NEWS CONFERENCE ON SUMMER UPDATE:
BUDGET AND ECONOMIC OUTLOOK

Tuesday, September 9, 2008

The News Conference was convened, pursuant to notice,
at 10:00 a.m. in room 483 of the Congressional Budget Office.

Speaker: Congressional Budget Office Director, Peter Orszag

ORSZAG: Thank you, and good morning. Before turning to the specifics of the budget and economic outlook that we are releasing this morning, let me say a few words about the steps announced by the Treasury Department and the Federal Housing Finance Agency on September 7th with regard to Fannie Mae and Freddie Mac.

Those steps were motivated by a desire to reduce the risk of systemic shocks to the financial system and to stabilize the mortgage market. They also, however, carry important implications for how the operations of Fannie Mae and Freddie Mac should be reflected in the federal budget. In particular, the activities of Fannie Mae and Freddie Mac are currently not encompassed within the federal budget, even though some supplemental data are reported on their activities along with federal budget information each year.

In a letter that we issued on the topic in July, CBO noted, and I quote, "A strong argument can be made that if the treasury used the proposed authority the GSEs (ph) operation should be incorporated directly into the federal budget." Now that the authority is indeed being exercised, it is CBO’s view that the operations of Fannie Mae and Freddie Mac should be directly incorporated into the federal budget. Doing so reflects a very tight nexus between the firms and the federal government and the degree of control being exercised by the federal government over their operations. It is also consistent with the guidelines put forward in the 1967 report on the President’s Commission on Budget Concepts.

What does it mean in practical terms? In practical terms what it means is that the revenue earned by the GSEs (ph) would be recorded as a federal receipt and their spending would be recorded as a federal outlet. So, for example, when they guarantee a mortgage-backed security that would be reflected in the federal budget. And when they pay their heating bills, that would count as a federal outlet.

We intend to reflect this new accounting in the baseline that we will be releasing in January. In the meanwhile, we will be working with the budget committees and with the Office of Management and Budget, which I would note is responsible for constructing the budget of the United States to evaluate many thorny technical issues, for example, how credit transactions are reflected in the federal budget.

I’d be happy to answer questions about this accounting change in more detail after discussing the economic and budget outlook. So turning to that, there was a very significant increase in the federal budget deficit between 2007 and 2008. The budget deficit rose from $161 billion last year to a projected $407 billion this year. In terms of shares of the economy or share of GDP, that’s an increase from 1.2 percent last year to 2.9 percent this year. And if you take that 1.7 percentage point increase as a share of the economy, it’s roughly evenly split between a 0.9 percentage point reduction in revenue, which itself in part reflects a significant decline in corporate tax revenue and a 0.8 percentage point increase in spending.

As we go out over time for the next couple of years under our official baseline, we project deficits that continue to be about 3 percent of the economy hovering around $400 billion, $450 billion or so. I think as is well known now, however, that official baseline makes a variety of assumptions with regard to the future that reflect the literal interpretation of current law. So, for example, all of the tax provisions that are scheduled to expire under current law are expiring in these sets of projections. If instead of doing that you assume that the expiring tax provisions as part of the 2001 and 2003 tax legislation are continued past their scheduled expiration at the end of 2010, and if you assume that the alternative minimum tax is indexed to inflation and you make a variety of other assumptions that many analysts have put forward as a reflection of the sort of current thrust of federal policy, you wind up with instead of the top line, which is what’s reflected in the official baseline, the bottom line, which is this alternative fiscal scenario in which deficits hover in the 4 to 5 percent of GDP range and the cumulative deficit over the next decade exceeds $7 trillion. And unfortunately, that’s the good news because thereafter we start to experience the longer term budget pressures that are at the heart of the long-term fiscal problems the nation faces.

In particular, even over the next decade Social Security spending is projected to rise from 4.3 percent of the economy to 5 percent. And even more prominently, Medicare and Medicaid spending are projected to rise in our projections from 4.6 percent of the economy to 6 percent by the end of the 10-year window and then under current policies, continue rising thereafter reaching 12 percent of GDP by 2050.

As we have said over and over in the past, the nation is on an unsustainable long-term fiscal course driven primarily by rising health care costs. And that does need to be addressed before a crisis hits.

Returning to the short-term for a moment, all these projections are based on a set of economic assumptions also. And I will now turn to those.

I don’t generally like to be—to play the dismal economist, but this report is unfortunately a big challenge from that perspective. The nation is experiencing a significant period of economic weakness. And although it is too soon to say whether the National Bureau of Economic Research will term the current period a recession, the increase in unemployment rates and the weakness in economic activity continued in our projections are consistent with the pattern seen in past recessions, the past few recessions, to be precise.

One of the drivers of economic weakness is difficulties in the housing market, as I think is now well-known. Housing prices have declined steeply, we assume, because the outstanding stock of unsold homes remains elevated and because building permits remain low and for other reasons, a further 10 percent decline in national home prices through the middle of 2009. That continued weakness in housing is putting pressure on the GSEs (ph), as exemplified by the recent activity that I discussed before and on the rest of the financial sector.

And indeed one sees, as the next chart shows, continued signals of pressure in the banking and the rest of the financial system, as is reflected in quite elevated spreads between the rates at which banks lend to each other over a three-month period, the three-month London Interbank operate (ph) or LIBOR and the federal funds rate. As that goes up, the amount of sort of stress in the banking system is heightened. And again, we continue to experience difficulties there.
In addition to that, as the next chart shows, the price of oil has gone up substantially. And even though it has since come down slightly, it remains much higher than it was over the past several years. As a result of that higher price of oil, oil imports into the United States have increased by about $160 billion over the past year. That’s a bit over 1 percent of GDP. And it acts—that increase in the import bill acts as a tax on the economy of roughly that size, so a significant constraint on economic activity coming from that source.

And in addition to that, and partly a reflection of that, prices of food have gone up significantly also. And here we just give you wheat, corn, and soybeans. That increase in food prices has some implications for federal government programs, for example, the food stamp program, which increased markedly this year in cost. And it also has implications for a headline inflation or overall inflation, which does remain elevated in our projections.

In terms of the labor market, we have seen, especially with the most recent report, an increase in the unemployment rate from about 4.5 percent in the first half of 2007 to 6.1 percent now. Employment growth has— or jobs themselves have declined by an average of 75,000 per month through August for this year. And we project a continued decline of about 50,000 per month for the second half of 2008.

In terms of our economic growth projections, the next chart shows that for 2008 on a fourth quarter-over-fourth quarter basis, we are projecting growth of 0.9 percent. That is somewhat below the administrations’ and somewhat below the blue chip consensus. And then some recovery in 2009 and an increase to 1.8 percent on a fourth quarter-over-fourth quarter basis for 2009. Inflation is projected to subside somewhat as there is some softening in oil prices and in food prices and the so-called core inflation rate and the overall inflation rate come closer together relative to where they have been over the past year or so.

ORSZAG: So let me just wrap up there and conclude again that we—we have experienced a very significant increase in the federal budget deficit over the past year, that as we look out over time, the key long-term fiscal challenge facing the nation involves rising health-care costs supplemented by demographic challenges.

And then in the short-term, we are experiencing a period of some significant economic difficultly, which we project will be attenuated over time and that we will return to somewhat more normal growth rates in 2009 and thereafter. And as I noted before, the change or the implementation of the authorities with regard to Fannie Mae and Freddie Mac raised significant federal budget accounting questions, and it is our view that at this point Fannie Mae and Freddie Mac should be directly incorporated into the federal budget.

Thank you and I’d welcome questions.

Christian (ph)?

QUESTION: Can I just clarify? Does that mean that you will be taking the stock of all the liabilities onto the government’s books, in other words the full $5.4 trillion of—of liabilities or only the 1.6 billion which is actually debt, the rest being mortgage-backed security?

ORSZAG: So there are two—there’re actually a series of questions involved in how this incorporation would be done, how to bring the entities onto the federal budget. Let me deal with a new—the new book of business first, and then the existing book of business raises other questions.

With regard to the new book of business, even there there are questions and just—I don’t want to bore everyone, especially those of you who are watching outside this room. But just for a moment, on the technicalities, there is tension between various different budget scoring rules. So for example, if the federal government bought a loan or engaged in a loan transaction that is supposed to be evaluated in terms of its subsidy value, that is how—if—if—if the federal government lends you a hundred dollars that’s not recorded as a hundred-dollar cost; instead it’s recorded as however big the subsidy to you is from that loan relative to the treasury borrowing rate. If, however, the federal government bought a stock worth a hundred dollars, that’s recorded as a hundred dollars.

And there’s tension when you get to things like mortgage-backed securities. Are those simply a collection of mortgages and loans or are those publicly traded securities? Because the treatment will vary between those two things. And obviously a mortgage-backed security is actually both of those things. So decisions need to be made about how to score or evaluate the new book of business. That’s one set of questions.

Another set of questions involves what do you do with their existing book of business and for example outstanding debt that they have and what have you. And all of those questions are things that we are grappling with and that will be reflected in our January baseline. Given that the announcement was just made on Sunday, I don’t want to be reaching judgments at this point, and we also do want to be consulting actively and will be with the budget committees and with the Office of Management and Budget about precisely how to do this.

Other questions? Yup?

QUESTION: Since Treasury was developing this GSE plan, did they reach out to you at all to just get some technical sense of if this was incorporated into the budget, what it’s effect might be? Is there any communication between Treasury and the CBO on the last month or so?

ORSZAG: I have been in communication with the Treasury Department over the past month at several points.

QUESTION: Do you have a full concept (inaudible) until January?

ORSZAG: We will reflect this new accounting—and again, I just want to emphasize it’s—these are big entities and there’s a lot of complexity involved in how to do this in our baseline in January.

QUESTION: If they inject the preferred stock—and the preferred stock right now is worthless. I mean, I think it’s almost virtually worthless. Then that’s just a straight cash injection. Wouldn’t that be—isn’t that how you would calculate...

ORSZAG: Well, if these entities are actually part of the federal budget, then that kind of transaction is actually an intergovernmental transfer where one part of the government is transferring money to another part of the government. And it doesn’t affect the net numbers.
The things that will affect the net numbers are, you know, the fees and the—and the new revenue on—on business. And again, things, you know, paying the bills for the air-conditioning and—and expenditures like that. That—that is what will drive the net impact on the federal budget. And then the transactions between the Treasury Department and the two entities would be intergovernmental in nature and not reflect the bottom line.

QUESTION: Do you have any—do you offer us any personal assessment as to whether you think this change in the relationship between the federal government and the assets and liabilities of these firms would have any increase—any affect on U.S. government borrowing costs?

ORSZAG: I’m not allowed to offer personal assessments any more. But let me relay the—I think the conventional wisdom on that point, which is that any affect would be relatively modest in part because the markets perceived an implicit guarantee before, and in part because the net impact, which is the difference between the firm’s liabilities and their assets, is obviously much, much smaller than the gross numbers.

So, yes, they have $1.5 trillion in debt or thereabouts. They also have something close to that number in assets. And the net number is not—not that—not that big.

QUESTION: (Inaudible) with CBS. Can you—I mean, you’ve said that you’re going to have to work out certain issues of how you count things with the banking committee and whatnot. But can you kind of give me a tick, tick, tick in the simplest terms possible of what exactly—you’re going to count it in the federal budget, but what exactly you have to work out now?

ORSZAG: Sure. What we’re going to count in the federal budget or in our baseline—I should be more precise. What we’re going to count for our purposes is all of the activities that Fannie Mae and Freddie Mac are engaged in.

So no longer will they be beyond the realm of the federal budget. And if they go out and spend a dollar on, you know, a new sedan, that will be a federal outlay. If they earn a dollar in revenue from a mortgage-backed security guarantee or from other sources, that will be reflected in the federal budget.

The tick-tock of the issues involved in this involve precisely how, for example, with regard to a mortgage-backed security purchase, how that’s reflected. So if the—if Fannie Mae and Freddie Mac go out and either guarantee or purchase mortgage-backed securities, precisely how is that reflected as opposed to the fact that it will be?

So I think the big change is it will be reflected somehow, at least in our baseline. What we need to work out, along with the budget committees and the Office of Management and Budget, is precisely how. So the change is that it will be reflected.

Yes?

QUESTION: So the federal government now has about $5 trillion in debt and Fannie and Freddie have about $5.2 trillion. Does the federal government now have $10.2 trillion? Does this double?

ORSZAG: No. We need to separate out a couple of things. First, the $5 trillion or so in Fannie Mae and Freddie Mac exposure to—to mortgages at large involves a significant component in which they’re just guaranteeing mortgage-backed securities. And that would not, presumably, count directly as debt.

Their outstanding debt is, at the end of the second quarter, was, you know, $1.7 trillion.

Even that debt, however, as was noted before, is of a different nature than conventional treasury securities both because it’s—it has some corresponding assets associated with it in terms of the entities balance sheet and because it is, you know, both for legal and other reasons, a distinct security.

And I think, again, coming back to the Tennessee Valley Authority, it is better to think of it as a, sort of, special category of debt that we believe should be reflected as part of our baseline in the federal budget, but that it is different from a ten-year treasury bond.

QUESTION: Would that be similar to—would that exposure be similar to, say, like loan guarantees or student loans or something along those lines? Wouldn’t that have some— some outlay affect?

ORSZAG: Well, loan guarantees are—I guess, loans guarantees are one of the examples in the federal budget that are not scored on a cash basis. They are scored at their subsidy value. And therefore, there are similarities in that, again, we’re just highlighting that.

The difficulty here is that these entities are engaged in credit transactions. And credit transactions can be treated differently in the federal budget depending on their precise form. And that’s what we are—are working through.

The loan guarantees are an example in the current federal budget of—of credit reform act transactions that are scored at their subsidy value.

QUESTION: So is it possible then that in terms of the budget outlook, that this could have a neutral effect or even a positive effect? Is that possible?

ORSZAG: One of the ironies of the current—I mean, what we’re—what we are exposing is the shortcomings in the way in which the federal government currently accounts for credit transactions because the credit reform act, again, does not reflect the cost of risk.

And to the extent that what the federal government is engaged in or what these entities, you know, as part of the baseline or federal budget are engaged in, involves risk. It can look profitable to the federal government even if, on a risk-adjusted basis, it’s not. But those are the rules.

ORSZAG: So it is— it is something that CBO has written about before that we don’t account for the riskiness of the transaction. We just sort of assume that away. And that can make these—these transactions look profitable even if a private sector entity wouldn’t view them as such.

QUESTION: When a federal agency repays a loan on which a borrower has defaulted, that counts as a federal outlay?

ORSZAG: No. The way that the system works is that when the loan guaranty is initially—just to take your example—initially issued, there is a cost to the federal government at that time for the subsidy value so in particular, if there’s a— a very risky borrower, and you guaranty that loan, that—that can—and—and don’t charge a sufficient fee for the loan guaranty, that involves a subsidy from the federal government to the borrower, and that is reflected in the budget at that time.

Later, as the world rolls forward and there, you know, it— reality turns out to be either the loan goes bad or it doesn’t—there are a set of technical adjustments made to the credit accounts to reflect the cash flows, but in terms of budget scoring, and the way that the budget process works, there’s sort of upfront recognition when that loan guaranty is issued of its expected costs.

QUESTION: On mandatory spending, you spoke about the percentage of GDP increasing from 4.5 to 6 percent on...

ORSZAG: Medicare and Medicaid.

QUESTION: Medicare and Medicaid?

ORSZAG: Yes.

QUESTION: Now, some are suggesting that there are ways to ameliorate that by looking at dynamic scoring, and one example is increased outreach and education for beneficiaries with chronic kidney disease—the idea being that if you get to them early enough, you can forego them going on to the ESRD benefit.

Is CBO working on something like that would—that would account for this, which is part of the new MIPA (ph) bill?

ORSZAG: Let me say a few things: Bending the cost curve on health care is the central long-term fiscal challenge facing the United States, period. Then there’s a bunch of footnotes that we could talk about, but that’s the bottom line.

CBO has very substantially expanded its efforts in the health arena. We have dramatically expanded our staff over the past year or so, and in December, we are going to be putting out two very substantial volumes on health care topics including an extensive array of health options that are— will have quantitative budget estimates associated with them and a somewhat more qualitative volume that discusses the large topics in health reform that are in discussion and that we will be providing CBO’s views about.

So there’ll be a lot—I’ll have a lot more to say about health care options in December, but I view it as—and by the way, this is consuming a huge amount of CBO’s time and my time, and I view it as crucially important, because policy-makers recognizing the path that we are on are struggling for options that they could adopt to try to bend that curve, and it’s not easy, and I’m not going to—I’m not going to promise magic, but we are doing the hard work of trying to delineate what those options are.

Now, with regard to not just the example that you put forward, but a whole variety of preventive medicine steps and other types of prevention, which are intended to intervene quickly and then ameliorate or attenuate costs down the road. We do take those into account when there is evidence of their efficacy. But it is unfortunately the case in a lot of examples where people think there’s sort of good evidence, but when you scrub the evidence a little bit, it turns out not to be so great.

And, in particular, you can get lots of examples where there’s selective discarding of studies that don’t show net benefits of not targeting the intervention well enough. And what we’re trying really hard to do is pinpoint those areas where through effective targeting and smart application of preventive steps, you could actually wind up saving money.

So let me give you—I’ll give you one tiny example: flu vaccination rates for the elderly in the United States are something like two-thirds, so about two-thirds of Medicare beneficiaries—elderly Medicare beneficiaries get a flu vaccine during flu season. The evidence suggests that if we got that up closer to universal take up, we would—even in the short term—save money. So that—that’s a, sort of, little tiny example, and there are presumably ways in which one could do that since the vast majority— way over two- thirds—of Medicare beneficiaries come into contact with a Medicare provider during that season.

So we’re looking at a whole variety of things, and we’ll have a lot more to say about the topic in December. (Inaudible).

QUESTION: Presumably your ’08 numbers include the fiscal stimulus...

ORSZAG: Yes, sir.

QUESTION: ... this year. Would it be just straightforward to say, if there was to be a further stimulus next year, we should simply add whatever that number is to your baseline?

ORSZAG: Yes, let me say a couple of things about this topic: First, despite what some analysts have suggested, our view—our analysis is that the stimulus that was enacted did boost economic activity during the second and third quarters of this year by something north of one percentage points per quarter during that period of time.

And one of the reasons that we project subdued economic activity during the latter part of this year is simply the withdraw of that economic stimulus. So you have a bump up, and then as it’s taken away, you have a bit of a, sort of, air pocket almost. There are discussions underway—as your question suggests—about a second stimulus package.

I would note questions about the timing with which stimulus could be delivered, and in particular whether there is much that is practical and timely to affect the growth during the second half of this year given that we’re already in September, and there are lags involved in all of these things. So with regard to 2009, again, a big question will be the spend-out rate.

Some of the things under—under discussion, may not even completely spend out during fiscal year 2009, in which case you wouldn’t want to simply add whatever the aggregate number is to our 2009 figure.

Other questions, (inaudible)?

QUESTION: In terms of revenues, in the last recession—’02 and ’03—there was a huge drop off in —in—in revenues, particularly non-withheld. To what extent are you concerned, or do you see that pattern recurring this time?

ORSZAG: Well, we did —we’ve already seen some diminution. Again, most dramatically in corporate tax revenue. I mean, I—I think this story still has not received sufficient attention. The dramatic increase in corporate tax revenue between 2003 and 2006, and then a little bit of, sort of, stabilization, and then over the past year or so, a decline.

So corporate tax revenue in 2007 amounted to 2.7 percent of GDP. This year, we project it to be 2.2 percent of GDP. That point five percentage point decline explains the bulk of the overall 0.9 percentage point decline in revenue as a share of the economy. So there you saw a dramatic kind of run up in corporate tax revenue where it more than doubled between ’03 and ’06 and now some ramping down as corporate profits subside as a share of the economy, and as over time we project more of those corporate profits to be in overseas and to be in the form of S corporations, which are not subject to the corporate income tax.

(Inaudible), and then back over here again.

QUESTION: Have you made any assessment as to what extent the decline in the corporate tax revenue take as a percentage of GDP is structural or cyclical? In other words, is it just that we’re in a—we’re in—we’re in a serious downturn now so that number dips down? Or is it that there were particular conditions that inflated the corporate tax take in the mid 2000s, and going forward, we ought to expect this more subdued corporate tax rate as a—as a long-term phenomenon?

ORSZAG: Yes, let me back up here and say, over time, the big story on corporate tax revenue is a very substantial decline. If you look back from the 1950s and ’60s, and then we have this very unusual almost Indian summer of a very substantial increase from 2003 to 2006, which was puzzling. Part of it—only a small part—had to do with a shift in the form of national income away from labor compensation and towards capital income.

A larger part seemed to have to do with shifts within capital income, which is to say more corporate profits and lower net interests, in particular, within capital income. We are now seeing a subsiding again of the—that Indian summer—it’s fading, and our projections assume that it does continue to fade over time, which is to say it looks like we’re back on this path in which corporate tax revenue is substantially lower than it was, say, in the 1950s or ’60s.

ORSZAG: And I think —again, just backing up to the bigger issue—that reflects a couple realities: one is, our corporate income tax system is very complicated, and international —increasing international integration and sophistication of tax planning means that it is increasingly difficult to pin down profits in the United States as opposed to profits abroad. And as you know, there are very complicated issues involving transfer pricing and where corporations are allowed to park their international profits, all of which raises, I think, significant issues, which many people have discussed about the long-term sustainability of the current corporate income tax structure and whether ultimately changes will be necessary in the face of international capital mobility.

Back over there?

QUESTION: On page 15, the footnote, you talk about if Congress scrapped the current rate setting system for Medicare, the SGR, installed a system that accounts for medical inflation.

ORSZAG: Yes.

QUESTION: Increased outlays would be $300 billion from 2010 to 2018. And that’s just one policy option. But that is a repeal of the SGR and a new system. And then the question is if they just delayed it again and put off this 21 percent cut that’s expected in 2010, what would that cost?

ORSZAG: So for those of you who don’t intimately follow the details of Medicare, there is something in law called the sustainable growth rate formula, which governs how much physicians are paid. And what has happened over time is that it imposes these very steep declines or constraints on payment rates for physicians.

And the Congress every so often has said we don’t actually want that to happen because it will put too much pressure on physicians. So they provide a temporary relief from it, almost like the alternative minimum tax patch. So both with regard to the sustainable growth rate formula and the alternative minimum tax, we’re in this kind of rolling system of providing patches every year or two that kind of keep a system going that most observers believe ultimately will have to be changed, both with regard to the sustainable growth rate formula and with regard to the alternative minimum tax.

You would ask what if we just provide one more patch rather than a 10-year change. The answer is it depends what you do thereafter because one of the things about the sustainable growth rate formula is if you provide a one-year patch and then you don’t do anything else, there’s this sort of claw back provision. And so, on a 10-year basis, the number could look like zero because anything you’re providing up front you’re clawing back at the back end.

Assuming you don’t do that, we could get you the one-year equivalent to the $300 billion. I don’t have it off the top of my head. OK.

Any other questions?

Jonathan?

QUESTION: Assuming that the Fannie/Freddie stuff is treated like TVA (ph) or agency debt
and therefore not included as debt subject to the limit, does any of the other part of that look like it’ll affect the forecast for when the debt ceiling would need to be raised? And also, when did you lock down the numbers in this?

ORSZAG: So first with regard to the debt ceiling, the debt limit will be affected by the cash transactions that the federal government undertakes. So the impact on the debt limit can be different from, you know, what’s reflected in the budget scoring, as it were, because to the extent you depart from a cash basis, you can get a divergence between the evolution of financing requirements, which are based on cash, and the presentation in the budget.

With regard to the numbers, I can get you the exact date, but we locked down our economic assumptions about the—the economic assumptions were locked down in July.

Lori (ph)?

QUESTION: In terms of the alternative baseline scenario with the Bush tax cuts extended and AFT (ph), whatever (inaudible)...

ORSZAG: Blah, blah, blah.

QUESTION: Yes, blah, blah, blah. There has been talk on the campaign trail, at least by one candidate, of maintaining the deficit at approximately, you know, around that level, maybe a little bit better, but maybe not so much better, which you’re saying could be a 4 to 5 percent of GDP. Is that economically harmful?

ORSZAG: How about if you rephrase your question and take out the part about the campaign? Because I just don’t even want to touch any questions that have to do with that. So let me ask your question for you. Would deficits of 4 to 5 percent of GDP be economically harmful? And what I would say is that deficits of that magnitude or even smaller magnitude do impose economic costs because they slow the rate at which we’re accumulating capital over time for the future and thereby impair our future income.

But I would say the real concern—and I’m not trying to downplay the concern over the next decade. Running deficits like that could cause significant problems. The real concern is the path that we are on. The real concern is that it’s not just that decade, but even thereafter.
And what that means—and I would hope one lesson that we learned from our current difficulties—is that things that, you know, even if for a short period of time while you’re kind of living on a credit card if things look good that doesn’t mean they’ll always look good. And eventually underlying reality and underlying arithmetic does come to rule.

There is no serious analyst that I know who believes that substantial policy changes are not necessary to avoid eventually a fiscal crisis. And the only question is whether that crisis hits before or after we get our act together. We would be all much better off if we address the path that we’re on and restored the nation to a sounder fiscal footing well before our creditors and in particular our international creditors, but other people who buy government debt, grew concerned about the course that we’re on.

And no one can tell you when that will happen. But when it does happen, it can become a much bigger mess and much faster than anyone suspects.

Krishner (ph)?

QUESTION: Back on Fannie and Freddie, while taking (inaudible) on your point that there are a lot of assets and a lot of liabilities associated with these companies, so we shouldn’t just be thinking about this in gross (ph) terms, your further qualification (ph) that there are then specific accounting complexities as to how you reflect all this, is it nonetheless, though, correct to say that at a minimum even if the impact in sort of recorded net debt and so forth is not very dramatic, the federal government has taken on substantial additional risk in the sense that it is now essentially exposed to the gap between the potential gap that could emerge between two very large numbers, being the assets on the one hand and the liabilities on the other of these both?

ORSZAG: The federal government has taken a series of extraordinary steps in response to an extraordinary situation. So we haven’t talked about and we don’t need to the other steps that the federal reserve has taken or the loan guarantees that have been provided to the auto manufacturers and the possibility of additional loan guarantees being provided or this step. But in a whole variety of settings, the federal government has intervened as a risk manager in a way and assumed risk in the face of economic difficulties.

There are questions about how much additional risk the federal government has assumed with regard to Fannie Mae and Freddie Mac because there was always an implicit guarantee. And the question is how much— how strong was that implicit guarantee. How close was it to a perfect guarantee?

And I would say one of the puzzles, by the way, with regard to this current environment is that after enactment of the legislation with regard to Fannie Mae and Freddie Mac, one would have expected that the interest rates on their debt, their senior debt relative to treasury, to decline markedly under the theory of the case put forward by the secretary of the treasury, which is, you know, we now stand ready with an open-ended commitment to help them. All of those concerns should have meant that the spreads declined dramatically.

Instead, if anything, they stabilized or went up. So that is a significant puzzle. That means either financial markets were concerned about exactly how the commitment would work or didn’t believe the commitment or have some other concerns. But it’s a reflection of perhaps an implicit guarantee not being perfect. And there it was even more than an implicit guarantee because legislation had been enacted. And that perspective would suggest that, at least from the markets’ perspective, the federal government has adopted somewhat more risk by taking the steps that it has not taken.

QUESTION: What would the correlation be between the companies’ own earnings reports and the impacts that you’ve incorporated in the federal budget would have?

ORSZAG: It won’t be a perfect correlation, again, because of these accounting issues that we’ve already described. But generically, one would expect that if the firms suffer substantial losses as reflected in their own account, that would also be reflected to some degree in the federal budget accounting. But again, I would just note that the details could vary. So there should be some correlation, but it’s not going to be perfect just because the accounting rules differ.

And by the way, that already happens even with regard to the entities themselves under their own accounting systems where their gap accounting varies from their fair-market value accounting. And, again, it just reflects the different accounting rules.

QUESTION: The quality of the numbers or the quality of the data they gave you?

ORSZAG: I’m not going to—I’m not going comment on that. I will let you—I will let you ask their regulator and the Treasury Department about any issues surrounding their reported numbers.

Any other questions or comments?

OK. Well thank you for joining us. And, again, the report is posted on the Web site at www.cbo.gov.

Thank you very much.

QUESTION: Sir, would you like to summarize for the benefit of those who came at 11 o’clock?

ORSZAG: OK. Very briefly, for—for those of us who are joining us now. We—we believe that at this point the operations of Fannie Mae and Freddie Mac should be directly incorporated into the federal budget.

We are experiencing a period of economic difficulty that, in our projections, appears similar to the past few recessions. And the budget deficit went up significantly in 2008 relative to 2007. And if you look out over time, the most important long-term fiscal challenge that we face is rising health care costs.

QUESTION: The deficit went up. What happens next?

ORSZAG: Under our projections, the budget deficit remains elevated and then after 2010, what happens depends on, in part, what occurs with regard to the tax legislation that is scheduled to expire.

QUESTION: You said the last time that we were skirting a recession but not going to be hit by it. What—where do you stand now?

ORSZAG: I believe what I had said was that we—the risk of a recession was elevated. And what we are now saying is that although responsibility for declaring a recession belongs to the National Bureau of Economic Research, and it is too soon to tell whether they will or won’t declare an official recession, that our projections, in particular the elevated unemployment rate and subdued economic activity, are similar to the conditions that we’ve seen in the past few recessions.

QUESTION: What affect on the federal budget then?

ORSZAG: As the economy weakens, the federal budget is affected both because revenue declines and because various expenditures like food stamps and unemployment insurance tend to go up during periods of economic weakness.

And by the way, that’s often viewed as a positive thing; the so- called automatic stabilizers help to mitigate the fluctuations in economic activity by providing some support to spending during periods of economic weakness.

QUESTION: If Congress passes another stimulus?

ORSZAG: If Congress passes another stimulus, that would also add to the deficit.
He got his own little press conference.

QUESTION: Your estimate earlier of what Fannie and Freddie would cost, now where does that stand now?

ORSZAG: What I said was we will be updating our numbers in January. There will be a new accounting basis for doing so because they will now be part of the federal budget in our baseline. And we’ll also have more information at that point.

QUESTION: (OFF-MIKE)

ORSZAG: There will be some affect on the budget deficit, that’s true.

Thank you very much. Thank you again. And the report is at www.cbo.gov.

NEWS CONFERENCE ON SUMMER UPDATE:BUDGET AND ECONOMIC OUTLOOK

Speaker: Congressional Budget Office Director, Peter Orszag

NEWS CONFERENCE ON SUMMER UPDATE:
BUDGET AND ECONOMIC OUTLOOK