OMB Project Grew Into $5-Billion Budget Bailout Plan : U.S. Loan Sales: ‘Yard Sale’ or ‘Sound Policy’?

First, surplus federal property went on the block. Then, the government got rid of Conrail and National and Dulles airports. This year, lucrative chunks of the nation’s $1-trillion loan portfolio will be offered for sale to private investors.

The Administration calls it “sound policy.” Critics call it the “national yard sale.”

While the debate rages, already:

- The Education Department has sent out letters offering colleges the first crack at buying back their own loans at an average discount rate of 37%.

- The Farmers Home Administration expects to have its water and sewer loans ready to offer to the public through an underwriter early this year.

- The Export-Import Bank has had a steady stream of Wall Street visitors inquiring about the bank’s loans to foreign governments or companies.

The sales of outstanding federal loans to the highest bidder is an idea whose time is here. But the first sales will be long consummated and paying interest to investors before the bitter disputes over their wisdom and their terms are put to rest.

$1 Billion in Interest to Be Lost

The Congressional Budget Office has estimated that loan sales in 1987 will yield about $5 billion in immediate revenue for the Treasury. But the sales will cost approximately $1 billion in interest and principal payments the government will have to forgo in 1988.

Congressional opponents of the sales, like House Budget Committee Chairman William H. Gray III (D-Pa.)--charge that the government is mortgaging its future for “short-term relief.”

But for the Administration, loan sales are part of the fine print of the Reagan revolution, one way to reduce the size and scope of government and “privatize” federal functions whenever possible.

John E. Buttarazzi, a research associate with the Heritage Foundation, a conservative think tank, said loan sales are “good policy” and “routine banking practice.”

“The government gets the revenues up front, the subsidies are explicit, you get more efficient management, and the value of the loans will actually go up once they are in private hands and people see how they perform,” he said.

“The government has not been doing a good job of managing its portfolios. The incentives to collect are just not there in the same way that they are if it is your own money.”

Congress Takes Different View

But for Congress, loan sales are mainly a money matter.

What began as an Office of Management and Budget pilot project ballooned into a $5-billion budget bailout in a few hectic horse-trading days last fall as Congress tried to get down to the Gramm-Rudman-Hollings deficit reduction target it had set.

“As much as we like to beat the Administration over the head on loan-asset sales,” said a senior congressional aide, “it was Congress that went hog-wild when the reconciliation bill was going through.”

“We started with a pilot project to sell loan assets with a face value of $4.4 billion, from which we hoped to get $2 billion in revenues,” said M. Kathryn Eickhoff, associate director for economic policy at OMB. “Congress increased it until we are now supposed to yield $5.5 billion in receipts.”

As a result, she said, “We have a program larger than we preferred, but it seems to be moving appropriately.”

As Congress moved toward adjournment last fall, “solid” proposals to cut spending were dropped one by one until “we were left with little else than loan sales,” according to Richard N. Brandon, chief budget aide to incoming Senate Budget Committee Chairman Lawton Chiles.

“It’s Gresham’s Law of Budget Process--the bad drives out the good,” he said.

‘No Permanent Relief’

Gray called the sales “artificial deficit reduction that . . . provides no permanent relief for the deficit headache.”

Referring to OMB plans to include $8 billion in revenue from loan sales in the fiscal 1988 budget, Gray said, “You may get $8 billion dollars in 1988, but in ‘89--nothing, in ‘90--nothing.”

Rep. Jack Brooks (D-Tex.) chairman of the Government Operations Committee, said in a statement: “Massive sales of the government’s loan portfolio is just another panicky reaction to the Reagan Administration’s disastrous budget policy.”

Bitter fights are to yet come on terms of the sales. OMB has insisted the government sell loans without recourse. That is, if the borrowers don’t pay, the investor can’t turn to the government to recoup. Some lawmakers believe the government will lose its shirt under these conditions, because investors will be afraid of defaults and the loans will go for a fraction of their true value.

In a study for Brooks, the General Accounting Office said the no-recourse provision would be costly for the government.

Government’s Risk Debated

“We believe these requirements will adversely affect the loan assets’ marketability and the potential net proceeds from their sale,” GAO said.

But OMB is adamant. Otherwise, it argues, the government would bear the risk, and the investment community would get the profits.

The federal government has a loan portfolio of just less than $1 trillion. It is made up of $257 billion in direct loans to beneficiaries ranging from students to small business executives; $410 billion in guaranteed loans, which the government agrees to pay off if they go bad; and $329 billion in guaranteed or implicitly guaranteed loans from government-sponsored enterprises, such as the Federal National Mortgage Assn. and the Student Loan Marketing Assn. that provide money for housing and student loans.

The number of delinquent loans is a subject of disagreement. Critics of the loan programs cite high figures--such as the 17% used by the Heritage Foundation. OMB says officially that $13.8 billion in direct loans are delinquent.

The reasons for the discrepancies are not fully understood. But agencies, eager to make their record appear as good as possible, sometimes count as current a borrower who is making only partial payments or has “restructured”--i.e., extended--his or her loans. Some loans can be extended for as long as 50 years.

Sale Candidates Limited

Only the direct loans are candidates for sale, and more than half of those are considered off limits for policy or practical reasons. Off-limits loans include loans in default and those made to foreign governments for military equipment or to hard-pressed farmers.

In addition, the government is expected to make about $33.8 billion in new loans this year, and Office of Management and Budget Director James C. Miller III has announced he will seek legislation to sell a portion of these immediately.

But while the immediate sale of new loans is only a proposal, sales of billions of dollars in outstanding loans are soon to be a fact. Congress, in its reconciliation bill last year, ordered the FHA to sell enough loans from its rural housing fund to yield $1.7 billion; from its rural development fund to yield $1 billion; from the Export-Import Bank portfolio to yield $1.5 billion; from its college housing loans to yield $579 million; and from the Economic Development Administration to yield $50 million.

The Office of Management and Budget has estimated it will require the sale of $7.1 billion in loans to yield $4.8 billion in revenue.

Why OMB Favors Sales

OMB favors loan sales on four grounds: philosophical, managerial, informational and budgetary.

Philosophically, the Administration believes the government should not be making many of the loans. “Why compete with the private sector?” asked Joseph R. Wright Jr., deputy director of OMB.

Some of the loan programs have been management nightmares. FHA has been operating under an “antiquated system,” according to Vance Clark, its administrator.

“We are just now getting computer equipment delivered,” he said.

In addition, the White House has sought to use loans sales to gather information about subsidies. “We’ve been making loans to boost rural America, but we’ve done it at a price--that price surfaces when we sell loans,” Clark said.

OMB Director Miller said, “The difference between the (sale price) and the (amount of the loan) would be a measure of the subsidy now inherent in direct loan programs.”

Budgetary Aspects Obvious

The budgetary aspects of the loan sale program are self-evident, although OMB is proposing to sell far fewer loans this year than enthusiastic supporters of the program--such as Wright--had wanted sold.

Wall Street has also been enthusiastic. When FHA became the first agency to advertise for a financial adviser to counsel the agency on selling its loans, 39 firms submitted bids.

In the end, Manufacturers Hanover Corp., the low bidder, was selected.

“We felt this first one out of the gate would offer a great deal of learning both for the government and the financial adviser,” said John R. Price, senior vice president and secretary of Manufacturers Hanover. “We felt it was an important, prestigious assignment.

“We think it will be a good piece of business.”

Financial advisers are prohibited from buying the loans on which they advise the government. But, Price said, “there will be future loan sales.”

Rural Development Loans First

The first loans on the public block are likely to be about $1 billion of rural development loans. Most of them are 20- to 25-year loans to finance the building of water and sewer facilities; they were made at about 5% interest to towns with fewer than 20,000 people. Currently, 98.8% of the payments are on or ahead of schedule, according to Kathleen Lawrence, deputy undersecretary for Small Community and Rural Development.

Education is offering to sell back its college housing and classroom building loans to the borrowers at a discount before offering them to the public.

“Clearly the colleges value these assets more than third parties,” said C. Ronald Kimberling, assistant secretary for Postsecondary Education. The 30- to 40-year loans at 3% interest are being offered to the colleges at an average discount of 37% off the face value of the loan. College housing loans have a default rate of 1.5%, the academic facilities loans 3% to 4%.

It makes sense to sell the loans now and get the revenue instead of waiting for the interest to dribble in over the years, because “of the time value of money,” Kimberling said. The income this year prevents the Treasury from having to borrow that amount, and also saves collection costs, he said.

SBA to Seek Adviser

The Small Business Administration is getting final clearance to advertise for a financial adviser this month to counsel the agency on selling its business and disaster loans.

The SBA loans are expected to sell at a large discount because interest rates on the disaster loans range between 1% and 8%, on the direct business loans between 5.5% and 15%; they may be prepaid at any time. The delinquency/default rate on some of the loans is about 10%, according to Edwin T. Holloway, SBA’s associate administrator for finance and investment.

The Department of Housing and Urban Development has decided not to hire outside financial advice, but to rely on its own expert--the Government National Mortgage Assn.

The Economic Development Administration is trying to figure out what to do. Congress ordered it to generate $50 million from loan sales, but prohibited it from selling any loan without the borrower’s permission.

The EDA’s 400 outstanding loans have a delinquency rate of approximately 50%, according to EDA spokesman Jon Mertz.