Fair-value accounting (FVA) has been featured a lot here on the Agenda, and it should be a plank in any “reform conservative” platform. In a nutshell, the government understates the cost of its credit programs by disregarding the market risk associated with expected repayments. FVA would incorporate the cost of that risk, making for a much more honest and transparent budget.
If that sounds unimportant, consider the current debate over the Export-Import Bank (Ex-Im). Government accounting shows Ex-Im earning a “profit,” and advocates have made that a key talking point. But FVA indicates that Ex-Im actually costs taxpayers money — all the more reason to abolish it.
Unfortunately, the case for FVA is not easily made with talking points. It’s a complicated issue that requires some explanation, and advocates need to be vigilant about getting it right, lest opponents pounce on a slip-up.
Overstating the case is one slip-up that I’ve seen a lot. The Washington Post’s Charles Lane has been a stalwart supporter of FVA, and his influence is probably what caused the Post to editorialize in its favor. But in an otherwise excellent op-ed last week, Lane got too loose with his language: “If Ex-Im backs loans that the private sector would not otherwise make, then, by definition, its portfolio is risky. Yet under existing law the federal budget accounts for Ex-Im’s loans as if they were as safe as Treasury debt.”
That’s not quite right. It gives the impression that the government assumes every cent of Ex-Im’s loans will be paid back. Existing law does account for defaults in the sense that expected repayments are less than the total principal and interest owed. For example, if the government is owed $100 in loan payments, but historically it tends to receive only 90 percent of what it is owed, then the government will assume it’s going to get $90, not $100. So the loans themselves are not considered as safe as Treasury debt.
The government’s real error is to treat the $90 expected repayment — which is merely an estimate of how much will be paid back — as a certainty. In reality, the government will receive more or less than $90 depending on the state of the economy. If an economic downturn occurs, the government will get less than the expected repayment at a time when money is already scarce.
That possibility — known as “market risk” — has a cost in the private sector. A private investor would never buy the right to that loan repayment for $90. He would demand a discount the expected repayment in order to protect himself against the possibility that the repayment will be lower. FVA incorporates the cost of the risk premium into federal credit programs, whereas existing accounting procedures do not.
Is this nit-picking Lane’s point? Maybe, but it’s important to be precise, or opponents might seize the initiative in a debate.