TABLE OF CONTENTS
Preface
Introduction - Deborah Lucas
DOI: 10.7208/chicago/9780226496597.003.0001
[financial market, federal accounting, financial risk, political process, federal agencies, costing system]
Despite the size and importance of federal involvement in financial markets, the costs and risks of most federal financial activities are only partially measured and are poorly understood. In important respects (e.g., the absence of capital budgets, risk adjustment, and sophisticated internal costing systems), federal accounting for financial risk and value lags well behind private-sector standards. The political process provides few incentives for improving disclosures. Also, with a few notable exceptions, academics have devoted relatively little attention to improving the measurements of federal financial costs and risks. Programmatic complexity and the difficulty of obtaining data from federal agencies create substantial barriers to entry for researchers, and the topic has remained outside of the mainstream of economic inquiry. Filling these gaps is extremely important. (pages 1 - 12)
This chapter is available at:
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Bringing Financial Literacy to Washington - Peter R. Fisher
DOI: 10.7208/chicago/9780226496597.003.0002
[federal government, financial market, investment, financial risk, stock market, taxpayers]
The federal government is not a limited purpose organization; it has many objectives. But if it is going to take on the responsibility of intervening in a highly complex market of investment and actuarial exposures, it is a shame that it cannot do so with its eyes open to the financial risks and with the ability to structure its balance sheet accordingly. While it may be hard for some to imagine an instrumentality of the federal government shorting the American stock market, if the U.S. government is going to take on the responsibilities of an insurance company, doing so with one arm tied behind its back is bound to be expensive for taxpayers, pension plans, and retirees. (pages 13 - 20)
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Measuring and Managing Federal Financial Risk - Donald B. Marron
DOI: 10.7208/chicago/9780226496597.003.0003
[federal finance, financial risk, financial techniques, risk adjustment, discount rates, expected values]
There is clearly room for improvement in the measurement and management of the federal budget, generally, and in the management and reporting of financial risk, in particular. Improvements have been made over the years both through statute (e.g., the FCRA) and innovations by the scoring agencies (e.g., use of expected values), but more remains to be done. Some improvements may require the use of modern financial techniques—for example, greater use of risk-adjusted discount rates—but significant gains may also come from simpler changes (e.g., greater recognition of the time value of money). (pages 21 - 28)
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The Cost of Risk to the Government and Its Implications for Federal Budgeting - Deborah Lucas, Marvin Phaup
DOI: 10.7208/chicago/9780226496597.003.0004
[federal budgeting, market risk, decision making, resource allocation, cost, securities]
This chapter lays out the economic case for incorporating the cost of market risk in government decision making, describes how risky securities are currently accounted for in the federal budget and how this likely biases real resource allocations, and surveys the results of recent research on the cost of market risk for federal obligations. The analysis begins by addressing both the philosophical and practical impediments to incorporating the cost of risk into federal budget estimates. While the idea that market risk is a legitimate cost is now widely accepted in the private sector and by most academic economists, the concept has not gained such wide acceptance among policymakers nor in the federal budgeting community. The chapter revisits the lively debate that took place in the late 1960s and early 1970s between the leading economists of the time over whether the risk of activities undertaken by the government should be treated as a cost. (pages 29 - 54)
This chapter is available at:
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Federal Financial Exposure to Natural Catastrophe Risk - J. David Cummins, Michael Suher, George Zanjani
DOI: 10.7208/chicago/9780226496597.003.0005
[expenditures, federal finance, natural catastrophe, infrastructure, disaster relief, political process]
This chapter draws on a wide variety of government and private-sector data sources to document the size and causes of various expenditures from 1989 to 2008. The analysis suggests that these expenses, which have been escalating rapidly, are to a large extent predictable and therefore could be better accounted for and controlled. The chapter makes a case for the likely continuing high rate of federal spending growth for catastrophes. One reason for the steady and protracted cost growth is the increasing value of infrastructure exposed to catastrophe. Disaster relief expenditures have been the most significant component of federal catastrophe exposure. Another driver of cost growth is the political process. While some of these obligations are explicit in the law, much of the assistance that is provided is “discretionary.” (pages 61 - 92)
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Housing Policy, Mortgage Policy, and the Federal Housing Administration - Dwight M. Jaffee, John M. Quigley
DOI: 10.7208/chicago/9780226496597.003.0006
[housing policy, federal cost, off-budget activities, homeownership, subprime market, tax code]
To further the goal of increasing homeownership, federal housing policy makes extensive use of credit and tax incentives. These activities involve substantial federal cost and risk. This chapter reviews these risks and estimates the value of indirect and off-budget activities supporting homeownership. The analysis emphasizes the Federal Housing Administration's (FHA) mortgage insurance programs, and revisits their rationale and future role in light of the rapid rise and subsequent fall of the subprime market. Federal housing policy is executed through a complex array of institutions and programs, including the tax code, the FHA, and the Veterans Administration (VA). A comprehensive look at these programs reveals that off-budget policies primarily provide subsidies for middle- and upper-income homeowners and home purchasers, whereas programs subject to Congressional budget appropriations are directed toward lower-income and rental households. (pages 97 - 130)
This chapter is available at:
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Valuing Government Guarantees - Deborah Lucas, Robert McDonald
DOI: 10.7208/chicago/9780226496597.003.0007
[Government-sponsored enterprise, government guarantees, Fannie, Freddie, costs and risks, subsidy value]
This chapter considers some of the methodological issues surrounding estimating government-sponsored enterprise (GSE) subsidy values using a derivatives pricing approach and provides new estimates of the subsidy to Fannie and Freddie, taking these considerations into account. Existing estimates of the GSE subsidy value—made under the relatively stable market conditions of the last decade—vary enormously, ranging from $200 million to $182 billion. The wide range reduces the credibility of cost estimates and suggests the need to reconsider what is driving these differences. The takeover of Fannie and Freddie by the federal government and the prospect that they may remain fully federal entities for an extended time period underscore the need for improved tools to evaluate and monitor their costs and risks. (pages 131 - 162)
This chapter is available at:
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Guaranteed versus Direct Lending - Deborah Lucas, Damien Moore
DOI: 10.7208/chicago/9780226496597.003.0008
[direct lending, student loans, Educational Loan Program, Direct Loan Program, loan guarantees, federal lending]
The existence of two competing government programs—the Federal Family Educational Loan Program (guaranteed program) and the Federal Direct Loan Program (direct program)—provides a unique opportunity to compare the cost to the government of direct federal lending versus loan guarantees. Both the direct and guaranteed student loan programs offer their borrowers very similar loan products and terms, but they differ significantly from the perspective of other key stakeholders, including educational institutions, commercial lenders, and state guarantee agencies. This chapter proposes a methodology to provide a comprehensive cost estimate for the two programs in market value terms, and analyzes the sources of the differential. There are several reasons for emphasizing market values. Arguably, they are the best estimate of the cost of federal obligations from the perspective of taxpayers. (pages 163 - 212)
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Market Valuation of Accrued Social Security Benefits - John Geanakoplos, Stephen P. Zeldes
DOI: 10.7208/chicago/9780226496597.003.0009
[market valuation, Social Security, accrued benefits, financial markets, market price, risk adjustment]
This chapter applies the principles of market valuation to Social Security obligations. The calculations are relevant, for instance, to assessing the size of unfunded federal liabilities. The chapter argues that it is important to use market value. Since claims on accrued benefits are not currently traded in financial markets, however, we cannot directly observe a market value. The chapter therefore uses a model to estimate what the market price for these claims would be if they were traded. In valuing such claims, the key issue is properly adjusting for risk. (pages 213 - 234)
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Environment and Energy - Geoffrey Heal, Howard Kunreuther
DOI: 10.7208/chicago/9780226496597.003.0010
[natural disasters, economic value, federal government, Price-Anderson Act, catastrophic risks, nuclear power plants]
This chapter provides an overview of the economic value of environmental systems in mitigating natural disasters, and then considers the role of the federal government in managing these hazards and the potential liabilities that they may incur should there be a catastrophic disaster. The second part of the chapter focuses on nuclear power as a source of energy and asks whether the risks associated with this technology could be managed more efficiently by private insurance markets rather than through the current arrangements under the Price-Anderson (P-A) Act. The P-A Act imposes significant liabilities on the federal government should there be large-scale losses from a future accident at a nuclear power plant. To gain insights into an increased role for the private sector in managing this technology, programs by which other catastrophic risks are managed today are reviewed in the concluding portion of the chapter. (pages 235 - 257)
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Contributors
Author Index
Subject Index
