Statement of G. Edward DeSeve

Controller and Acting Deputy Director for Management

Office of Management and Budget

before the

House Small Business Committee

July 16, 1997

Introduction

Chairman Talent, Congressman LaFalce, Members of the Committee, I am Edward DeSeve, Controller and Acting Deputy Director for Management of the Office of Management and Budget. I am here today representing OMB to discuss the error recently found by the General Accounting Office in the FY1998 subsidy estimate for the 7(a) loan program; to describe the important contribution of the Federal Credit Reform Act (FCRA) to more accurate budgeting; and to outline the significant ongoing improvements in the loan subsidy cost estimates of the Small Business Administration (SBA).

First, I would like to thank the Committee and GAO for pointing out the computational error. We at OMB and, as Administrator Alvarez will testify, SBA believe that it is an extremely serious matter and are taking steps to correct it. I accept the findings of SBA's Inspector General that both SBA and OMB share responsibility for the problem.

The 7(a) Miscalculation and Steps to Prevent Future Errors

In April, you requested that the General Accounting Office (GAO) review loan subsidy estimates for the 7(a) general business loan guarantee program and the 504 certified development company guarantee program. In particular, you asked about the recent changes in the estimated subsidies for these programs. The error in the calculation of the FY 1997 7(a) loan subsidy estimate discovered by GAO was an incorrect reference formula in one cell of a summary spreadsheet. The summary spreadsheets aggregate cashflow data to produce the single subsidy estimate for the 7(a) program. GAO's and Administrator Alvarez' statements describe the error in more detail.

We are pleased that the GAO review undertaken at your request found the error so that it could be corrected. All other reference formulas have been double-checked. GAO and SBA confirmed that the correct reference formulas were used in both the FY 1996 and FY 1998 estimates.

Administrator Alvarez' testimony details the additional quality control steps instituted by SBA to prevent similar errors in the future -- enhanced internal quality control, inspector general audits, and reviews by outside expert consultants. OMB also will expand the checks it makes of SBA loan program subsidy calculations. An additional step we also are considering is to complete decisions about SBA credit subsidy estimates earlier in the annual budget process to allow more time for rechecking calculations before the President's Budget is transmitted to Congress.

The Importance of Credit Reform

The Federal Credit Reform Act (FCRA) is a major force in improving the accuracy of the Federal Budget. The Budget now more accurately reflects the cost of loan program spending decisions as well as the impact of those programs on the economy. The credit reform requirement to budget for the cost of loan programs on a present value basis also has removed score keeping distortions that artificially influenced spending decisions -- particularly in appropriations laws -- prior to enactment of the FCRA. Perhaps most importantly, because the cost of loan programs is considered when credit decisions are initially made, Congress and the President have the ability to more effectively control credit costs.

Credit reform takes the best information available, at the time the President's Budget is decided, to measure the budget impact of Federal loan programs. It uses the actual historical cash transactions of loan programs to compare the net present value of payments by the Government (direct loan disbursements and guarantee claims, for example) with the net present value of receipts (such as loan repayments, fees, and recoveries). This allows policy makers to make more informed decisions about credit programs and to compare more accurately the budget impact of loan programs with other Federal expenditures.

Prior to the FCRA, the cost of Federal loan programs was very uncertain. In many instances, it took years for costs to be apparent. Loan defaults and guarantee claims payments were reflected in the Budget several years after loan disbursements and guarantee commitments had been made. The cost of interest subsidies were clear only after several years of experience with market interest rates. Loan program cost estimates are significantly more accurate today because of the analysis and improvements in loan databases made in response to the FCRA. The error is an aberration and does not undermine the progress made since credit reform was enacted.

Improved Analysis and Information

You asked the GAO to review why the subsidy estimates for the 7(a) and 504 programs have changed. The concise answer is that they have improved because more accurate and complete historical data and analytical information became available. That is an important conclusion of the GAO review.

Prior to the FY 1997 Budget, the subsidy estimates for these programs were based on samples of loan data prepared shortly after the enactment of the FCRA. Administrator Alvarez' statement details the major undertaking completed by SBA in late 1995 to compile and analyze the available historical data for the 7(a) and 504 programs. This work directly led to a significant improvement in subsidy estimates. The prior estimates based on samples had understated loan default rates and overstated recoveries from loans in liquidation. OMB staff joined with SBA last year to discuss the results of that study with your predecessor, Chairwoman Meyers.

SBA has made substantial progress in compiling and using its historical data to improve the accuracy of subsidy estimates as required by the FCRA. However, as Administrator Alvarez notes, additional work remains. SBA's study stands out as an excellent example of the benefits that accrue from giving a high priority to the creation and maintenance of loan databases and the analysis of that data as required by the FCRA. Administrator Alvarez has stated that continued improvements in loan program databases and analysis are part of her goal of making SBA a leading edge financial institution. OMB will do all it can to support that effort.

Other Federal agencies are engaged in ongoing improvements of their loan program subsidy estimates. For example, HUD is undertaking a major plan to integrate its data systems, which will result in significant improvements in its database and subsidy estimates. In comparison to SBA's major 1995 study, some agencies have accomplished incremental, annual improvements in their estimates. The degree of improvement varies from agency to agency and program to program, and we believe the changes required by the FCRA have been positive for the Federal Budget process.

Conclusion