The Agenda

Chris Papagianis on the Federal Government as an Investor

An interesting new ideological fault line has emerged: should the public sector account for market risk? A number of thinkers on the political left believe that the answer is no — because the public sector doesn’t have shareholders, it has no need to deliver return on equity. My Economics 21 colleague Chris Papagianis advances a different view in a new column on how to think about the federal government as an investor:

Most people don’t know this, but an “only in Washington” law (codified under the Federal Credit Reform Act) requires that to project the costs of a federal loan program, official scorekeepers must discount the expected loan performance using risk-free U.S. Treasury interest rates. There is no factor for “market risk”, which is the likelihood that loan defaults will be higher during times of economic stress and those defaults will be more costly as a result.

Jason Delisle of the New America Foundation has written extensively on this topic, arguing that when the government values risky investments using only risk-free discount rates, lawmakers have a perverse incentive to expand rather than limit the government’s loan programs. This is because a private-sector institution that extends the same loans (say on the exact same terms) would be required to factor in market risk. And, when this difference results in the government program showing that its lending activities would turn a profit, policymakers are inclined to expand the program to capture more of these fictitious profits (which conveniently they can also spend on other programs, even if the returns never materialize).

The confusion about how to view the U.S. government’s role as an investor has led many in Washington to argue that loan programs can subsidize everything from mortgages to student loans – all at no cost to the taxpayer. The principal concern with not evaluating a government and private investment in the same manner is that the government’s purported profits are often cited as proof of an inherent advantage the government has over the private sector in delivering credit. The truth is that this result generally comes from a less-than-full accounting of the risks taxpayers have been made to bear. (For more, see the work by Deborah Lucas at MIT, who also consulted on the COP report and other CBO studies.)

Papagianis’s core argument is that “when the government issues a loan guarantee, it’s the taxpayers who become equity investors.” And so the government has a responsibility to protect the interests of taxpayers, e.g., by accounting for and protecting against market risk. 

Last year, Josh Barro had a similar reaction to Dean Baker’s argument that the public sector can offer generous defined benefit pensions at very low cost to taxpayers.


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