Thursday, February 26, 2009

Which budget deficit?

I am in the midst of preparing the 7th edition of my intermediate macroeconomics textbook. The following draft of a new case study is relevant for current policy debates:

Case Study
Accounting for TARP

In 2008, many U.S. banks found themselves in substantial trouble, and the federal government put substantial taxpayer funds into rescuing the financial system. A case study in Chapter 11 discusses the reasons for this financial crisis, the ramifications, and the policy responses. But here we note one particular small side effect: It made measuring the federal government’s budget deficit more difficult.

As part of the financial rescue package, called the Troubled Assets Relief Program (TARP), the U.S. Treasury bought preferred stock in many banks. In essence, the plan worked as follows. The Treasury borrowed money, gave the money to the banks, and in exchange became a part owner of those banks. In the future, the banks were expected to pay the Treasury a preferred dividend (similar to interest) and would eventually repay the initial investment as well. When that repayment occurred, the Treasury would relinquish its ownership share in the banks.

The question then arose: How should the government’s accounting statements reflect these transactions?

The U.S. Treasury adopted the conventional view that these TARP expenditures should be counted like any other spending. When the banks repaid the Treasury, these funds would be counted as revenue. Accounted for in this way, TARP caused a surge in the budget deficit when the funds were distributed to the banks, but it would lead to a smaller deficit, and perhaps a surplus, in the future when repayments were received from the banks.

The Congressional Budget Office, however, took a different view. Because most of the TARP expenditures were expected to be repaid, the CBO thought it was wrong to record this spending like any other. Instead, CBO believed “the equity investments for TARP should be recorded on a net present value basis adjusted for market risk, rather than on a cash basis as recorded thus far by the Treasury.” That is, for the purposes of this program, CBO adopted a form of capital budgeting. But it took into account that these investments might not pay off. In their estimation, every dollar spent on the TARP program cost the taxpayer only about 25 cents. If the actual cost turned out to be larger than the estimated 25 cents, the CBO would record those additional costs later, and if the actual cost turned out to be less than projected, the CBO would later book a gain for the government.

The bottom line: Because of these differences in accounting, while the TARP funds were being distributed, the budget deficit as estimated by CBO was much smaller than the budget deficit as recorded by the U.S. Treasury.

Update: Here is how President Obama's new budget treats the issue:

Estimates of the value of the financial assets acquired by the Federal Government to date suggest that the Government will get back approximately two-thirds of the money spent purchasing such assets—so the net cost to the Government is roughly 33 cents on the dollar. These transactions are typically reflected in the budget at this net cost, since that budgetary approach best reflects their impact on the Government’s underlying fiscal position. The figure recorded in this Budget as a placeholder similarly reflects this net cost concept. The $250 billion reserve would support $750 billion in asset purchases.


Addendum: If you teach macroeconomics and would like to consider the 7th edition for your course, please contact Scott Guile at