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For Release on Delivery
at 9:00 A.M., EST
Thursday, June 19, 1980

Statement by

Lyle Gramley

Member, Board of Governors of the Federal Reserve System

Before the

Senate Budget Committee's

Special Subcommittee on Control of Federal Credit

June 19, 1980

Mr. Chairman and members of this Special Subcommittee
on Federal Credit,

I am pleased to be here today to discuss

measures to improve control over federally assisted credit pro­
grams .

The need for more adequate budget treatment and con­
trol of these activities has long been recognized.

Both the

1963 Report of the President's Committee on Federal Credit
Programs and the 1967 Report of the President's Commission on
Budget Concepts called for reforms in the budgetary treatment
of federal credit.
was evident.

Until recently, however,

In particular,

little progress

the Congressional Budget Act of

197 4 specifically exempted loan guarantees from the budget pro­
cess and did not develop a comprehensive framework for evaluating
these activities.

It was therefore especially heartening that

the administration recommended a new budgetary framework for
controlling federal credit programs in its 1981 budget, and
that the Congress has incorporated a new federal credit budget
into its First Concurrent Resolution.

As you know,

federal credit programs have expanded

both in amount and in scope.

loan guarantees outstanding,

Direct loans and

for example, are projected to

total over $425 billion in the fiscal year ending September

This is nearly triple the $164 billion level reached just

10 years ago.

In addition, loans held by government-sponsored

agencies now are projected to be $176 billion at the end of



fiscal year 1980, up $17 billion from the year before and more
than four times the level of 10 years earlier.
activities, moreover,
in the years ahead.

Federal credit

are projected to continue growing rapidly
The Administration forecasts that net cred­

it advanced under federal auspices— direct, guaranteed and
sponsored— will
year 1981.

increase by more than $70 billion during


If total credit flows in the coming year turn out

to be roughly the same as in the past year,

funds raised under

federal credit assistance will account for over one-sixth of
the total net funds raised in financial markets.

The widening in the range of economic activities
sponsored by guaranteed loans has been particularly notable.
In the late 1950's,

the home mortgage guarantee programs of

the Federal Housing Administration and the Veteran's Adminis­
tration accounted for 90 percent of the total volume of guar­
anteed and insured loans outstanding.

This proportion has

since trended down, reaching 68 percent last year, mainly
because of an expansion of loan guarantees into new areas—
such as military sales, rural electrification and student
lo ans .

The provision of federal credit assistance through
direct loans and loan guarantees to achieve particular social
and economic objectives has been widely recognized as a legiti­
mate and valuable activity.

Many credit programs originally



were established to correct imperfections in capital markets
that denied credit to some groups or made its cost prohibitive.
For example,

the FHA-insured loan programs were devised during

the Great Depression to reduce the risks perceived by lenders.
By pooling risks across a large number of loans issued in a


the government program encouraged private

lenders to advance credit at a lower cost to borrowers and on
less restrictive terms than would otherwise have been possible.
As a result, private individuals were able to finance the pur­
chase of homes on terms involving more reasonable interest
charges, more liberal loan-to-value ratios and longer maturities
than before.

Over time, these more liberal terms gained general

acceptance among all types of private lenders.

Many other federal credit assistance programs have
been introduced over the years to foster social objectives.

these programs have involved substantial

According to OMB estimates,


the present value of

the interest subsidy on new direct loan obligations and commit­
ments to guarantee loans in fiscal 1981 will amount to almost
$30 billion.

In contrast to the home mortgage area, moreover,

the default rate in some of these programs— such as student
loans and assistance for low-incorne housing— has been compara­
tively high.


the government has had to absorb sizable

default losses in addition to providing a very large interest
rate subsidy to borrowers.

In the past few years,

the federal



government has also guaranteed sizable loans to single borrowers
that carry a large potential for default.

Purposes of Controls over Federal Credit Programs
Improvement in the budgetary treatment of federal
credit programs should seek to achieve several interrelated
p u rp os es .


it should encourage recognition by the Congress

and the public that resources used in programs

financed by

federal credit activities may have been shifted away from more
productive uses.

In setting annual credit targets,

the Congress

must not lose sight of the long-run consequences resulting
from such a shift in resource use.


it should identify where possible the costs

in federal credit activities.

These costs include

not only the interest subsidides, the administrative expenses,
and the default losses but also the loss in public welfare
that occurs when federal credit programs are expanded beyond
socially desirable and efficient levels.


it should focus attention on the macroeconomic

effects of federal credit activities— on employment and output;
on prices, and on developments in credit markets.


that helps to assess these effects is, of course, especially



important to the Federal Reserve in its formulation of monetary

It has long been recognized that federal borrowing
can "crowd-out" private borrowers— and thereby transfer command
over resources from the private to the public sector.


degree of such displacement depends on the extent to which the
economy's real resources are being utilized and on conditions
in credit markets.

During recessionary periods, when credit

supplies are readily available, credit assistance programs may
help promote a more intensive use of resources and an expansion
in the level of economic activity.

In this instance,


principal effect of the increase in expenditures made possible
by the federal credit activity is likely to be an increase in
aggregate demand rather than a redistribution of resource use.
On the other hand, when little excess capacity exists in the
economy and credit supplies are tight,

there is a much stronger

tendency for credit extended under federal auspices to raise
interest rates and to divert loanable funds, and hence real
resources, away from private producers.

Moreover, when such

programs create additional demands on limited resources,


also add to pressures on prices.

It would, however, be potentially misleading in a
discussion of the crowding-out problem to focus simply on the
cyclical condition of the economy.

The long-run potential for



the diversion of resources from private to public uses stem­
ming from Federal credit programs is a serious problem.

In recent years, the performance of productivity in
our economy has been dismal.

We do not know all the reasons

why, and that will limit our ability to deal effectively with
the problem.

We do know, however,

that a substantial increase

in the share of national output will have to be devoted to
capital formation if we are to have much hope of increasing
the rate of productivity advance.

Since the need for additional

capital to deal with our nation's energy and environmental
problems will also be large,

it will be critical to adopt tax

and expenditure policies that free up resources— real resources
as well as financial resources— to make that possible.

The need for a higher rate of business capital forma­
tion is critical to the long-run health of our economy.


down the share GNP devoted to federal expenditures will con­
tribute importantly to that effort.

So also will the orientation

of future tax cuts toward business investment incentives.


these efforts may go for naught if we do not control carefully
the share of national resources absorbed by federal credit

One of the problems that has impeded the development
of better budgetary treatment of federal credit programs is
the lack of a good analytic framework in which to assess the



economic effects of these programs.

Some federal credit pro­

grams affect the economy much like direct federal expenditures.
Loan guarantees for low-income housing and foreign military
assistance are the most obvious examples.

Others provide only

marginally lower interest rates, or marginally better nonprice
credit terms, to borrowers whose credit needs would otherwise
probably have been met by the private financial market.


differing effects, moreover, do not bear any necessary relation
to whether credit is supplied through direct loans or loan
gu a ran tee s.

Since research in the area of federal credit programs
has barely begun, what appears extremely complex today may
appear more simple tomorrow.

I suspect, however,

that the

problems we face in this regard stem from the diverse nature
of these credit programs.

If so, we will have to be satisfied

with statistical measures and budgetary solutions for dealing
with federal credit programs that are inherently less than
fully satisfactory.

For example,

the proportion of total

borrowing in financial markets that is federally assisted can
be used as an indicator of credit resources whose direction
is governed by federal lending programs.


the share

of GNP accounted for by the total of federal expenditures plus
credit activities is a rough measure of the proportion of real
resources whose use is directed by the federal government.



Summary measures such as these have inherent weaknesses
because they add up things that are really very different.


they are better than nothing.

Your committee is rightly concerned about the poten­
tial problems that federal credit programs may create for mone­
tary policy.

It is sometimes argued that expansion in federal

credit programs during periods of monetary restraint might
frustrate the achievement of the objectives of monetary policy
by insulating some borrower groups from the discipline of the
market place.

For most federal credit programs, however,

interest charges vary with market rates of interest; moreover,
increases in the quantity of credit available from federal
sources seldom are large enough to offset completely the declines
in the quantity available from private sources.

It is true,

that assuring larger numbers of borrowers ready

access to credit requires higher interest rates to achieve a
given degree of monetary restraint.

This is one more reason for

putting limits on how fast federal credit programs can expand.

Suggestions for Improvement in the Budgetary Treatment of Credit

Let me turn now to a few suggestions on ways to sharpen
the focus on the effects of federal credit programs.



First, procedures should be developed

that would permit

policymakers to determine the tradeoffs between accomplishing
social objectives through direct outlays, on the one hand, and
through Federal credit programs on the other.

Similar criteria

need to be developed to provide guidance for choosing between
giving credit assistance through direct loans or loan guarantees.


further consideration might be given to ways

of controlling net as well as gross lending.
limits apply to gross loans;
place to begin.

The present credit

that is, I believe,

the appropriate

Gross lending and guarantee activities reflect

the current scope of various programs,

thus indicating the over­

all support being given to a sector by the federal government.
On the other hand,

the net change in such programs determines

the current impact of federal credit activities on economic and
financial market conditions.

So perhaps we ought to seek to

limit the net, as well as the gross,

increase in federal credit

ext ensions.


the budgetary treatment of nonrecourse loans—

such as those made by the Commodity Credit Corporation to far­
mers— should be studied in greater detail.
loans need not be repaid,

Since nonrecourse

it is not clear whether these trans­

actions should be treated as outlays or as loans at the time
when the funds are disbursed.


10 -

Fourth, the accounting treatment of loans made through
the Federal Financing Bank could be further improved.

FFB activ­

ities in the past have reduced the accountability of federal
credit programs, because lending activities typically have been
attributed only to the FFB rather than to the agency originating
the transaction.

The new budget rectifies a large part of this

difficulty by attributing I'FS outlays to the originating agencies
(within the FFB account), and by establishing limitations on the
absolute amount of credit— direct and guaranteed— that can be
financed by an agency in a given year.

The attribution process,

is not yet complete because the combined total of out­

lays and direct and guaranteed loans never appears in a consoli­
dated statement by function and agency.
were taken,

If this final step

the unified budget accounts would provide a more

complete picture of the federal government's support for parti­
cular programs and activities.


if the control system established by the

Congress is to be successful,
detailed scorekeeping system.

it must be accompanied by a
To satisfy this requirement the

Congress should consider establishing a Credit Control Office
within the Congressional Budget Office in order to provide the
Congress with detailed technical data on the costs and benefits
of federal credit programs, and with up-to-date reports on
federal credit activities.

These reports also would include a

credit information system that encompasses total federal lending


11 -

activity by budget function and by economic sector.


such a system would provide information that highlights the
federal government's total involvement in, and assistance to,
sectors in the form of direct outlays, direct loans, and loan
gua ra nte es .

To sum up, the Board of Governors welcomes the progress
that has been made in establishing a credit budget.

It will

improve our ability to evaluate and control federal credit
activities, and enhance the long-run prospects for increased
private capital formation.

We will be happy to provide you

whatever assistance we can in refining further the procedures
for dealing with federal credit programs in the budget.