Federal Credit Research Articles

Design and Implementation of Federal Credit and Insurance Programs

The effectiveness and the efficiency of a credit or an insurance program critically depend on the design of the program.In designing a program, the government should carefully consider various factors, including incentives of private parties, possible information advantages of private parties, and competition and liquidity in the target market. Due to failures to reflect these factors in the program design fully, many credit and insurance programs may not be serving their target populations effectively and efficiently. Some partial loan guarantee programs allow private lenders to set the lending rate within a range. In these programs, lenders can increase the profit by lending more to high-risk borrowers who pay a high interest rate. Resulting inefficiencies include underserving of low-risk borrowers, excessive profits for lenders, and excessive costs to the government. Possible solutions include tying the guarantee fee to the lending rate and taking a partial ownership of loans. A main problem with direct loans and full loan guarantees is prepayments by low-risk borrowers. Two main ways to recapture the value of the prepayment option are a prepayment penalty and a high lending rate. The preferable way is a prepayment penalty because a high lending rate may further prompt low-risk borrower to prepay. To finance highly risky activities, such as technology start-ups, the government should take an equity position. Without sharing a few jackpots, the government cannot recoup its investment. Nevertheless, the government takes a debt position in venture capital investments. The consequence is either that the government suffers large losses or that the government fails to finance truly high-risk, high-return projects. In some insurance programs, the government shares risk with private parties in a way that favors private parties. Private insurers have opportunities to take advantage of mispricing of insurance policies. Policyholders underpay during good times, but they don't necessarily make up the underpayment during bad times. An efficient way of sharing risk is that the government bears all of catastrophic risk and let private insurers bear policy-specific risk. The government implicitly guarantees GSE debts. Since GSEs have incentive to take excessive risk, the government is providing a very expensive guarantee free of charge. An explicit guarantee made available to both GSEs and private entities at a fee should lower the cost to the government, make the market more competitive, and contain financial crises effectively. For proper budget discipline and efficient management, it is important to estimate the costs of credit programs accurately. The cost estimation for credit programs has two main steps: estimating future cashflows and discounting future cashflows to arrive at the net present value of cashflows. Some models estimating future cashflows do not fully consider the effects of economic fluctuations. The consequence can be a systematic underestimation of the cost of a credit program. Some also argue that discounting uncertain cashflows with Treasury rates leads to an underestimation of the cost to taxpayers by ignoring the risk premium. This argument is off the mark. Discounting with Treasury rates is appropriate, considering that budgeting is more about accounting accuracy than economic optimization and that the costs of other government programs do not include the risk premium. The focus should be on estimating cashflows more accurately, fully taking into account the possibilities of extraordinary losses cause by economic downturns.

Roles and Contributions of Federal Credit and Insurance Programs

This paper evaluates the contributions of federal credit and insurance programs based on their effectiveness in addressing imperfections in credit and insurance markets, including adverse selection caused by asymmetric information, moral hazard resulting from monitoring difficulties, resource constraints caused by high transactions costs, limited ability to absorb hard-to-predict exogenous shocks, and temporary disequilibria caused by overreactions of market participants. For the purpose of subsidizing target populations, other policy tools, such as direct subsidies and tax credits, can be more effective. During normal times when economic agents behave rationally, credit programs including Government Sponsored Enterprises (GSEs) make at best minor contributions. Subsidized federal loans have ambiguous effects on adverse selection. The private market is capable of providing sufficient liquidity without GSEs. In a financial crisis when lenders may be overreacting to increased loan delinquencies, federal credit programs can be a critical source of funding. However, this secondary role alone may not be enough to justify continuous presence of credit programs. Insurance programs have stronger justifications. Regulatory authority gives the federal government an advantage in monitoring certain types of policyholders, such as depository institutions and pension funds. The most critical advantage of the federal government derives from its ability to secure enough resources ex post to honor claims. Thanks to this ability, the federal government can provide credible insurance against hard-to-predict catastrophic events.

A Critical Look at Public Private Partnership

Potentially, public-private partnership (PPP) can significantly improve economic efficiency by combining the strengths of the public sector and the private sector. On the other hand, poorly designed PPPs may allow private partners to make excessive profits without making meaningful contributions. This paper takes a systematic approach to analyze the PPP structures of federal credit and insurance programs and to evaluate claims made by advocates of infrastructure PPPs. It decomposes the implementation process of a program or a project by functions, analyzes the relative strengths of the public sector and the private sector in each function, and ascertains whether the PPP assigns each function to the right sector with proper incentives to materialize its strength. Many PPPs are poorly designed. In many cases, some functions are assigned to the sector with the relative weakness. In particular, it can rarely be justified to assign the financing function to the private sector. Even when a PPP correctly assigns some functions to the private partner, it oftentimes fails to incentivize the private partner to materialize its strength. Advocates of infrastructure PPPs cite efficiency gains from bundling and risk transfer to the private sector as justifications for transferring the financing function to private partners. Their claims are mostly rhetoric lacking a systematic analysis. In most cases, PPP seems to be a costly way to bypass budget constraints.

Help Borrowers, Don't Hurt Them: Federal Credit Programs Need to Focus on Outcomes, Not Volume

Help Borrowers, Don't Hurt Them: Federal Credit Programs Need to Focus on Outcomes, Not Volume

Farm and lender structural change: implications for federal credit

PurposeThe purpose of this paper is to examine changes in the structures of US farms and lenders and identify prospective implications for federal credit.Design/methodology/approachData from US farm operations for 1996-2014 were adjusted to 2014 values using commodity price indices. Farm size groups were constructed by value of farm production to analyze changes in farm numbers, production, assets, debt, leverage, liquidity, profitability, land tenure, commodity type, contract production, organization type, and use of Farm Service Agency (FSA) direct and guaranteed loans by farm size. Bank, Farm Credit System (FCS), and FSA data from 1996 to 2015 were adjusted to 2014 values. Lender size groups were constructed to analyze changes in bank and association numbers, farm loans, and use of FSA guaranteed loans by lender size.FindingsThe greatest consolidation has been by farms with over $2 million in production. More farm debt is held by large, complex organizations, frequently with multiple operators, more variable income, and greater reliance on production contracts and operating and nonreal estate credit. Large farms have greater leverage, are more profitable, and have a larger share of household income from the farm. Banks and FCS institutions are fewer and larger, yet smaller institutions use FSA guarantees to a greater extent. Larger farms tend to be more reliant on both direct and guaranteed FSA loans and are likely to become more dependent on FSA credit.Originality/valueChanging farm and lender structure together with softening farm income may require FSA farm loan program changes to meet any increase in loan demand. Policy alternatives are provided to meet changing demand for farm credit.

Making Sense of Soft Information: Interpretation Bias and Ex-Post Lending Outcomes

We explore whether behavioral biases impede the effective processing and interpretation of soft information in private lending. Taking advantage of the internal reporting system of a large federal credit union, we delineate three important biases likely to affect the lending process: (1) limited attention (or distraction), (2) task-specific human capital, and (3) common identity. Specifically, we find that using soft information in lending decisions leads to worse loan quality when loan officers are busy or before weekends and around national holidays, when loan officers have earlier sales experience, and when both the officers and borrowers are men. Overall, we provide novel evidence of non-agency-related costs in the use of soft information in lending decisions.

Do tax credits stimulate R&D spending? The effect of the R&D tax credit in its first decade

This paper examines the impact of the U.S. federal R&D tax credit between 1981–1991 using confidential IRS data from corporate tax returns. The empirical analysis makes two key advances on previous work. First, it implements a new instrumental variables (IV) strategy based on tax changes that directly addresses the simultaneity of R&D spending and marginal credit rates. Second, the analysis makes use of new restricted-access IRS corporate return data describing R&D expenditures. Estimates imply that a10% reduction in the user cost of R&D leads the average firm to increase its research intensity—the ratio of R&D spending to sales—by 19.8% in the short-run. Long-run estimates imply that the average firm faces adjustment costs and increases spending over time, though small and young firms show evidence of reversing initial increases. Analysis of the components of qualified research shows that wages and supplies account for the bulk of the increase in research spending. Elasticities of qualified and total research intensities from a smaller sample suggest firms respond to user cost changes largely by increasing their qualified spending, meaning that the type of R&D the federal credit deems qualified research is an important margin on which the credit affects firm behavior.

Effective weight-loss using an e-health delivered physical activity and dietary intervention: A federal credit union pilot study

This pilot study investigated the effectiveness of a distance-based e-health program delivered across multiple rural Federal Credit Union worksites that focused on physical activity and dietary education. Program design and implementation were based on the premises of Social Impact Theory (SIT). A sample of fifty-four participants (47 white. 7 black) aged 24 to 58 across different worksite locations completed 10 weeks of e-health delivered physical activity and dietary intervention. Pre to post weight changes were examined as a primary outcome. The findings showed that regardless of worksite location, participants on average reduced their weight by 10.13 lbs if they completed both the exercise and lunch and learn components of the study compared to a decrease of 2.73 lbs for participants who chose not to engage in the exercise related activities. Participant dropout from either group was less than four percent. The results of this study show the beneficial influence of physical activity integration using SIT upon distance programs targeting weight loss. In addition, the high adherence and weight loss success show promise and demonstrates the potential for e-health delivered exercise and lifestyle interventions. Further replication of results via additional randomized controlled trials is needed.

Credit Policy as Fiscal Policy

The $1.6 trillion that U.S. households borrowed in 2010 through government-backed direct loan and loan guarantee programs—most notably from Fannie Mae and Freddie Mac, the student loan programs, and the Federal Housing Administration, but also more than 100 smaller programs—provided credit subsidies and relaxed credit-rationing constraints that caused both borrowing and spending that year to be higher than they would otherwise have been. A simple theoretical model illustrates these channels. Estimates of the increases in borrowing, scaled by multipliers similar to those applied to traditional government spending and tax policies, suggest that the programs provided a fiscal stimulus of roughly $344 billion, similar to what was provided by the American Recovery and Reinvestment Act of 2009. Although there is considerable uncertainty about this point estimate, its size suggests the importance of taking the stimulus and automatic stabilizer effects of federal credit programs into account, particularly during economic downturns that are accompanied by severe financial market distress. However, though credit programs are shown to be a relatively low-cost source of fiscal stimulus, to assess their overall welfare implications, these benefits must be weighed against the significant costs of the programs during more normal times, including the likelihood that lax federal credit policies were an exacerbating cause of the 2007 financial crisis.

The Landscape of Urban Preservation: A Spatial Analysis of Federal Rehabilitation Tax Credits in Richmond, Virginia

ABSTRACT:Historic preservationists tout the federal historic rehabilitation tax credit (RTC) as one of the nation’s most successful urban revitalization programs, but minimal research exists on the local use of this private-sector, market-responsive tool. Using geocoded data on RTC investments in Richmond, Virginia that occurred between 1997 and 2010, the research explores the city’s RTC geography, finding that these investments are most intense in the central city, but have centrifugally diffused outward over time. The research shows that RTC investments are contributing to Richmond’s postindustrial transformation, offer a measure of resiliency in the recently volatile real estate market, and function as a de facto housing policy without directly resulting in gentrification. The research offers policymakers improved understanding about the urban geography and spatial effects of RTCs and outlines potential policies that can capitalize on and further encourage these private-sector investments.

The Developing Federal Student Loan Debacle and the Real Cost to Taxpayers

Government financed student loan debt of $1.3 trillion has grown 15% a year for over a decade as tuition and other college costs have risen at a multiple of the inflation rate. Problematic are defaults and income-based repayment arrangements with their partial loan forgiveness. Applied to this burgeoning balance they pose a serious burden on taxpayers and the economy that bear the costs and effects of borrowing and taxation to fund the program. Also alarming is the prospect of total loan forgiveness and ongoing free college education gaining political currency amid the wails of so many overextended borrowers, some of whom seemingly face lifelong debt. This paper examines the true cost of the student loan program which is enormously distorted by the U.S. Department of Education and the Congressional Budget Office. The reason is the Federal Credit Reform Act of 1990 (FCRA) requires government to adopt a misleading methodology for computing the program’s profit and loss that greatly understates defaults. As a result, the program is mistakenly believed to be profitable. Specifically, the government computes operating results based on a net present discounted value of future cash flows. This process effectively amortizes defaults over the remaining life of respective loans, which can be up to 20 years or more, rather than recognize them fully in the period they occur like a bank. The analysis herein contrasts this methodology (subject to the limitations of opaque federal accounting), with a pro forma presentation of operations based on generally accepted accounting principles (GAAP) observed by banks. The upshot: a $135 billion government projected profit for the ten-year period 2015-2024, versus a $1.9 trillion loss that a bank would report. As such, the real cost of the student loan program in the coming years compares with the losses of the 2008 financial crisis as explained in the study.And that is just the current student loan program. If blanket loan forgiveness were declared in the next decade, taxpayers would bear an immediate budget hit of $1 trillion to $4 trillion depending on the loans outstanding at the time of implementation. In addition, taxpayers would have to support subsequent free college for all thereafter. Not only is this time bomb concealed by the current accounting methodology, but also by the political class that is loathe to inviting opposition to a program that could be a new government entitlement.

Cybersecurity, Data Breaches, and the Economic Loss Doctrine

Data breaches are pervasive and costly. Recent civil data breach cases have centered on the consumer credit card payment chain in the retail industry. An important issue in such cases is whether the economic loss doctrine should bar negligence claims for purely pecuniary losses suffered by a non-negligent party, such as an issuing bank or a federal credit union that must incur costs to reimburse cardholders for fraudulent use of stolen card numbers. The economic loss doctrine should not bar these claims. Large scale data networks, such as the consumer credit card network, often entail significant network externalities. These include externalities relating to market concentration as well as to the weakest link nature of security in these networks. Although the primary players in these networks are tied together in a complex web of contractual relationships, there are significant transaction costs involved with any effort to change or monitor another party’s security measures. Moreover, outside entities such as third party payment processors, which are not in contractual privity with all other parties in the network, have become ubiquitous. Under these circumstances, a negligence rule should help improve cybersecurity hygiene and promote a more robust cyber risk insurance market.

The Effect of the Earned Income Tax Credit in the District of Columbia on Poverty and Income Dynamics

Using unique longitudinal administrative tax panel data for the District of Columbia (DC), we assess the combined effect of the DC supplemental earned income tax credit (EITC) and the federal EITC on poverty and income dynamics within Washington, DC, from 2001 to 2011. The EITC in DC merits investigation, as the DC supplement to the federal credit is the largest in the nation. The supplemental DC EITC was enacted in 2000, and has been expanded from 10 percent of the federal credit in 2001 to 40 percent as of 2009. To implement the study, we estimate least squares models with 0/1 dependent variables to estimate the likelihood of net-EITC income above poverty and near-poverty thresholds. We also estimate the likelihood of earnings growth and income stabilization from the EITC. To identify the effect of the EITC, we exploit variation in the EITC subsidy rate from 2008 to 2009, when an additional EITC bracket of 45 percent was added for workers with three or more dependent children, up from 40 percent in the previous year for workers with two or more children. We also estimate a model examining the impact of city-level changes to the EITC. The structure and richness of our data enable us to control for tax filer fixed effects, an important innovation from many previous EITC studies. Overall, we find that the combined EITC raises the likelihood of net-EITC income above poverty and near poverty by as much as 9 percent, with the largest consistent effects accruing to single-parent families.

Stacking of Multiple Environmental Credits: An Alberta Discussion Paper

The Province of Alberta, Canada, has created, or is contemplating creating, offset and credit system for greenhouse gases, for wetlands, and for other ecosystem components. In addition, several actual or potential federal (Canadian) environmental offset and credit systems might apply within the province. This paper examines the issue of whether and how credits in each of these systems ought to apply in combination with one another when derived from activities in a single location. It reviews several considerations which have been recommended in the academic literature and briefly examines policy approaches in Canada, the U.S., and Australia.

Treasury Finance in the U.S. Financial System

Treasury finance plays a key role in an economy with four sectors identified as Treasury, Fed, Banks, and Nonbanks. Congress sets federal tax, credit, and spending policy which vary with the state of the economy. This causes autonomous changes of the federal balance sheet. Congress delegates control of monetary policy to Fed. To transmit monetary policy Fed controls the average interest rate charged on an overnight loan of reserve balances in the interbank fed funds market. To help Fed retain control of the fed funds rate Treasury applies cash management with a goal to minimize changes in levels of reserve balances caused by Treasury finance operations. During an accounting period Treasury applies debt management to cover the cash deficit or dispose of the cash surplus. Treasury borrows from the public to cover the unified budget deficit, to increase Treasury operating cash, and to cover cash disbursements driven by other changes in the federal balance sheet. Treasury pays off debt held by the public to dispose of the cash surplus caused by the unified budget and other changes in the federal balance sheet. Treasury altered its cash management activity during the financial crisis.

The Optimal Long-Run Earned Income Tax Credit System

The Earned Income Tax Credit (EITC) became a prominent social tool especially in the US where the maximum federal credit reaches 45 percent of the wage. In this paper we ask the following question: assuming that in the long-run From Welfare to Work Program succeeds in increasing the propensity to work by the Working Poor; what is the optimal combination of EITC and transfers to the unemployed? Will the optimal EITC increase or decrease in the long-run? For this purpose we add to Saez (2002) seminal contribution an endogenous elasticity of labor participation. The addition of this feature can be compared to the sensitivity analysis conducted in Saez’s simulations, in which he examined how different (exogenous) levels of the extensive margin elasticity affect the respective magnitudes of the EITC and guaranteed income. Like Saez, we find that (in most cases), a higher extensive margin elasticity yields a higher EITC and lower guaranteed income. However, we find that with an endogenous extensive margin elasticity this effect is much weaker, and in some cases it is even reversed, due to the fact that in the endogenous case a high extensive elasticity is obtained when low income individuals have a high labor aversion, and thus the initial share of unemployed individuals is larger relative to the working poor - which makes the EITC a less attractive tool for the policy maker. Our simulations show that when the initial share of working poor is small enough relative to the unemployed the expected long run reduction of labor aversion produces an increasing optimal EITC, whereas in the case in which the initial proportion of the unemployed is low relative to the working poor, the reduction of labor aversion produces a decreasing optimal EITC.

The Market for Electric Vehicles: Indirect Network Effects and Policy Impacts

The market for plug-in electric vehicles (EVs) exhibits indirect network effects in that there is interdependence between consumer decision of EV purchase and investor decision of charging station deployment. Through a stylized model, we demonstrate that indirect network effects on both sides of the market lead to feedback loops which could amplify shocks and alter the diffusion process of the new technology. The relative strength of indirect network effects on the two sides of the market has important implications on policy design. Based on quarterly EV sales and charging station deployment in 353 Metro areas from 2011 to 2013, our empirical analysis finds indirect network effects on both sides of the market with those on the EV demand side being stronger. The federal income tax credit of up to $7,500 for EV buyers contributed to 40% of the EV sales during 2011-2013 with feedback loops explaining 40% of that increase. A policy of equal-sized spending but subsidizing charging station deployment would have been more than twice as effective in promoting EV adoption.

Exception Reports as a Source of Idiosyncratic Information

Firms commonly use exception reports that describe and justify deviations from guidelines to mitigate poor decisions and employee opportunism. This study examines whether exception reports can also be used to help lower-level employees make better-informed decisions. We propose that exception reports can facilitate the sharing and use of local information that is not systematically collected, shared, and codified into rules, routines, or operating procedures (“idiosyncratic information”). Consistent with our expectation, we find that lower-level employees of a large federal credit union use idiosyncratic information in each other’s exception reports to increase lending, and reduce interest rates and loan charge offs. In additional analyses, we find that this occurs because accountability pressure from superiors makes exception reports a particularly credible source of idiosyncratic information and a common understanding of work practices facilitates the interpretation of exception reports.

Demand-Pull and Innovation in the U.S. Solar Market

It is widely known that demand-pull policies in the United States, especially the federal investment tax credits (ITC) and the California Solar Initiative (CSI), have led to a rapid escalation in the installation of solar photovoltaic (PV) systems. But there has been little systematic study into the impacts of the ITC and CSI on technological innovation. To understand the extent and nature of innovations spurred by major solar demand-pull policies, we examine patent activity in four categories of the distributed solar PV balance of system (BOS) — inverters, mounting systems, monitoring, and site assessment. Using patent counts from a unique dataset, we find that patent activity for each of these four BOS categories has increased substantially since 2005-06: ~200-400% increase in 2006-08 and ~100-200% increase in 2009-10 over prior periods (2002-05 and 2006-08, respectively). Through examining correlations of measured patent activity with cost trends of BOS and with the timing of major demand-pull policies, we conclude that demand-pull policies have largely engendered the new wave of innovations in PV BOS. We also find that new entrants account for a significant portion (34% - 74%) of patent activity in all four BOS categories. New business model innovations that tap into the large markets created through ITC and CSI have driven demand for new technological innovations in areas that had largely been untouched by incumbents, thereby allowing new entrants the opportunity to compete in and shape the market landscape.

Renewable Energy—Finance: Financing US Renewable Energy Projects in a Post‐Subsidy World

AbstractThe federal renewable energy production tax credit (PTC) was created in 1992 when Congress enacted the Energy Policy Act of 1992. The creation of the PTC for renewable energy generating projects signaled the birth of the modern renewable energy industry in the United States. In the years since its birth, the industry has grown in fits and starts, seeing the creation of the investment tax credit (ITC) in 2005 and no less than six extensions of the PTC.