Accounting for Fannie and Freddie

 An editorial yesterday in the Wall Street Journal called on the Administration to support the reform of the two housing financing enterprises originally sponsored and now owned by the federal government, Fannie Mae and Freddie Mac, and at a minimum, to show the full cost of those organizations in its budget. 

Mr. Obama …can order the White House budget office to embrace honest accounting today and bring Fannie and Freddie on the federal budget.
In the wake of the financial and fiscal crises of the past two years, budgeters have struggled to devise appropriate budgetary accounting for new and extraordinary financial and fiscal interventions. Luckily, many of these have a precedent: the 1990 Credit Reform Act.   That act mandated how the budget should treat the cost of loan and loan guarantee programs. Under the Act, OMB and CBO calculate the cost of loans and guarantees as the net discounted present value of the expected cash flows to and from the federal Treasury resulting from the extension of the loan or guarantee, including any default costs net of recovered resources and any premiums or fees paid to the Government. (The cost for credits extended in the budget year divided by the volume of new direct and guaranteed loans is the subsidy rate). The subsidy cost for credit is included in budget outlays and the deficit in the year the loans are made. For the TARP, the Economic Stabilization Act mandated that TARP purchases be treated similarly, with the added stipulation that the cost of direct loans and guarantees should be calculated using fair market values. 
In the case of Freddie and Fannie, OMB and CBO disagree about whether they should now be included in the budget as government agencies. In September 2008, the federal government placed the GSEs in conservatorship to address their growing financial losses.  In exchange for a federal commitment to provide an infusion of cash, Fannie and Freddie gave Treasury a controlling equity interest in the enterprises. 
CBO argues that because “conservatorship” means the federal government now owns and controls Freddie and Fannie, their costs should be recorded in the budget as though they were federal agencies.  Earlier this year, CBO issued a report  and its Director wrote a blog on why CBO believes these two agencies and their costs should be on-budget.  In addition, in its budget update, it included the cost of covering their past financial losses AND included an estimate of the government’s cost over the next ten years in its budget projections. CBO now treats Fannie and Freddie purchases of loans and mortgage-backed securities as though they were being made by federal agencies.
In contrast, the President’s FY 2011 Budget continues to show both entities as off-budget. It shows the cost of the government’s cash payments to the entities to keep them afloat in 2009. It does not address the costs of future transactions at the point of control, or when Fannie and Freddie purchases mortgage-backed securities or otherwise take on additional risks.  In 2009, CBO shows outlays of nearly $300 billion for Fannie and Freddie support, while OMB records cash payments of less than $100 billion.
The current difference between CBO and OMB only deals with two failed GSEs. However, there are others still operating with the financial benefit of federal sponsorship.  Budget reform needs to look at the subsidies conveyed by government sponsorship of large financial enterprises such as the Federal Home Loan Banks and the Farm Credit System.  The budget should not shy away from recording the real cost of government commitments to the stability of such quasi-private entities. The subsidies are real, taking the form of lower funding costs than would be demanded of such risky entities if the Government were not behind them. The budget should record the costs of such federal commitments when they arise, not just when the bills are due. If the budget recognizes the potential costs of these programs as subsidies are conveyed, policymakers can act ahead of time to limit or offset the cost of the government subsidy and reduce the risk of a future bailout of other housing funds or programs.