Uncle Sam’s Trillion-Dollar Portfolio Partly Offsets the Public Debt

When policy folks talk about America’s federal borrowing, their go-to measures are the public debt, currently $12 trillion, and its ratio to gross domestic product, which is approaching 75 percent. Those figures represent the debt that Treasury has sold into public capital markets, pays interest on, and will one day roll over or repay.

These debt measures are important, but they paint an incomplete picture of America’s fiscal health. They don’t account for the current level of interest rates, for example, or for the trajectory of future revenues and spending. A third limitation, the focus of this post, is that the public debt doesn’t give Treasury any credit for the many financial assets it owns.

As we noted last week, Uncle Sam has been borrowing not only to finance deficits but also to make student loans, build up cash, and buy other financial assets. That portfolio now stands at $1.1 trillion, equivalent to almost one-tenth of the public debt.

Those assets have real value. They pay interest and dividends and could be sold if Treasury ever cared to. In fact, Treasury has sold many financial assets in recent years, including mortgage-backed securities and equity stakes in TARP-backed companies, even as it expanded its portfolio of student loans.

Debt Measures

One way to take account of these holdings is to subtract their value from the outstanding debt. The rationale is straightforward. If Ann and Bob each owe $30,000 in student loans and have no other debts, they both have the same gross debt. But that doesn’t mean their financial situations are the same. If Ann has $10,000 in the bank and Bob has only $5,000, then Ann is in a stronger position. Her net debt is $20,000, while Bob’s is $25,000.

The same logic applies to the federal government: $12 trillion in debt is easier to bear if the government has some offsetting financial assets than if it has none. That’s why both the Office of Management and Budget and the Congressional Budget Office regularly report the public debt net of financial assets. The net debt isn’t a perfect measure; many assets are harder to value than Ann and Bob’s bank accounts, and official valuations may not fully reflect their risk. Nonetheless, as CBO has said, the net public debt provides “a more comprehensive picture of the government’s financial condition and its overall impact on credit markets” than does the gross public debt.

The net debt is now a bit less than $11 trillion or about 68 percent of GDP. That’s more than $1 trillion less than the usual, gross measure of public debt, or about 7 percent of GDP. That difference was only 3 percent of GDP as recently as 2006. Under President Obama’s budget, it would expand to almost 10 percent by 2023, with financial assets growing twice as fast as the public debt.

Financial assets are thus playing a bigger role in America’s debt story. Accumulating deficits remain the prime driver of the debt. But the expansion of Uncle Sam’s investment portfolio means the growing public debt overstates America’s debt burden.

This post was coauthored by Hillel Kipnis, who in interning at the Urban Institute this summer.

Uncle Sam’s Growing Investment Portfolio

The federal government has been borrowing rapidly to finance recent budget deficits. But that’s not the only reason it’s gone deeper into debt. Uncle Sam also borrows to issue loans, build up cash, and make other financial investments.

Those financial activities have accounted for an important part of government borrowing in recent years. Since October 2007, the public debt has increased by $6.9 trillion. Most went to finance deficits, but about $650 billion went to expand the government’s investment portfolio, including a big jump in student loans. Before the financial crisis, Uncle Sam held less than $500 billion in cash, bonds, mortgages, and other financial instruments. Today, that portfolio has more than doubled, exceeding $1.1 trillion:

Uncle Sam Investment Portfolio

Financial crisis firefighting drove much of the increase from 2008 through mid-2010. Treasury raised extra cash to deposit at the Federal Reserve; this Supplemental Financing Program (SFP) helped the Fed finance its lending efforts in the days before quantitative easing. Treasury placed Fannie Mae and Freddie Mac, the two mortgage giants, into conservatorship, receiving preferred stock in return; shortly thereafter, Treasury began to purchase debt and mortgage-backed securities (MBS) issued by Fannie, Freddie, and other government-sponsored enterprises (GSEs). And through the Troubled Asset Relief Program (TARP), Treasury made investments in banks, insurance companies, and automakers and helped support various lending programs.

Together with a few smaller programs, these financial crisis responses peaked at more than $600 billion. Since then, they have declined as Treasury sold off all its agency debt and MBS and most of its TARP investments and as quantitative easing, in which the Fed simply creates new bank reserves, eliminated the need for cash raised through the SFP.

Those declines have been more than offset by the government’s growing student loan portfolio. The federal government used to subsidize student borrowing not only by providing loans directly to students, but also by guaranteeing many private loans. In 2009, however, Congress eliminated private guarantees and dramatically expanded direct federal lending. The government’s portfolio of student loans has since increased from about $90 billion at the start of fiscal 2008 to more than $560 billion today.

As a result, the government’s financial investments now total about $1.1 trillion, essentially all of which was financed by borrowing. The debt supporting Uncle Sam’s investment portfolio thus accounts for almost 10 percent of the $11.9 trillion in public debt.

Source: The Federal Reserve Financial Accounts (formerly known as the Flow of Funds), Daily Treasury Statement, and the President’s Budgets. The figures here compare balances as of March 31, 2013 (most recent available) with balances as of September 30, 2007 (the end of fiscal 2007). We define financial investments to be all the federal government’s financial assets except for official reserve assets, trade receivables, and tax receivables; this definition approximates those used by the Office of Management and Budget and the Congressional Budget Office in certain debt calculations.

This post was coauthored by Hillel Kipnis, who in interning at the Urban Institute this summer.

A Second Thought on the Cost of TARP

Two commenters (Jack B. and John L.) raise an important point about the $25 billion price tag that the Congressional Budget Office recently placed on the Troubled Asset Relief Program. Their concern is that the $25 billion figure includes some impacts that should rightfully be attributed to other government actions, not to TARP itself.

To illustrate, suppose that Treasury used TARP to buy $10 of preferred stock in Bank X in 2008 and that a year later Treasury sold its position for $12, including accrued dividends. This investment would be recorded as achieving a $2 profit in TARP (subject to one technical caveat, see below).

That’s the normal way of calculating profit on an investment, and is what CBO was instructed to do for its part of TARP oversight. But as Jack and John point out, there’s an important complication here. During the year, the federal government undertook many other policy actions which may have boosted the value of Bank X (remember all the new acronyms?). From the perspective of policy evaluation, some or all of the $2 gain should be attributed to those other policies, not TARP.

It could be, for example, that absent further action, Bank X would have struggled, leaving Treasury with stock worth only $6. Other government actions, however, breathed enough life into the company (or, at least, boosted the value of its assets) that the stock ultimately became worth $12.

In that case, you could argue that TARP, by itself, resulted in a $4 loss, while the other government actions created a $6 gain. That puts the budgetary impacts of TARP in a different light: a 40% loss versus a 20% gain in this example.

Of course, you could also argue that the $6 gain was only possible because of the TARP ownership stake. There’s certainly an element of truth to that. But the basic concern still applies: the $2 gain in this example reflects both TARP and subsequent government actions, not just TARP alone. That’s an essential point when trying to evaluate these policies after the fact, and we commenters should keep that in mind when interpreting CBO’s findings.

And that’s not all. The other government actions may also have imposed additional direct or indirect costs on the federal budget. As a result, the $2 gain in this example may be offset (or more) by other costs that aren’t included in the calculation.

Bottom line: One reason that TARP appears much less expensive than originally predicted is that many of its investments benefitted from other government actions whose costs show up elsewhere in the budget.

Caveat: CBO’s methodology actually judges the profitability of investments relative to benchmark rates of return. The details are surprisingly complex, but just for purposes of illustration, suppose that the appropriate benchmark rate of return for investing in Bank X was 10%. If Treasury sold the stock for $11 after one year, CBO would deem that as breaking even. If it sold it for $12, that would be a $1 profit.

How Much Did TARP Cost? $25 Billion

The much-maligned TARP program will cost taxpayers only $25 billion according to the latest estimates from the Congressional Budget Office. That’s substantially less than the $66 billion CBO estimated back in August or the $113 billion that the Office of Management and Budget estimated in October.

The good news, budget-wise, is that the government is on track to make about $22 billion on its assistance to banks.

However, CBO estimates that TARP’s other activities will cost $47 billion. This reflects aid to AIG ($14 billion), the auto industry ($19 billion), mortgage programs ($12), and a few smaller programs ($2 billion).

The Looming Budget Battle over the Bank Tax

Treasury Secretary Tim Geithner appeared before the Senate Finance Committee today to push the Administration’s proposal for a Financial Crisis Responsibility Fee, more commonly known as the Bank Tax. The purpose of the fee is to

[M]ake sure that the direct costs of TARP are paid for by the major financial institutions, not by the taxpayer.  Assessments on these institutions will be determined by the risks they pose to the financial system.  These risks, the combination of high levels of riskier assets and less stable sources of funding, were key contributors to the financial crisis.

The fee would be applied over a period of at least ten years, and set at a level to ensure that the costs of TARP do not add to our national debt.  One year ago we estimated those costs could exceed half a trillion dollars.  However, we have been successful in repairing the financial system at a fraction of those initial estimates. The estimated impact on the deficit varies from $109 billion according to CBO to $117 billion according to the Administration.  We anticipate that our fee would raise about $90 billion over 10 years, and believe it should stay in place longer, if necessary, to ensure that the cost of TARP is fully recouped.

As noted by other participants in today’s hearing, the bank tax raises a host of questions: Is it possible to design the tax so that it is ultimately paid by major financial institutions (by which I presume Geithner means their shareholders and top management), or will it get passed through to their customers? How much, if at all, would the tax reduce bank lending? Is it fair to target the banks even though the bank part of TARP actually made money for taxpayers? Would the tax reduce risks in the financial system?

Those are all interesting questions, but today I’d like to highlight another one: Can Congress embrace the idea of a bank tax that would be used to “ensure the costs of TARP do not add to our national debt”?

As described by the Administration, the bank tax would be used to reduce the deficit, thus offsetting budget costs of TARP. Congress, however, is hungry for revenues that it can use to offset the budget costs of new legislation, e.g., extending the ever popular research-and-experimentation tax credit or limiting the upcoming increase in dividend taxes. With PAYGO now the law of the land (for many legislative proposals), some members are looking at the $90 billion of potential bank tax revenues as the answer to their PAYGO prayers.

All of which points to a looming budget battle: Will the bank tax be used to pay off the costs of TARP, as the President has proposed, or will it be used to pay for other initiatives?

How Did Treasury Vote Its Citigroup Shares?

The United States Treasury is Citigroup’s largest common shareholder, owning 7.7 billion shares, or about 27% of the company. Which raised an interesting issue at today’s annual meeting: how should the Treasury vote its shares?

Treasury answered as follows:

As we have previously stated, Treasury is a reluctant shareholder in private companies and intends to dispose of its TARP investments as quickly as practicable.  When it acquired the Citigroup common shares, Treasury announced that it would retain the discretion to vote only on core shareholder issues, including the election of directors;  amendments to corporate charters or bylaws; mergers, liquidations and  substantial asset sales; and significant common stock issuances.  At the time of the exchange, Treasury agreed with Citigroup that it would vote on all other matters proportionately–that is, in the same proportion (for, against or abstain) as all other shares of the company’s stock are voted with respect to each such matter.  Treasury is abiding by the same principles in the few other companies in which it owns common shares, which are very few, as most TARP investments were in the form of nonvoting preferred stock.

Those sound like good principles. So how did Treasury actually vote?

Treasury voted FOR three ballot proposals:

  • 15 Nominees to the Board of Directors
  • To issue $1.7 billion of “common stock equivalents” to workers in lieu of cash incentive compensation (a way to conserve cash that Citi agreed to in a deal to repay some TARP money)
  • Reverse stock split

Treasury voted PROPORTIONALLY on the remaining proposals:

  • Ratify KPMG as the firm’s accountant
  • An increase in shares for a stock incentive plan
  • Executive compensation (nonbinding “say on pay”)
  • A “Tax Benefits Protection Plan” which discourages ownership changes that would reduce the value of Citi’s $46 billion in deferred tax assets
  • Six shareholder proposals covering such issues as corporate governance and political activity.

Treasury emphasizes that its proportional votes don’t mean it lacks an opinion on these proposals. Referring to two corporate governance proposals, for example, Treasury noted that it may have a policy preference but:

Treasury believes that it would be inappropriate to use its power as a shareholder to advance a position on matters of public policy and believes such issues should be decided by Congress, the SEC or through other proper governmental forums in a manner that applies generally to companies.  For this reason, and because voting on such matters was not necessary in order to fulfill its EESA responsibilities, Treasury refrained from exercising a discretionary vote.

Although Treasury expressed that view with respect to the corporate governance provisions, I can’t help but wonder what it felt about the “Tax Benefits Preservation Plan.”

You can see all the proposals in Citigroup’s proxy statement.

Disclosure: I own no Citigroup securities of any kind (see this post for a summary of my previous thoughts about Citi securities).

Goldman Really Did Overpay for Its TARP Warrants

Yesterday, Treasury released a comprehensive report on the disposition of TARP warrants through 12/31/2009. It’s a font of fascinating information–at least for fellow TARP warrant aficionados.

Treasury apparently did quite well when it negotiated with banks that wanted to repurchase their TARP warrants. I am still a fan of auctions, but you have to give Treasury credit–they did defend taxpayer interests in the negotiations.

Treasury drove an especially hard bargain with Goldman Sachs. As shown in the following chart from the report, Goldman ended up paying much more than any of the estimates that Treasury considered:

The green line is what Goldman actually paid: $1.1 billion. The yellow lines are Goldman’s earlier bids ($600 million and $900 million). The black bars are the range of estimates from three different modeling efforts. Bottom line: Goldman overpaid.

The report has similar graphs for the other 33 firms that have repurchased their warrants; some of them paid at the upper end of the black bars, but none overshot like Goldman.

Disclosure: I have no investments in Goldman Sachs (or any TARP recipients).