30 th Annual Economic Policy Conference On the Importance of the Plumber Douglas J. Elliott, President Center on Federal Financial Institutions October 20, 2005 Federal Credit and Insurance Programs

30 th Annual Economic Policy Conference Definition of Intimidation The Act of Making Timid or Fearful

30 th Annual Economic Policy Conference Alternative Definition Being asked to speak at Conference with One President of a Fed Bank Two Nobel Prize Winners At least one Nobel Prize Winner-to-be

30 th Annual Economic Policy Conference Humility Function Humility Fn(New Yorker, Ex-Investment Banker, Think Tank President) < 0

30 th Annual Economic Policy Conference Federal Financial Institutions Matter $1.4 trillion of loans and guarantees Over $7 trillion of insured risk Tens of millions of lives affected Major public policy areas affected –Housing –Education –Pensions –Agriculture, etc.

30 th Annual Economic Policy Conference Agenda Structure of institutions Budget rules Human Resources Tools

30 th Annual Economic Policy Conference FCC Spectrum Auction Borrowers were betting their companies FCC had little lending expertise Borrowers perceived as high risks Loans were really “disguised equity”

30 th Annual Economic Policy Conference PBGC No ability to choose clients Ad hoc pricing Little price differentiation based on risk No meaningful regulatory authority Little ability to negotiate workouts

30 th Annual Economic Policy Conference Old-Style Cash Budgeting Disincentives to expand lending Incentives to garner near-term cash, regardless of economics Heavy bias towards guarantees

30 th Annual Economic Policy Conference Credit Reform Budgeting Future cash flows are projected Subsidy is based on net present value Discount rate is government borrowing rate for a “basket of zeroes” Administrative costs remain an annual cash item Net effect is to level playing field between loans, guarantees, and grants

30 th Annual Economic Policy Conference Discount Rate for Floating Rate Loans Current rules use “basket of zeroes” with rates based on year of expected payment But, maturity of loan may be less relevant than re-set date for interest rate Congress uses discount rate as if it were funding cost, making discount rate critical for policy decisions Current rules create an asset-liability mismatch

30 th Annual Economic Policy Conference Discount Rates & Risk Adjustments Discount rate is based on government borrowing rates for relevant maturities Financial markets use risk-adjusted rates Should U.S government be different? Does vast diversification potential make risk- adjustment irrelevant? Or is taxpayer in position of shareholder?

30 th Annual Economic Policy Conference Small Business Administration Policy analysts favor lending to minorities and high-impact entrepreneurs But, politicians want large volumes at low taxpayer cost These two criteria favor loans to the most creditworthy applicants, not to those targeted by policy analysts

30 th Annual Economic Policy Conference PBGC Cumulative GAAP deficit of $23 billion Cumulative federal budget effect is $12 billion contribution to deficit reduction Budget rules propagate a $35 billion difference and opposite signs for the key measure of the budget effect

30 th Annual Economic Policy Conference Flood Insurance Presented as a self-supporting program, since it went over 20 years without needing Congressional appropriations But, highest risk quarter of policies are subsidized 60%, for total subsidy rate of 40% Circle is squared by measuring solvency against “historical average loss year” from a period known to be lucky Catastrophe insurers lose big when they lose

30 th Annual Economic Policy Conference Valuing Uncertain Liabilities PBGC liabilities have actuarial uncertainty Do we discount them at Treasury rates? How about Treasury plus a spread? How about Treasury minus a spread? What about private market valuation?

30 th Annual Economic Policy Conference Human Resources & Tools Structure and budgeting are important But, we need people to operate the agencies They need software and other tools Unfortunately, Congress does not like to pay for people or tools This makes it difficult to keep up with the “revolution in financial services” in private sector

30 th Annual Economic Policy Conference Grand Finale Federal financial institutions are critical They need more attention from objective sources and less from vested interests We all need to help –Many interesting theoretical questions remain –Practitioners can insist on use of sound principles Don’t forget