(Archived document, may contain errors)
GROWING ENTHUSIASM FOR THE SALE . OF THE FEDERAL LOAN PORTFOLIO
(Updating Backgrounder No. 541, "Cashing in on the Federal Quarter-Trillion Dollar Loan Portfolio," October 28, 1986)
Federal government loan asset sales are rapidly gaining acceptance where it counts most--on Capitol Hill and on Wall Street. Turning the bulging federal loan portfolio into cash increasingly is seen as a means of meeting Gramm-Rudman-Hollings deficit reduction targets and of managing federal credit programs more efficiently. Interest in the sales is very high. Soon after the Farmers Home Administration announced that it intended to sell portions of its rural housing portfolio, it received 39 unsolicited proposals to manage the sale. The treasurer of the Export-Import Bank reports the Bank has been "inundated by people from New York" wanting a piece of the action. Office of Management and Budget Director James Miller wants to move forward and beyond the $4.8 billion pilot program included in the recent Budget Reconciliation Bill. It thus seems likely that the Administration will propose in its FY 1988 budget that virtually all new direct loans should be-sold promptly to the private sector without recourse to a federal guarantee. In FY 1988, this could total approximately $26 billion in new loans.
The impact of loan sales goes beyond providing immediate deficit-reducing revenue. Even more important is to bring the discipline and efficiency of the private marketplace to the credit process and to determine accurately how much of a subsidy is given to federal credit assistance. This important objective, however, would be jeopardized if the loans were sold with fedqral guarantees, as some Wall Street bankers and congressional lawmakers propose.
By providing the buyer of an agency's portfolio some form of recourse to the government in the event of borrower delinquency or default, the incentive for the purchaser to pursue collection would be reduced, undermining a central reason for selling the loans. Some
lawmakers argue that, by guaranteeing loans, the federal government would receive higher prices for such loans than if they were sold without recourse. But this is true only for the very short term. With a guarantee,.Washington would lose money eventually on borrowers who default. By contrast, if Washington originally sells the loans on a nonrecourse basis, it maintains the incentive for the private sector to improve the rate of collection. This in turn would make the loans more valuable by generating more net revenue over the long run.
Rather than turning to the government for a guarantee, the quality of the loans, and hence the price, could be improved by arranging some form of private insurance. Several forms are available. Private mortgage insurance, for instance, is a mature and well-seasoned industry, with more than $22 billion of policies in place. Private debt insurance also is commonplace. Just as municipal bonds are sold with and without insurance for the timely receipt of interest and principal, government loans could be sold with the cost of insurance borne by the investor. Existing federal guarantees could also be reinsured with private insurance companies and the premiums charged to the appropriate agency account. Such insurance would upgrade the ratings of the issue, reduce the discount rate and enhance the market price of the asset.
Some financiers have called for "overcollateralization.11 By this, the underwriters and issuing agency designate a small.number of well-performing loans to serve as collateral to secure the repayments of other loans in the same pool as a form of self-insurance. It is critical that these designated loans be included in the pool that is bought and paid for by the private banks. otherwise overcollateralization is just another name for a federal guarantee.
The sale and management of loan portfolios as a means of raising much-needed capital is a routine banking practice. Selling the federal loan portfolio would utilize this highly professional industry to manage loans more efficiently. These potential efficiency gains would make the loans themselves more valuable, thus raising more cash for the Treasury than the value of projected income under government ownership management. Thus the sale of government loans is not merely \u239\'95 way of "cashing out" future income to address current needs. It is \u239\'95 way of improving,the value of the portfolio, to the benefit of the taxpayer. For this reason, loan sales should be a top priority in the new Congress. It also should be a priority for the Administration as it drafts its FY 1988 budget.
John E. Buttarazzi Research Associate