The Congressional Budget Office reported in its Monthly Budget Review for October that the federal budget deficit for that month will be $134 billion. But CBO predicts that when the Treasury Department releases the official deficit number later this month, it will be $232 billion.

The $98 billion gap is the product of differing interpretations on how purchases under the Troubled Asset Relief Program (TARP) should be scored. According to CBO:

...the stock investment and associated warrants should not be recorded on a cash basis but on a net present value basis, accounting for market risk, as specified in the Emergency Economic Stabilization Act. CBO's preliminary estimate of $17 billion for the present value cost is included in its estimate of $134 billion for the October deficit.

So far, Treasury has purchased $115 billion in bank stocks. Treasury says that this will increase the budget deficit by $155 billion, while CBO says it should increase the deficit by $17 billion.

This is an interesting development, as the potential impact on the budget deficit could be hundreds of billions of dollars, depending on whether Treasury follows the law, and uses a present value calculation -- the method employed in CBO's estimate, or if it continues to use a cash basis of accounting. There are a number of ramifications that could result from these accounting differences.

• A larger budget deficit figure may impose constraints on future fiscal policy
• Cash-basis accounting of these assets deviates from current practice. For example, a student loan is not counted as a cash expenditure, but as an asset, as the government expects to see the principal repaid
• The future sale of purchased bank stock would appear to decrease the budget deficit. This could open the door to manipulation by an administration seeking political gains to be had from decreasing the federal budget deficit.

Section 123 of Emergency Economic Stabilization Act (EESA) of 2008 reads:

a. IN GENERAL.Subject to subsection (b), the costs of purchases of troubled assets made under section 101(a) and guarantees of troubled assets under section 102, and any cash flows associated with the activities authorized in section 102 and subsections (a), (b), and (c) of section 106 shall be determined as provided under the Federal Credit Reform Act of 1990 (2 U.S.C. 661 et.seq.), as applicable.

In addition to "mortgage-related security," EESA defines "troubled asset" as "any other financial instrument that the Secretary, after consultation with the Chairman of the Board of Governors of the Federal Reserve System, determines the purchase of which is necessary to promote financial market stability, but only upon transmittal of such determination, in writing, to the appropriate committees of Congress." So, it appears that the bank stock acquired under TARP purchases should be considered "troubled assets."

Continuing...

b. COSTS.For the purposes of section 502(5) of the Federal Credit Reform Act of 1990 (2 U.S.C. 661a(5))

1. the cost of troubled assets and guarantees of troubled assets shall be calculated by adjusting the discount rate in section 502(5)(E) (2 U.S.C. 661a(5)(E)) for market risks; and
2. the cost of a modification of a troubled asset or guarantee of a troubled asset shall be the difference between the current estimate consistent with paragraph (1) under the terms of the troubled asset or guarantee of the troubled asset and the current estimate consistent with paragraph (1) under the terms of the troubled asset or guarantee of the troubled asset, as modified.

Title 2, section 661a, of the U.S. Code reads:

5(A) The term "cost" means the estimated long-term cost to the Government of a direct loan or loan guarantee or modification thereof, calculated on a net present value basis, excluding administrative costs and any incidental effects on governmental receipts or outlays.

5(E) In estimating net present values, the discount rate shall be the average interest rate on marketable Treasury securities of similar maturity to the cash flows of the direct loan or loan guarantee for which the estimate is being made.