—roughly tripled between 1972 and 1982, the major increases occurring in off-budget lending and loan guarantees. The budgetary impact of this growth, however, was restricted to the relatively stable net outlays of on-budget agencies.

Moreover, the use of net-lending figures gives a greatly reduced picture of federal credit activity because of the unusual accounting devices utilized by federal agencies. It is perfectly reasonable, for example, to deduct repayments of old loans from new loan commitments in order to measure an agency's net lending during a given fiscal year. These repayments, however, need not be made by the borrowers to whom the loans were extended. Instead, agencies are permitted to sell their direct loan obligations to the Federal Financing Bank (FFB).¹² When certain agencies sell loan obligations to the FFB, the sales are treated as repayments. On-budget direct loans are converted into off-budget loans, and this conversion allows agencies to add the new funds gained by loan sales to their appropriated funds. In 1981, for example, the Farmers Home Administration (FmHA) extended more than $9 billion in new direct loans for its agricultural credit program, but the net outlays for the program showed repayments exceeding new loans by some $900 million. This apparently negative loan activity was misleading, since almost $7 billion in supposed repayments was actually nothing more than the sale of loans to the FFB. The FmHA was repaid for its loans; the government was not. The on-budget loans, however, were now off-budget loans, and the