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For release on d e l i v e r y
E x p e c t e d at 9:30 a.m.
E.S.T.
O c t o b e r 29, 1981

S t a t e m e n t by

N a n c y H. T e e ters

M e m ber, B o a r d of G o v e r n o r s of the F ederal R e serve S y s t e m

before the

T a s k F o r c e on E n f o r c e ment, C r e d i t and M u l t i - y e a r B u d g e t i n g




of the

C o m m i t t e e on the B u d g e t

U.S. Ho use of R e p r e s e n t a t i v e s

Oc t o b e r 29, 1981

Mr. C h a i r m a n ,

it is a p l e a s u r e to be here to d a y to

p r e s e n t the F e d e r a l R e s e r v e B o a r d ' s v i e w s on the b u d g e t i n g and
c o n t r o l of f e d e r a l l y a s s i s t e d credit.

In p a r t i c u l a r ,

it is a

p l e a s u r e to have the o p p o r t u n i t y to e x p r e s s our s u p p o r t for
H.R.

2372, the bill i n t r o d u c e d by Mr. M i n e t a and Mr. B e t h u n e

to e s t a b l i s h p r o c e d u r e s for b u d g e t a r y c o n t r o l of federal c r e d i t
p r o grams.
such steps.

T h i s is a p a r t i c u l a r l y a p p r o p r i a t e time to c o n s i d e r
G i v e n the s e r i o u s i n f l a t i o n p r o b l e m c u r r e n t l y

p l a g u i n g our nation,

it is im p e r a t i v e that g r o w t h in m o n e y and

c r e d i t be hel d to a m o d e r a t e pace.

W i t h i n this context, e v e r y

e f f o r t s h o u l d be m a d e to insure that federal c r e d i t a c t i v i t i e s
as well as federal s p e n d i n g are c a r e f u l l y e v a l u a t e d in o r d e r
to av o i d c r e a t i n g s e r i o u s d i s t o r t i o n s in f i n a n c i a l markets.
Indeed,

it w o u l d be m o s t i n a p p r o p r i a t e for o f f - b u d g e t

fede r a l loa n p r o g r a m s and loan g u a r a n t e e s to p r o v i d e a less
c o n s p i c u o u s s u b s t i t u t e for direct, o n - b u d g e t f ederal s p e n d i n g
at a time w h e n s t r e n u o u s e f f o r t s are being m a d e to br i n g the
g r o w t h of s p e n d i n g under control.

A l t h o u g h the e c o n o m i c and

c r e d i t m a r k e t c o n s e q u e n c e s of federal loans and loan g u a r a n t e e s
are not in all c a s e s the same as those of d e f i c i t f i n a n c e d
federal sp e n d i n g ,

there are e n o u g h s i m i l a r i t i e s to w a r r a n t p a r ­

allel p r o c e d u r e s for b u d g e t a r y r e v i e w and control.
therefore,

I shall argue,

that formal p r o c e d u r e s for b u d g e t a r y c o n t r o l of federal

c r e d i t a c t i v i t i e s are h i g h l y desirable.

Furthermore,

I shall

r e n e w m y e a r l i e r r e c o m m e n d a t i o n s for e s t a b l i s h m e n t of a new
b u d g e t c o m m i s s i o n to a n a l y z e the a p p r o p r i a t e a c c o u n t i n g for f e d ­
eral c r e d i t pr o g r a m s , and for c o n t i n u i n g a n a l y s i s and e v a l u a t i o n




-2-

of the a p p r o p r i a t e t o o l s — d i r e c t spending, loans, loan g u a r a n t e e s
or tax e x p e n d i t u r e s — for a c h i e v i n g a l t e r n a t i v e p r o g r a m o b j ectives.
G r o w t h of F e d e r a l C r e d i t P r o g r a m s
As you know, Mr. Chairman,

federal c r e d i t p r o g r a m s have

e x p a n d e d e n o r m o u s l y , b oth in amount and in scope,
years.

in r e cent

The total v o l u m e of o u t s t a n d i n g d i r e c t loans and loan

guarantees,

for example, has been p r o j e c t e d to total over $540

b i l l i o n by the end of the fiscal year w h i c h just en d e d last
month.

T h i s is n e a r l y t riple the $190 b i l l i o n level r e a c h e d

just 10 y e a r s ago.

In addition,

the v o l u m e of loans hel d by

g o v e r n m e n t - s p o n s o r e d a g e n c i e s was p r o j e c t e d to total a b o u t
$170 b i l l i o n at the end of fiscal year 1981, up $20 b i l l i o n from
last year and mor e than four times the level of 10 y e a r s earlier.
In fact, their g r o w t h has be e n much larger than a n t i c i p a t e d ,
p r i n c i p a l l y due to i n c r e a s e d d e m a n d s on the Fe d e r a l H o m e Loan
Banks.
F e d e r a l c r e d i t activities, m o r e o v e r , are l i k e l y to c o n ­
tinue to g r o w r a p i d l y in the years ahead u n l e s s d e l i b e r a t e
e f f o r t s are m a d e to c o n s t r a i n them.

The J a n u a r y b u d g e t p r o j e c t e d

that net c r e d i t a d v a n c e d under federal a u s p i c e s — direct, g u a r a n t e e d
and s p o n s o r e d — w o u l d total over $100 b i l l i o n du r i n g fiscal year
1982.

The M i d - S e s s i o n R e v i e w of the FY 1 9 8 2 b u d g e t c a l l e d for

a s i g n i f i c a n t r e d u c t i o n in loan o b l i g a t i o n s and g u a r a n t e e c o m ­
m i t m e n t s and further r e d u c t i o n s are soon to be announced.

Even

so, if total c r e d i t flows in the c o m i n g y e a r s w e r e r o u g h l y to
m a t c h those of the p a s t year, funds ra i s e d under federal c r e d i t




-3-

au s p i c e s will a c c o u n t for well over o n e - q u a r t e r of the total
net funds r aised by n o n f i n a n c i a l and f i n a n c i a l b o r r o w e r s in
d o m e s t i c c r e d i t markets.
The w i d e n i n g range of e c o n o m i c a c t i v i t i e s a s s i s t e d by
federal p r o g r a m s is a l s o noteworthy.

In the late 1950s, the

home m o r t g a g e g u a r a n t e e p r o g r a m s of the F e d e r a l H o u s i n g A d m i n ­
i s t r a t i o n and the V e t e r a n ' s A d m i n i s t r a t i o n a c c o u n t e d for 90
p e r c e n t of the total v o l u m e of g u a r a n t e e d and i nsured loans
outstanding.

T h i s p r o p o r t i o n has since t r e n d e d down, and was

e x p e c t e d to have b e e n about 73 p e r c e n t at the end of the last
fiscal year, m a i n l y b e c a u s e of an e x p a n s i o n of loan g u a r a n t e e s
into n e w a r e a s — such as m i l i t a r y sales and s t u d e n t loans.
The p r o v i s i o n of federal c r e d i t a s s i s t a n c e thro u g h
d i r e c t lo a n s and loan g u a r a n t e e s to ac h i e v e p a r t i c u l a r social
and e c o n o m i c o b j e c t i v e s has be e n w i d e l y r e c o g n i z e d as a l e g i t i m a t e
and v a l u a b l e activity.

M a n y c r e d i t p r o g r a m s o r i g i n a l l y were

e s t a b l i s h e d to c o r r e c t i m p e r f e c t i o n s in c a p i t a l m a r k e t s that
d e n i e d c r e d i t to some g r o u p s or mad e its c o s t p r o h i b i t i v e .
example,

For

the F H A - i n s u r e d loan p r o g r a m s wer e d e v i s e d d u r i n g the

G r e a t D e p r e s s i o n to r educe the risks p e r c e i v e d by lenders.

By

p o o l i n g risks a c ross a large number of loans issued in a s t a n ­
d a r d i z e d fashion, the g o v e r n m e n t p r o g r a m e n c o u r a g e d p r i v a t e
l e n d e r s to a d v a n c e c r e d i t at a lower cos t to b o r r o w e r s and on
less r e s t r i c t i v e terms than wou l d o t h e r w i s e hav e bee n possible.
Over time, these m o r e liberal terms g a i n e d g e n e r a l a c c e p t a n c e
am o n g all types of p r i v a t e lenders.




-4-

M a n y ot h e r f e d eral c r e d i t a s s i s t a n c e p r o g r a m s have b e e n
i n t r o d u c e d over s u b s e q u e n t y e a r s to foster social o b j e c t i v e s .
Increasingly,
subsidies.

these p r o g r a m s have involved s u b s t a n t i a l i n t e r e s t

A c c o r d i n g to O M B estimates,

the p r e s e n t v a l u e of

the i n t e r e s t s u b s i d y on n e w d i r e c t loan o b l i g a t i o n s and c o m m i t ­
m e n t s to g u a r a n t e e loans in the fiscal year just en d e d a m o u n t e d
to a l m o s t $27 billion.
moreover,

In c o n t r a s t to the home m o r t g a g e area,

the d e f a u l t rate in some of these p r o g r a m s — su c h as

s t u d e n t loans and a s s i s t a n c e for l o w - i n c o m e h o u s i n g — has b e e n
c o m p a r a t i v e l y high.

Thus, the g o v e r n m e n t has had to a b s o r b

sizable, and in some c a s e s u n a n t i c i p a t e d , d e f a u l t losses in
a d d i t i o n to the m e a s u r e d in t e r e s t rate s u b s i d i e s to borrowers.
In the p a s t few years,

the federal g o v e r n m e n t has also g u a r a n t e e d

s i z a b l e loans to s i n g l e b o r r o w e r s that c a r r y a large p o t e n t i a l
for default.
Im p a c t s of F e d e r a l C r e d i t P r o g r a m s
S i n c e the g e n e r a l p u r p o s e of federal c r e d i t p rograms,
obviously,

is to e n a b l e i ndivi d u a l b o r r o w e r s or g r o u p s of b o r ­

r o w e r s to o b t a i n c r e d i t w h i c h w o u l d o t h e r w i s e be u n a v a i l a b l e to
them, or o n l y a v a i l a b l e at a higher cost,

it fo l l o w s that these

p r o g r a m s will g e n e r a l l y tend to i n crease c r e d i t use by p r o g r a m
beneficiaries.

W h e t h e r this i n crease will,

in turn, re s u l t in

g r e a t e r use of c r e d i t in the aggregate, and the d e s i r a b i l i t y of
suc h an increase, d e p e n d s on the c h a r a c t e r i s t i c s of the p a r t i c u l a r
p r o g r a m s and on the st a t e of the e c o n o m y at large.
Let me g i v e some e x a m p l e s to d e m o n s t r a t e the d i f f e r e n c e s
in the e c o n o m i c e f f e c t s of federal c r e d i t a s s i s t a n c e programs.



-5-

In some cases, p r o g r a m s m a y serve as close s u b s t i t u t e s for d e f i c i t financed,

f e d eral spending.

Consider,

for example, a s i t u a t i o n

in w h i c h the C o n g r e s s was c o n t e m p l a t i n g e x p a n d i n g the p r o g r a m
in w h i c h the f e d eral g o v e r n m e n t g u a r a n t e e s deb t issued by state
and local a u t h o r i t i e s w h o then use the p r o c e e d s to p r o v i d e low
c o s t h o u s i n g to the poor.

M a n y of the end r esults of such an

e x p a n s i o n c o u l d be q u i t e similar to those that w o u l d be o b s e r v e d
if the federal g o v e r n m e n t were, a l t e r n a t i v e l y ,

to i n crease its

d i r e c t s p e n d i n g to u n d e r t a k e the c o n s t r u c t i o n of the rental units,
and w e r e then to rent space on a s u b s i d i z e d basis.

Not e that

under e i t h e r a p p r o a c h c o n s t r u c t i o n funds w o u l d be p r o v i d e d by
p r i v a t e i n v e s t o r s e i t h e r through the a c q u i s i t i o n of f e d e r a l l y
G u a r a n t e e d s e c u r i t i e s or by a c q u i r i n g mor e T r e a s u r y s e c u r i t i e s
than o t h e r w i s e ;

the same e s s e n t i a l type and v o l u m e of p r o d u c t i v e

r e s o u r c e s w o u l d be used to c o n s t r u c t the rental units; and low
income f a m i l i e s w o u l d be p r o v i d e d wit h better h o u s i n g than they
are o t h e r w i s e abl e to obtain.
W h i l e s t r e s s i n g basic similarities, however,
note some i m p o r t a n t d i f f er e n c e s .
m u s t be p a i d back.

Thus,

I sh o u l d also

The mos t i m p o r t a n t is that loans

if such a p r o g r a m w e r e to g r o w to a

p l a t e a u and then r e m a i n c o n s t a n t in size,

the v o l u m e of loan

r e p a y m e n t s w o u l d equal n ew loans being g u a r a n t e e d and the net
e c o n o m i c e f f e c t w o u l d be small.

G r o w t h in the net vo l u m e of

g u a r a n t e e d loans o u t s t a n d i n g , however, co u l d have an e f f e c t
si m ilar to that of d e f i c i t spending.

In addition,

interest paid

on the d e b t i n s t r u m e n t s issued by states and l o c a l i t i e s under



-6-

the p r o g r a m is not s u b j e c t to federal tax, as it w o u l d be on
a d i r e c t deb t issue of the federal govern m e n t ,

so net tax

r e v e n u e s w o u l d also be r e duced by an e x p a n s i o n of the program.
Th e r e are, of course, other c r e d i t p r o g r a m s w h i c h have
m u c h less s i m i l a r i t y to n o n c r e d i t federal spending.

For example,

h o m e b u y e r s w h o take out m o r t g a g e s under federal g u a r a n t e e s could,
in m o s t instances, o b t a i n p r i v a t e c r e d i t w i t h o u t the g u a rantee,
a l b e i t at a s l i g h t l y higher rate.

P r o v i d i n g ro u g h l y e q u i v a l e n t

a s s i s t a n c e t h r o u g h d i r e c t federal sp e n d i n g in this case w o u l d
r e q u i r e the federal g o v e r n m e n t to give h o m e b u y e r s onl y a m o d e s t
i n t e r e s t subsidy.

The small size of this su b s i d y s u g g e s t s that

net d e m a n d s on real r e s o u r c e s and c r e d i t m a r k e t s are r e l a t i v e l y
little a f f e c t e d by the g u a r a n t e e program.
fall s o m e w h e r e b e t w e e n these two extremes.

M a n y cases o b v i o u s l y
C o m p a r e the e f f e c t s

of d i r e c t federal loans and o u t r i g h t g r a n t s in-aid.

In both

cases, b e n e f i c i a r i e s g a i n i m m e diate c o m m a n d over goo d s and services.
The ma j o r d i f f e r e n c e b e t w e e n the two a p p r o a c h e s — that in the case
of the loan the g o v e r n m e n t o b t a i n s a c l a i m on the b e n e f i c i a r y
w h i l e it does not w i t h the g r a n t — is an im p o r t a n t d i s t inction.
It is, however, a d i s t i n c t i o n w i t h o u t s u b s t a n c e in those c ases
w h e r e the b o r r o w e r defaults.
In general,

the c l o s e n e s s of the a n a l o g y b e t w e e n a s s i s t a n c e

p r o v i d e d by federal c r e d i t p r o g r a m s and d e f i c i t - f i n a n c e d d i r e c t
federal s p e n d i n g a p p e a r s to d e p e n d less on w h e t h e r the aid in
q u e s t i o n is p r o v i d e d t h r o ugh d i r e c t loans or loan g u a r a n t e e s
than o n such t hings as c r e d i t w o r t h i n e s s of b e n e f i c i a r i e s ,



the

- 7 -

size and riskiness of their undertaking and their relative ability
to tap private credit sources on their own.
As in the case of deficit-financed federal spending, federal
credit activities may reduce the availability of credit to others
who are not program beneficiaries.

The extent to which such "crowding

out" takes place, however, depends importantly on the state of conditions
in the economy and financial markets.

During recessionary periods when

credit supplies are readily available, credit assistance may work mainly
to enable borrowers to obtain additional funds which can be used to
increase demands for goods or services.

Thus, in these periods the

net result of such programs may, to a great extent, promote a more
intense use of resources and an expansion of economic activity rather
than a transfer of credit (and resulting effective demand) from one
borrower to another.
In times when there is less slack in resource utilization and
credit market conditions are relatively tight, however, there is a
much greater tendency for credit extended under federal auspices to
channel loanable funds, and hence cantnand over real resources, toward
assisted borrowers and away from others.

In other words, just as

private borrowers can, at times, be crowded out of credit markets when
federal outlays are financed through the issuance of Treasury debt, so
can some private borrowers face higher credit costs when other selected
borrowers obtain loans with the assistance of the federal government.
There need be nothing inherently wrong with the resulting allocation of
credit if the federal intervention in credit markets reflects a careful
assessment of the market imperfections that the government is trying
to overcome and a careful weighing of costs and benefits.



Continuous

-

8 -

scrutiny of priorities under a credit budget process is important,
however, if such balancing of costs and benefits is to be achieved.
And such scrutiny is essential in current circumstances when the growth
of credit is necessarily limited by anti-inflation policies.
Budgetary Control of Federal Credit Activities
As you know, Mr. Chairman, Congressional review and control of
federal credit activities have been evolving over time.

The utilization

of the "unified budget" concept, beginning with the 1969 budget, is one
notable watershed.

At that time, the government adopted for control

purposes a budget framework that was, in most respects, a cash accounting
system.

In making this choice, it was decided (after considerable debate)

to include the net outlays of all direct lending programs on budget.

This

new approach, however, was uncomfortably silent on how federal loan
guarantees were to be treated.

In the early 1970's, moreover, there

was some backsliding from the comprehensive coverage of the unified
budget, as a number of agencies were removed from the budget and newly
established agencies were accorded off-budget status.
Furthermore, the advantages for orderly marketing of federal
debt gained through creation of the Federal Financing Bank in 1974 had
an unfortunate side effect.

Since the FFB's activities have been

off-budget from the outset, its acquisition of loans is not reflected
on the budget.

Accordingly, the budgetary scrutiny intended to apply

to direct loan programs as a result of the comprehensive coverage of
the unified budget tended to be eroded.

And, agencies that made direct,

on-budget loans to the public were able to sell these loans to the
FFB thereby enabling them to extend new loans without constraint.




-

9 -

In recent years, this erosion process has begun to be turned
around.

A number of important steps have been taken to make coverage

of the unified budget more comprehensive and to improve controls of
credit programs.

In addition to incremental improvemsnts in budget

coverage, major strides have been taken in the development of a
separate, credit budget process.

In the past two years, totals have

been calculated and presented in the budget for gross new direct loan
obligations and new loan guarantee canmitments. Components of the
credit budget total have been shown in respective budget functions
and have been subdivided by agency and program in the Special Analysis
accompanying the budget and in the budget Appendix.

Also, the outlays

of the FFB (direct loans and loan-asset purchases) are now attributed
to the originating agency, which in my view eliminates the tendency
for the operation of the FFB to obscure the nature of credit programs.
A final important step taken by Congress last year was to have the
budget resolutions include target ceilings for total new loan obligations
and total new guarantee canmitments and to distribute these totals
by budget function.
Both the past and the current administration have also proposed
that a substantial proportion of the credit budget totals be made subject
to annual appropriations limitations.

The January budget proposed that

63.8 percent of the credit budget for FY1982 be so limited.

Those

programs exempted are limited to: unambiguous entitlements that cannot
be effectively limited by appropriations; programs that provide for
unforeseeable contingencies, such as deposit insurance; guarantees
of certificates of beneficial ownership that are sold by the Farmers
Hate Administration and Rural Electrification Administration; and a



- 10 -

catch-all of programs, such as export promotion loans by Cbnmodity
Credit Corporation, that the last adninistration believed appropriate
not to curtail due to economic circunstanoes. That final area of
exemption, in particular, deserves careful evaluation by the Congress.
Broadening the coverage of the unified budget and the formulation
of a separate but parallel credit budget sets the stage for a nuiiber
of further steps in implementing an effective process to bring credit
programs under systematic review and control.

H.R. 2372 would formalize

the credit budget process implemented on an experimental basis last
year.

This bill would amend the Budget Act to apply to the credit

budget the same enforcement procedures and legislative time tables
that apply to the rest of the budget.

The Federal Reserve B oard, in

general, enthusiastically endorses the establishment of these formal
procedures as, logically, the next step in budgetary control of credit
programs.
It is the Board's view, however, that the section of this bill
pertaining to appropriations limitations should be modified.

Limitations

are, of course, central to the budgetary control process proposed by
the last administration and endorsed by the present administration.
However, exemption of at least some emergency assistance and entitle­
ment programs appears warranted.

The Board, therefore, suggests

that all such programs continue to be exempted from appropriations
limitations at least until more experience is gained with the new
budget process and a case-by-case review of these programs can determine
the possible difficulties or advantages of applying appropriations
limitations to than.

The exemption of entitlement and emergency

assistance programs from appropriations limitations need not imply




- 11 -

changing the current procedures whereby legislation creating or
expanding entitlements is referred to the Appropriations Oorrndttee
for review.

The Board's reccrnnendation that entitlements and emergency

assistance programs be exempted from binding appropriations ceilings
is intended only to promote the effective operations of those programs
thought by the Congress to be worthwhile, even in the event of unantic­
ipated demands upon then resulting from natural disasters or unforeseen
economic developments.
Although enactment of H.R. 2372 would go far to bring order
into the federal credit program scene, there are other steps that
I would like to recommend.

One is a systematic review of the treatment

of federal credit programs in the unified budget.

The current haphazard

situation, in which some loan programs are included in the unified budget
and others are not, should be ended.

A careful analysis should be under­

taken of the question of whether or not the principal amount (net) of
all direct loans should be included in the unified budget and whether,
if the principal amount of direct loans is excluded as I am inclined
to prefer, the amount of the implicit or explicit interest subsidy
should be placed on budget.

Similarly, a conprehensive review of

guarantee programs would be desirable in order to determine whether the
potential subsidy or future outlay for defaults is taken appropriately
into account.

I have previously called for the establishment of a new

budget conrnission which would be charged with analyzing and resolving
these questions.

In iry view, the passage of time lias not reduced the

advisability of establishing such a carirassion.




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Finally, I reocntnend to this Conmittee a continuing evaluation
of the extent to which direct spending, direct loans, loan guarantees
or beneficial tax treatment can most effectively be used to achieve
particular program objectives and the extent to which, in* particular
budget functions, there may be duplicative and excessive use of these
various approaches.

Hie budget process has cane a long way in providing

the accounting framework and legislative process needed to address such
questions.

I look forward to further progress and I believe that

enactment of H.R. 2372 would contribute to it.