Government is getting burned in the loan business

Among the many things it does, the federal government is one of the nation’s largest lenders. It lends to farmers, homeowners, students, small businesses, exporters and rural electric utilities, among others. Altogether, there are more than 100 loan programs administered by 20 agencies overseeing lending worth $3.4 trillion in fiscal 2015, up from $1.5 trillion in 2007.

These fascinating figures come from a new report on federal credit programs. The report’s verdict is mixed: Many programs are justified to correct failures of private credit markets, but lending standards are often too lax, resulting in unnecessary losses to the Treasury and harm to borrowers.

In theory, the government — that is, taxpayers — could be on the hook for the entire outstanding amount of $3.4 trillion (actually, the total is greater now). This would be a significant addition to the existing publicly held federal debt of more than $14 trillion.

But in practice, the government’s exposure is more limited, because many of the federal loans will be repaid in full or, if not, repaid in part from the proceeds of a business or the sale of houses, which serve as collateral for home mortgages. Just how large losses might be is unclear.

The report, supported by the American Society for Public Administration, was written by Thomas Stanton, a well-known expert on government credit programs; Alan Rhinesmith, a former top official of the Office of Management and Budget; and Michael E. Easterly, a former staff member of the commission that investigated the 2008-09 financial crisis.

As they describe it, federal lending has taken on a life of its own. Of the outstanding amount of $3.4 trillion, roughly two-thirds are loan guarantees (the government reimburses private lenders for losses) and the remainder are direct loans (borrowers stiff the government directly).

Government lending is dominated by two categories: housing credit ($1.9 trillion) and student loans ($1.1 trillion). But there are many other sizable programs. For example:

Small Business Administration loan guarantees, $106 billion

Export-Import Bank, $85 billion

Advanced vehicle manufacturing, $16 billion

Transportation infrastructure, $11 billion

Federal lending is usually justified to offset the reluctance of private lenders — with the benefits assumed to exceed the costs (delinquencies and defaults). The Federal Housing Administration was created in the 1930s because “the private sector was failing to serve the credit needs of thousands of prospective homebuyers who (could) repay mortgage loans,” the report says.

But over time, political pressures have rationalized much dubious lending, which ultimately benefit neither borrowers nor lenders. Among the weakest borrowers, default rates were highest both for home mortgages and student loans, according to the report. The Department of Education projects that a quarter or more of today’s college undergraduates will ultimately default on their loans.

What’s needed, the report argues, is a shift in culture — borrower outcomes should matter more than loan volumes. The evils of over-lending are obvious, it contends.

“The huge volume of federal credit outstanding means that too many borrowers end up defaulting on their loans,” says the report. “Credit programs continue to grow in volume, with credit managers under pressure to ‘get the money out the door’ before the fiscal year ends. It is time to change the focus from the volume of credit an agency extends to borrower outcomes.”

This is common sense. Unfortunately, it might not make political sense.