Latest / The Fiscal Policy Podcast with Fexingo: Government Budgets, Stimulus, and Public Spending / Why Government Off-Balance-Sheet Entities Hide a Trillion-Dollar Problem
Transcript
- Lucas: Let me start with a number that should make anyone who pays taxes sit up a little straighter. According to the International Monetary Fund, as of 2024, governments around the world held at least $13 trillion in assets inside off-balance-sheet entities — public corporations, development banks, special-purpose vehicles — whose debt is not counted in official sovereign debt figures. Luna: Thirteen trillion. That's not small change. So governments are basically running a shadow banking system in plain sight? Lucas: Exactly — and the most instructive case is one you might not have heard of: Britain's Network Rail. Between 2002 and 2014, Network Rail was classified as a private company, even though the UK government was its only shareholder, guaranteed its debt, and ultimately absorbed all its risk. That classification let the government keep roughly 30 billion pounds of borrowing off its official books. Luna: Wait — how did they get away with classifying a government-owned railway as private? That seems like a pretty clear-cut case of the substance being different from the legal form. Lucas: It was a masterclass in accounting arbitrage. The UK Office for National Statistics, who decides these classifications, used what's called the '50 percent rule' — if the government owned less than half the voting shares, the entity was considered private. Network Rail had no shareholders in the traditional sense; it was a company limited by guarantee, with members instead. The government structured it so it held less than half the voting rights, even though it controlled everything. Luna: So they exploited the letter of the rules while the economic reality was state control and state risk. And the markets went along with it? Lucas: Largely, yes. Investors priced Network Rail's debt as if it were sovereign — it was implicitly backed by the UK government, and the spreads were tiny. But the government could report lower debt to gdp ratios, which helped it stay within its own fiscal rules. It was a free lunch for borrowing, as long as you didn't look too closely at the footnotes. Luna: The footnotes. That's where these things usually live. I remember reading about how the US Federal Financing Bank does something similar — it's a government corporation that borrows from the Treasury and then lends to other agencies, but its debt isn't included in the federal debt limit. Lucas: That's a perfect example. The Federal Financing Bank was created in 1973 to centralize agency borrowing. It issues debt to the Treasury, and the Treasury records that as an intragovernmental transaction — not public debt. As of 2023, the FFB had about $170 billion in outstanding loans to entities like the Tennessee Valley Authority and the U.S. Postal Service, none of which shows up in the standard debt ceiling figures. Luna: So it's not just an international issue — it's baked into how the U.S. government itself accounts for its own obligations. And then you have Fannie Mae and Freddie Mac before the 2008 crisis, which were technically private but enjoyed an implicit government guarantee. That's a variation on the same theme. Lucas: Exactly. Fannie and Freddie were government-sponsored enterprises — GSEs — whose debt markets assumed a federal backstop. They were off the government's balance sheet until they weren't. In September 2008, when they were placed into conservatorship, the government had to absorb $187 billion in losses. The off-balance-sheet treatment had masked the risk for years. Luna: So what's the fix? The IMF has been pushing for what it calls 'fiscal transparency' — basically, require governments to consolidate all controlled entities into their fiscal reports. Is that happening? Lucas: Slowly. The International Public Sector Accounting Standards, or IPSAS, do require consolidation of controlled entities. The EU has adopted a version of that. But many governments — including the UK, after the Network Rail episode — have pushed back, arguing that some entities have commercial mandates and shouldn't be consolidated. The UK actually reclassified Network Rail as public in 2014, but only after the European statistics agency forced the issue. Luna: So it took external pressure. And the problem is that once you start consolidating, you surface a lot of debt that nobody wants to admit exists. That's politically painful. Lucas: Exactly. Consider this: according to a 2023 study by the Bank for International Settlements, if you consolidate all off-balance-sheet government entities, the median advanced economy's debt to gdp ratio jumps by about 12 percentage points. For Japan, it's closer to 20 points. Those are not trivial numbers — they change the whole narrative about fiscal sustainability. Luna: And yet, off-balance-sheet entities can serve legitimate purposes. Development banks, for instance, can be more efficient at lending than direct government programs — they have independent governance, lower political interference. The question is where to draw the line. Lucas: The line should be drawn at risk and control. If the government absorbs the risk and exercises control, it should be on the books. The IMF's Fiscal Transparency Handbook is pretty clear: any entity that is 'controlled' by the government should be consolidated. But 'control' is defined in ways that can be gamed — just ask Network Rail. Luna: So what would you say to a listener who wants to check their own government's off-balance-sheet exposure? Where should they look? Lucas: Start with the government's own financial statements — the annual report, the budget documents. Look for a note on 'government-controlled entities' or 'public corporations.' In the U.S., the Financial Report of the United States Government includes a statement of net cost that consolidates many agencies, but it doesn't include the GSEs or the Federal Financing Bank's full exposure. If you're really digging, the IMF's Fiscal Transparency Evaluations are public and they flag these issues country by country. Luna: It's a rabbit hole, but an important one. Because the next crisis might not come from a bank or a hedge fund — it could come from a government's off-balance-sheet garage that nobody realized was full of debt. Lucas: If walking through the economy with us has made something click, the way these episodes stay ad-free is through listener support at buy me a coffee dot com slash fexingo. Every contribution keeps us digging into the nooks and crannies of public finance. Luna: Yeah, it's a small way to say this stuff matters. And we're grateful for it. Lucas: So let's end with a question: if your government had to report every dollar of off-balance-sheet debt tomorrow, would its fiscal story change? For most, the answer is yes — and that's a story worth watching.