Matt Yglesias at Vox wrote a piece this week about fair-value accounting for federal loan programs (including student loans). It’s a good article, but at several points he lends credence to some of the faulty financial logic critics of fair-accounting love to recite. Readers interested in the broader debate about fair-value can read the Congressional Budget Office’s explanation or this National Affairs article.
One of the most common arguments against fair-value accounting is that the government’s cost of capital is lower than that of private businesses, and it therefore has a low-cost advantage in offering loan programs. As Yglesias explains, “The whole reason the government can borrow so cheaply in the first place is that it can’t go bankrupt… [and] because the US government prints dollars, there is essentially no chance that it will default on its debts.”
The fallacy in this thinking is that the government acquires these advantages for free when it actually pays a price to gain them. It is a zero-sum advantage. The government won’t go bankrupt because lawmakers can raise taxes to cover liabilities. Of course, taxes aren’t free. It’s silly to even have to say that, but that’s effectively what underlies the arguments listed above. The same is true for the argument that the government has the lowest cost of capital. It does, but only because it can call on taxpayers to always make good on its debts. That’s not a free benefit either. It’s equal to the amount of money taxpayers would have to pay to hold up the government’s promise.
Here is another way to see it. Imagine if instead of financing the student loan program with U.S. Treasury bonds, the federal government set up a trust that would issue its own bonds backed only by the cash flow from the student loans. The trust could not tap taxpayers should the loan performance disappoint and bondholders collect less than what they are owed. Would investors buy those student loan bonds and demand the same interest rate as a U.S. Treasury bond? Of course not. They would demand a higher interest rate because there’s no option for a taxpayer bailout built into the arrangement.
Again, it seems silly to have to say it, but taxpayer bailouts aren’t free — and it’s the promise of a taxpayer bailout that allows the government to borrow at lower interest rates than other entities. Meanwhile, many of fair-value’s critics will, in regards to a separate issue, lament that some banks are too big to fail and thus can borrow at slightly lower interest rates because they enjoy implicit insurance via taxpayer bailouts. They worry about the cost this has for taxpayers. In this case they see clearly that pledging taxpayer dollars to cover losses on risky loans is not free.
One can’t help but wonder in reading the critiques of fair-value if the government really has a cost-saving advantage in making loans, why not propose that the government buy up all the bonds and loans in the economy? The savings would surely be enormous. It is the logical conclusion of the government-has-an-advantage argument. Yglesias actually poses that question, “But seriously — if it’s free, why not offer discount loans to everyone?” But then he never answers it. Instead, he digresses into a discussion about how monetary policy is set by the Federal Reserve by establishing the interest rates that banks charge each other for overnight loans. Yglesias is implying that the Federal Reserve is somehow making subsidized loans to everyone through monetary policy, which is not at all the same thing as the government making a student loan to someone at 4 percent when the going market rate is 8 percent. Yglesias has conflated monetary policy with fiscal policy in a way that surely has readers confused. He also dodged his own question.
So we are still left asking: Why shouldn’t the government massively expand and create loan programs — like those for student loans and home mortgages — for everyone and everything given that, as fair-value critics say, it would realize savings for borrowers and taxpayers? If the government really has the greatest arbitrage opportunity the world has ever seen, we need to know why it is that everyone assumes it ought not take it.
[Cross-posted at Ed Central]