Advanced economies made available more than 5 trillion USD through government-supported credit gu... more Advanced economies made available more than 5 trillion USD through government-supported credit guarantee and direct loan programs to provide lifelines to firms in the face of the COVID-19 pandemic. Notwithstanding the unprecedented scale of credit made available, an in-depth analysis of the fiscal consequences is missing, and the costs of these programs are not recognized in a transparent way. In this paper, we fill in an important aspect of the fiscal picture by estimating the subsidies that were provided by the largest credit guarantee programs introduced in 2020 in seven advanced economies. We estimate the subsidies on a fair value basis that provides a consistent and comprehensive upfront measure of cost. We explain the logic behind applying a fair value framework in a government context and compare it to alternative approaches. For the programs that we examine, total credit extended totaled 1.7 trillion USD. The subsidy element (cash-equivalent subsidy) is estimated to be 67 percent of loan principal on average (37 percent, excluding the US PPP), with a wide range across programs, from 12 to 100 percent. The variation is explained by differences across programs including eligibility criteria, loan terms, compensation to lenders, and other program design choices.
This paper develops a formal model of the timing and pricing of new equity issues, assuming that ... more This paper develops a formal model of the timing and pricing of new equity issues, assuming that managers are better informed than new investors about the quality of the firm. Firms will prefer to issue equity when the market is most informed about the quality of the firm. This implies that equity issues tend to follow information releases, such as earnings announcements. The model also predicts a relation between the timing and pricing of equity issues. The price drop at the time of the equity issue announcement should increase in the time since the last information release, and the price drop at issue should increase with the time since the last information release or issue announcement. We teat the predictions of the theory on a sample of NYSE, AMEX and OTC firms who issued equity over the period 1978-1983. We find evidence that there is a clustering of equity issues following earnings announcements and annual reports, and also that the price drop at the time of the equity issue is increasing in the time since the announcement of the issue.
Department of Education indicate that in the same year, about 6.8 million students, and 750,000 p... more Department of Education indicate that in the same year, about 6.8 million students, and 750,000 parents of students, borrowed $56 billion in new federally backed loans. The guaranteed program was responsible for 77 percent of this new loan volume. Another 2.5 million borrowers took advantage of the option to convert their outstanding Stafford loans into more favorable consolidation loans, resulting in $69.6 billion of new consolidation loans. 2.2 Product Offerings and Loan Terms Both the direct and guaranteed programs offer three basic types of loans: Stafford Loans, Parent Loans to Undergraduate Students (PLUS), and Consolidation loans. We restrict the analysis to Stafford and Consolidation loans, since these comprise the vast majority of loans in both programs. The terms on all loans are set by statute under the Higher Education Act. From the perspective of students, the terms on Stafford and consolidation loans are virtually identical under both the direct and guaranteed programs. Government payments to and from guaranteed lenders are also set by statute, and differ across loan types. Stafford. These 10-to 30-year loans are available to students enrolled in eligible educational institutions, which includes most U.S. colleges and universities but not trade or for-profit schools. Between 1998 and July 2006, these loans carried a floating rate that reset annually, based on the 3-month Treasury rate plus a fixed spread. Since July 2006, Stafford loans carry a fixed 6.8 percent per annum interest rate, with flexible repayment plans that begin upon completion or dropping out of a course of study. 1 Borrowers in the guaranteed program are assessed a one-time 2 percent origination fee, although this may be paid by the lender. 2 Borrowers pay a further 1 percent guarantee fee at origination that accrues to guaranty agencies in the guaranteed program. In the direct program borrowers are charged 3 percent upfront, although they can receive a 1.5 percent rebate for an on-time first p 3 ayment. Although all Stafford loans carry below-market rates, the loans are further classified as "subsidized" or "unsubsidized." The federal government pays all of the accrued interest on subsidized Stafford loans while a borrower is in school, grace or deferment, whereas interest accrues on unsubsidized loans. Eligibility for subsidized loans is based on income. On Stafford loans, guaranteed lenders receive special allowance (SAP) payments from the government that provide net cash flows (including payments from students) equal to 1 From July 2008, the rate on new loans is scheduled to decline in gradual increments until it reaches 3.4 percent in July 2011 before reverting to 6.8 percent in July 2012, at which time the Higher Education Act comes up for reauthorization. The analysis here is based on the rules in effect from August 2006 to June 2007. 2 Under current law, the origination fee phases out over the next several years. 3 Historically, the guarantee fee has also been waived, but this is no longer the case.
When a private pension plan sponsor with an underfunded plan becomes insolvent, the difference be... more When a private pension plan sponsor with an underfunded plan becomes insolvent, the difference between the value of the plan's assets and its termination liabilities represents a liability for the Pension Benefit Guaranty Corporation (PBGC). Hence, accurately modeling the joint statistical distribution over time of defined benefit (DB) pension underfunding and sponsor terminations is critical for estimating PBGC's prospective cash flows and evaluating its financial position. It appears that the current Pension Insurance Modeling System (PIMS) approach to modeling risk does a reasonable job of capturing its statistical properties effects on PBGC cash flows, though some aspects of the might be improved and metrics expanded. The paper outlines how an options-based approach to modeling the joint distribution of defaults and underfunding in PIMS might be implemented while preserving the strengths of the current model. Moving to an options-based approach would allow PIMS to be used to estimate the fair values of future liabilities. Such an approach could have a significant effect on the perceived financial position of PBGC.
The North American Journal of Economics and Finance, 1999
This paper suggests a mechanism by which nominal price rigidities can create a transmission mecha... more This paper suggests a mechanism by which nominal price rigidities can create a transmission mechanism for monetary shocks through relative price distortions in an economy with both spot and contract markets. The globally unique equilibrium time path of interest rates and prices following an impulse shock to the money supply is characterized. The model predicts that prices and interest rates cycle around the new steady state, with real interest rates initially falling and prices overshooting in the case of a positive shock. The volatility of spot prices and interest rates exceeds that of contract prices.
Journal of Natural Resources Policy Research, 2014
The radical proposition of Arrow and Lind (1970) – that governments should use risk-free rates in... more The radical proposition of Arrow and Lind (1970) – that governments should use risk-free rates instead of market rates to discount their risky investments – can best be understood by first considering the work in its historical context. During the late 1960s and early 1970s, a debate was raging between the leading economists of the time about the cost of risk to the government, and related, the identification of the social discount rate. Recent advances in general equilibrium theory (notably, Arrow & Debreu, 1954; Debreu, 1959) allowed for more general welfare analyses of policy than had been undertaken previously; underscored the benefits of risk-sharing as well as the aggregate limits on risk-sharing; and clarified the role of market prices in aggregating the risk preferences of society. Such analyses also highlighted the potentially salutary role for governments in improving risksharing when markets are incomplete. On one side of the debate were authors who took the position that governments should rely on market prices in evaluating the cost of investments. Diamond (1967) analyzed an economy with technology risk and a stock market. Perhaps not surprisingly, he concluded that if markets are sufficiently complete for stock prices to reflect the social cost of risk, then those prices are also relevant to the government in evaluating its investment policy. Hirshleifer (1964, 1966) reached similar conclusions and argued forcefully for the use of market prices by governments. Other leading economists of the time advocated the position that was subsequently formalized in Arrow and Lind. Samuelson and Vickrey (in Jorgenson et al., 1964) argued that because of the large and diversified portfolio held by the government, the marginal return from public investment overall is virtually risk-free, and hence should be evaluated at the risk-free rate rather than the higher market rate demanded by less diversified investors. (The government’s own borrowing rate is usually taken as a proxy for the risk-free rate.) The specialness of the assumptions required to formalize the idea that the cost of market risk is irrelevant to the government – in particular, that there is no aggregate uncertainty affecting the value of government investments – was acknowledged by Arrow and Lind: ‘The results...depend on returns from a given public investment being independent of other components of national income’ (p. 373). Arrow and Lind defended that assumption with the assertion that correlated risk is likely to be insignificant for many government investments.
Defined benefit (DB) pension plans cover about 44 million U.S. workers and retirees, and represen... more Defined benefit (DB) pension plans cover about 44 million U.S. workers and retirees, and represent a significant liability for many corporations. 1 The total number of participants in defined benefit plans has increased modestly in the last decade, although the number of singleand
The federal government explicitly guarantees a portion of deposit obli-gations of commercial bank... more The federal government explicitly guarantees a portion of deposit obli-gations of commercial banks and thrifts through deposit insurance, and is thought to provide protection beyond this legal obligation for institu-tions considered “too big to fail. ” Although not explicitly guaranteed until
The federal government makes subsidized federal financing for higher education widely available. ... more The federal government makes subsidized federal financing for higher education widely available. The extent of the subsidy varies over time with interest rate and credit market conditions. A loan provision that adds considerably to the size and volatility of the subsidy is the consolidation option, which allows students to convert floating-rate federal loans to a fixed rate equal to the average floating rate on their outstanding loans. We develop a model to estimate the option’s cost and to evaluate its sensitivity to changes in program rules, economic conditions, and borrower behavior. We
Advanced economies made available more than 5 trillion USD through government-supported credit gu... more Advanced economies made available more than 5 trillion USD through government-supported credit guarantee and direct loan programs to provide lifelines to firms in the face of the COVID-19 pandemic. Notwithstanding the unprecedented scale of credit made available, an in-depth analysis of the fiscal consequences is missing, and the costs of these programs are not recognized in a transparent way. In this paper, we fill in an important aspect of the fiscal picture by estimating the subsidies that were provided by the largest credit guarantee programs introduced in 2020 in seven advanced economies. We estimate the subsidies on a fair value basis that provides a consistent and comprehensive upfront measure of cost. We explain the logic behind applying a fair value framework in a government context and compare it to alternative approaches. For the programs that we examine, total credit extended totaled 1.7 trillion USD. The subsidy element (cash-equivalent subsidy) is estimated to be 67 percent of loan principal on average (37 percent, excluding the US PPP), with a wide range across programs, from 12 to 100 percent. The variation is explained by differences across programs including eligibility criteria, loan terms, compensation to lenders, and other program design choices.
This paper develops a formal model of the timing and pricing of new equity issues, assuming that ... more This paper develops a formal model of the timing and pricing of new equity issues, assuming that managers are better informed than new investors about the quality of the firm. Firms will prefer to issue equity when the market is most informed about the quality of the firm. This implies that equity issues tend to follow information releases, such as earnings announcements. The model also predicts a relation between the timing and pricing of equity issues. The price drop at the time of the equity issue announcement should increase in the time since the last information release, and the price drop at issue should increase with the time since the last information release or issue announcement. We teat the predictions of the theory on a sample of NYSE, AMEX and OTC firms who issued equity over the period 1978-1983. We find evidence that there is a clustering of equity issues following earnings announcements and annual reports, and also that the price drop at the time of the equity issue is increasing in the time since the announcement of the issue.
Department of Education indicate that in the same year, about 6.8 million students, and 750,000 p... more Department of Education indicate that in the same year, about 6.8 million students, and 750,000 parents of students, borrowed $56 billion in new federally backed loans. The guaranteed program was responsible for 77 percent of this new loan volume. Another 2.5 million borrowers took advantage of the option to convert their outstanding Stafford loans into more favorable consolidation loans, resulting in $69.6 billion of new consolidation loans. 2.2 Product Offerings and Loan Terms Both the direct and guaranteed programs offer three basic types of loans: Stafford Loans, Parent Loans to Undergraduate Students (PLUS), and Consolidation loans. We restrict the analysis to Stafford and Consolidation loans, since these comprise the vast majority of loans in both programs. The terms on all loans are set by statute under the Higher Education Act. From the perspective of students, the terms on Stafford and consolidation loans are virtually identical under both the direct and guaranteed programs. Government payments to and from guaranteed lenders are also set by statute, and differ across loan types. Stafford. These 10-to 30-year loans are available to students enrolled in eligible educational institutions, which includes most U.S. colleges and universities but not trade or for-profit schools. Between 1998 and July 2006, these loans carried a floating rate that reset annually, based on the 3-month Treasury rate plus a fixed spread. Since July 2006, Stafford loans carry a fixed 6.8 percent per annum interest rate, with flexible repayment plans that begin upon completion or dropping out of a course of study. 1 Borrowers in the guaranteed program are assessed a one-time 2 percent origination fee, although this may be paid by the lender. 2 Borrowers pay a further 1 percent guarantee fee at origination that accrues to guaranty agencies in the guaranteed program. In the direct program borrowers are charged 3 percent upfront, although they can receive a 1.5 percent rebate for an on-time first p 3 ayment. Although all Stafford loans carry below-market rates, the loans are further classified as "subsidized" or "unsubsidized." The federal government pays all of the accrued interest on subsidized Stafford loans while a borrower is in school, grace or deferment, whereas interest accrues on unsubsidized loans. Eligibility for subsidized loans is based on income. On Stafford loans, guaranteed lenders receive special allowance (SAP) payments from the government that provide net cash flows (including payments from students) equal to 1 From July 2008, the rate on new loans is scheduled to decline in gradual increments until it reaches 3.4 percent in July 2011 before reverting to 6.8 percent in July 2012, at which time the Higher Education Act comes up for reauthorization. The analysis here is based on the rules in effect from August 2006 to June 2007. 2 Under current law, the origination fee phases out over the next several years. 3 Historically, the guarantee fee has also been waived, but this is no longer the case.
When a private pension plan sponsor with an underfunded plan becomes insolvent, the difference be... more When a private pension plan sponsor with an underfunded plan becomes insolvent, the difference between the value of the plan's assets and its termination liabilities represents a liability for the Pension Benefit Guaranty Corporation (PBGC). Hence, accurately modeling the joint statistical distribution over time of defined benefit (DB) pension underfunding and sponsor terminations is critical for estimating PBGC's prospective cash flows and evaluating its financial position. It appears that the current Pension Insurance Modeling System (PIMS) approach to modeling risk does a reasonable job of capturing its statistical properties effects on PBGC cash flows, though some aspects of the might be improved and metrics expanded. The paper outlines how an options-based approach to modeling the joint distribution of defaults and underfunding in PIMS might be implemented while preserving the strengths of the current model. Moving to an options-based approach would allow PIMS to be used to estimate the fair values of future liabilities. Such an approach could have a significant effect on the perceived financial position of PBGC.
The North American Journal of Economics and Finance, 1999
This paper suggests a mechanism by which nominal price rigidities can create a transmission mecha... more This paper suggests a mechanism by which nominal price rigidities can create a transmission mechanism for monetary shocks through relative price distortions in an economy with both spot and contract markets. The globally unique equilibrium time path of interest rates and prices following an impulse shock to the money supply is characterized. The model predicts that prices and interest rates cycle around the new steady state, with real interest rates initially falling and prices overshooting in the case of a positive shock. The volatility of spot prices and interest rates exceeds that of contract prices.
Journal of Natural Resources Policy Research, 2014
The radical proposition of Arrow and Lind (1970) – that governments should use risk-free rates in... more The radical proposition of Arrow and Lind (1970) – that governments should use risk-free rates instead of market rates to discount their risky investments – can best be understood by first considering the work in its historical context. During the late 1960s and early 1970s, a debate was raging between the leading economists of the time about the cost of risk to the government, and related, the identification of the social discount rate. Recent advances in general equilibrium theory (notably, Arrow & Debreu, 1954; Debreu, 1959) allowed for more general welfare analyses of policy than had been undertaken previously; underscored the benefits of risk-sharing as well as the aggregate limits on risk-sharing; and clarified the role of market prices in aggregating the risk preferences of society. Such analyses also highlighted the potentially salutary role for governments in improving risksharing when markets are incomplete. On one side of the debate were authors who took the position that governments should rely on market prices in evaluating the cost of investments. Diamond (1967) analyzed an economy with technology risk and a stock market. Perhaps not surprisingly, he concluded that if markets are sufficiently complete for stock prices to reflect the social cost of risk, then those prices are also relevant to the government in evaluating its investment policy. Hirshleifer (1964, 1966) reached similar conclusions and argued forcefully for the use of market prices by governments. Other leading economists of the time advocated the position that was subsequently formalized in Arrow and Lind. Samuelson and Vickrey (in Jorgenson et al., 1964) argued that because of the large and diversified portfolio held by the government, the marginal return from public investment overall is virtually risk-free, and hence should be evaluated at the risk-free rate rather than the higher market rate demanded by less diversified investors. (The government’s own borrowing rate is usually taken as a proxy for the risk-free rate.) The specialness of the assumptions required to formalize the idea that the cost of market risk is irrelevant to the government – in particular, that there is no aggregate uncertainty affecting the value of government investments – was acknowledged by Arrow and Lind: ‘The results...depend on returns from a given public investment being independent of other components of national income’ (p. 373). Arrow and Lind defended that assumption with the assertion that correlated risk is likely to be insignificant for many government investments.
Defined benefit (DB) pension plans cover about 44 million U.S. workers and retirees, and represen... more Defined benefit (DB) pension plans cover about 44 million U.S. workers and retirees, and represent a significant liability for many corporations. 1 The total number of participants in defined benefit plans has increased modestly in the last decade, although the number of singleand
The federal government explicitly guarantees a portion of deposit obli-gations of commercial bank... more The federal government explicitly guarantees a portion of deposit obli-gations of commercial banks and thrifts through deposit insurance, and is thought to provide protection beyond this legal obligation for institu-tions considered “too big to fail. ” Although not explicitly guaranteed until
The federal government makes subsidized federal financing for higher education widely available. ... more The federal government makes subsidized federal financing for higher education widely available. The extent of the subsidy varies over time with interest rate and credit market conditions. A loan provision that adds considerably to the size and volatility of the subsidy is the consolidation option, which allows students to convert floating-rate federal loans to a fixed rate equal to the average floating rate on their outstanding loans. We develop a model to estimate the option’s cost and to evaluate its sensitivity to changes in program rules, economic conditions, and borrower behavior. We
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Papers by Deborah Lucas