1 Few people are aware that the federal government lends almost as much money as it borrows.
2 From 1980 to 1988, while federal budget deficits totaled $1.41 trillion, the government issued $394 billion of new direct loans and an additional $756 billion of new primary loan guarantees.
3 These figures omit secondary guarantees, deposit insurance, and the activities of Government-Sponsored Enterprises (a huge concern in its own right, as detailed on this page May 3).
4 Federal credit programs date back to the New Deal, and were meant to break even financially.
5 Since the 1950s, federal lending has experienced extraordinary growth in credit volume, subsidy rates, and policy applications, spurred on by the growth of government in general and budget gimmicks and deceptive management in particular.
6 As we will see, many of these obligations don't show up as part of the federal deficit.
7 But recent events indicate that federal credit is out of control.
8 Student loan defaults remain high at about 12%, and the program has been rocked by allegations of fraud and mismanagement.
9 Farmers Home Administration (FmHA) loans have turned into de facto giveaway programs; losses over the next three years are expected to exceed $20 billion.
10 Defaults on Veterans Affairs loan guarantees have quadrupled in the past eight years.
11 Last month, the General Accounting Office reported that defaults in Federal Housing Administration guarantees were five times as high as previously estimated, and that FHA's equity fell to minus $2.9 billion.
12 GAO's findings are particularly troubling because the FHA has about $300 billion in obligations outstanding and had previously been considered one of the most financially secure credit programs.
13 Scores of other credit programs, subsidizing agriculture, small business, exporters, defense, energy, transportation and others, are less visible but in no better shape.
14 If the programs continue their present path, the potential government losses are staggering: The federal government holds $222 billion in direct loans outstanding and backs an additional $550 billion in primary guarantees. (Secondary guarantees of pools of FHA- and VA-backed loans by the agency known as Ginnie Mae currently exceed $330 billion.)
15 Although external events have contributed to the morass, the principal causes of the current crisis are internal and generic to all programs.
16 To reduce the risks while still retaining the legitimate benefits these programs can provide, credit policy must:
18 Use credit to improve the operation of capital markets, not to provide subsidies.
19 There is a fundamental conflict between providing a subsidy and maintaining the integrity of a credit program.
20 If the program is meant to provide a subsidy, collecting the debt defeats the original goal.
21 Thus, subsidized loans tend to turn into giveaway programs, with increasing subsidy and default rates over time.
22 To avoid this problem, government should issue credit only if it intends to use every legal method to collect.
23 In contrast, credit programs can be appropriate tools to improve the operation of capital markets.
24 For example, legal restrictions on interstate banking once inhibited the supply of credit to the agricultural sector.
25 Farm lending was enacted to correct this problem by providing a reliable flow of lendable funds.
26 However, this in no way justifies the huge government subsidies and losses on such loans.
27 Credit policy should separate these two competing objectives and eliminate aspects that provide the subsidy.
28 For example, student loans currently attempt to subsidize college attendance and mitigate problems created by the fact that students' future earnings are not accepted as collateral.
29 The program provides highly subsidized loans to any student whose family earns less than a particular amount.
30 High default rates, a low interest rate, and government coverage of all interest costs while the student is in school make program costs extremely high.
31 Families that do not need the loan can make money simply by putting the loan in the bank and paying it back when the student graduates.
32 In contrast, a student loan program that was meant solely to correct capital-market imperfections would allow loans for any student, regardless of family income, at market or near-market rates.
33 While the student was in school, interest costs would either be paid by the student or added to the loan balance.
34 This program, combined with cash grants to needy students, would reduce program costs and much more effectively target the intended beneficiaries.
36 Provide better incentives.
37 Given the structure of most credit programs, it is surprising that default rates are not even higher.
38 Guarantee rates are typically 100%, giving lenders little reason to screen customers carefully.
39 Reducing those rates moderately (say, to 75%) would still provide substantial assistance to borrowers.
40 But it would also encourage lenders to choose more creditworthy customers, and go a long way toward reducing defaults.
41 For example, the Small Business Administration has had reasonable success in reducing both guarantee rates and default rates in its Preferred Lenders' Program.
42 Borrowers' incentives are equally skewed.
43 Since the government has a dismal record of collecting bad debts, the costs to the borrower of defaulting are usually low.
44 In addition, it is often possible to obtain a new government loan even if existing debts are not paid off.
45 Simple policy prescriptions in this case would be to improve debt collection (taking the gloves off contracted collection agencies) and to deny new credit to defaulters.
46 These provisions would be difficult to enforce for a program intended to provide a subsidy, but would be reasonable and effective devices for programs that attempt to offset market imperfections.
48 Record the true costs of credit programs in the federal budget.
49 Since the budget measures cash flow, a new $1 direct loan is treated as a $1 expenditure, even though at least part of the loan will be paid back.
50 Loan guarantees don't appear at all until the borrower defaults, so new guarantees do not raise the deficit, even though they create future liabilities for the government.
51 By converting an expenditure or loan to a guarantee, the government can ensure the same flow of resources and reduce the current deficit.
52 Predictably, guarantees outstanding have risen by $130 billion since 1985, while direct loans outstanding have fallen by $30 billion.
53 The true budgetary cost of a credit subsidy is the discounted value of the net costs to government.
54 This figure could be estimated using techniques employed by private lenders to forecast losses, or determined by selling loans to private owners (without federal guarantees).
55 Neither technique is perfect, but both are better than the current system, which misstates the costs of new credit programs by amounts that vary substantially and average about $20 billion annually, according to the Congressional Budget Office.
56 A budget that reflected the real costs of lending would eliminate incentives to convert spending or lending programs to guarantees and would let taxpayers know what Congress is committing them to.
58 Impose standard accounting and administrative practices.
59 Creative accounting is a hallmark of federal credit.
60 Many agencies roll over their debt, paying off delinquent loans by issuing new loans, or converting defaulted loan guarantees into direct loans.
61 In any case, they avoid having to write off the loans.
62 Some agencies simply keep bad loans on the books; as late as 1987, the Export-Import Bank held in its portfolio at face value loans made to Cuba in the 1950s.
63 More seriously, FmHA has carried several billion dollars of defaulted loans at face value.
64 Until GAO's recent audit, FHA books had not been subject to a complete external audit in 15 years.
65 The administration of federal credit should closely parallel private lending practices, including the development of a loan loss reserve and regular outside audits.
66 Establishing these practices would permit earlier identification of emerging financial crises, provide better information for loan sales and budgeting decisions, and reduce fraud.
67 Government lending was not intended to be a way to obfuscate spending figures, hide fraudulent activity, or provide large subsidies.
68 The reforms described above would provide a more limited, but clearer, safer and ultimately more useful role for government as a lender.
69 Without such reforms, credit programs will continue to be a large-scale, high-risk proposition for taxpayers.
70 Mr. Gale is an assistant professor of economics at UCLA.

These figures omit secondary guarantees , deposit insurance , and the activities of Government - Sponsored Enterprises ( a huge concern in its own right , as detailed on this page May 3 ) .
secondary guarantees ,
What is a secondary guarantee?