Valuing Federal Disaster Loans: A Stochastic Model Approach

Between 1986 and 1990, the Small Business Administration made approximately $800 million in hurricane and flood disaster loans. The President's 1999 budget submission proposes that these loans be sold to private investors. Using data on over 130,000 disaster loans, and employing a stochastic interest rate model, we estimate the probability of a loan prepaying or being written off. We find that interest rate subsidy costs are significant components of the overall subsidy rate - for every dollar in loans granted, the government recovers between seventy and seventy-four cents, in present value terms. The valuation approach used in this paper can be applied to other government programs that repackage and sell loans to private investors.