Tag: loan guarantees

Political Support for Energy’s Loan Guarantees

Several weeks ago, 127 House Republicans joined 155 Democrats to defeat an amendment introduced by Rep. Dennis Kucinich (D-OH) and Rep. Tom McClintock (R-CA) that would have shut down the Department of Energy’s Title 17 loan guarantee program. That’s the program that gave birth to Solyndra, which has come to symbolize the failure of the Obama administration’s crony capitalist policies.

Why would members of Congress, and Republicans in particular, continue to support this federal boondoggle incubator? A new paper from Cato adjunct scholar Veronique de Rugy that looks at the Energy loan guarantees explains:

One reason is it serves three powerful constituencies: lawmakers, bankers, and the companies that receive the subsidized loans. Politicians are able to use loan programs to reward interest groups while hiding the costs. Congress can approve billions of dollars in loan guarantees with little or no impact to the appropriations or deficit because they are almost entirely off-budget. Moreover, unlike the Solyndra case, most failures take years to occur, allowing politicians to collect the rewards of granting a loan to a special interest while skirting political blame years later when or if the project defaults. It’s like buying a house on credit without having a trace of the transaction on your credit report.

Veronique notes that most of the money for the loan guarantees issued under section 1705 of Title 17 have gone to large and established companies:

These include established utility firms, large multinational manufacturers, and a global real estate investment fund. In addition, the data shows that nearly 90 percent of the loans guaranteed by the federal government since 2009 went to subsidize lower-risk power plants, which in many cases were backed by big companies with vast resources. This includes loans such as the $90 million guarantee granted to Cogentrix, a subsidiary of Goldman Sachs. Currently, Goldman Sachs ranks number 80 on the list of America’s Fortune 500 companies.

In recent testimony before the House Budget Committee, Chris Edwards and I also discussed the crony nature of the president’s “green” energy subsidies:

President Obama’s green energy programs illustrate how corporate welfare creates corrupting relationships between businesses and politicians. The Washington Post found that “$3.9 billion in federal [energy] grants and financing flowed to 21 companies backed by firms with connections to five Obama administration staffers and advisers.” It also noted that the “main players in the Solyndra saga were interconnected in many ways, as investors enjoyed access to the White House and the Energy Department.” According to the New York Times, Solyndra “spent nearly $1.8 million on Washington lobbyists, employing six firms with ties to members of Congress and officials of the Obama White House.”

American businesses, of course, have a right to lobby the federal government. But given that reality, Congress throws fuel onto the corruption fire by creating business subsidy programs. When subsidy money flows out the door from Washington to businesses at the same time that money flows back from businesses to Washington for lobbying, it’s no surprise that we get influence-peddling. Corporate welfare undermines honest and transparent governance, and Americans are sick and tired of the inevitable scandals.

Unfortunately, most members of Congress apparently aren’t sick and tired of it.

CBO Perpetuates Small Business Administration Myth

A new brief from the Congressional Budget Office discusses the role of small businesses in the economy and how they’re affected by federal policy. The CBO cites the Small Business Administration as one example of how federal policy favors small businesses over larger businesses:

Assistance from the Small Business Administration (SBA), through loan guarantees that enable small firms to borrow at more attractive terms (for example, lower interest rates and fees) than they might otherwise obtain.

That’s the popular perception of the SBA’s loan guarantee programs, but I would argue that it’s inaccurate for two reasons:

  1. The Government Accountability Office has calculated that SBA 7(a) loans only account for a little more than one percent of total small business loans outstanding. Veronique de Rugy and I looked at the top 15 industries that received SBA-backed loans from 2001-2010 and found that only 0.5 percent of the small businesses that comprise these industries received loans backed by the SBA. Thus, rather than helping small businesses compete against big businesses, SBA loan guarantees mainly help a tiny share of small businesses compete against other small businesses.
  2. The real winner from the SBA’s loan guarantees is the banking industry—particularly large banks. In 2009, the top 10 lenders (out of 2,600 total lenders) accounted for close to one-quarter of the SBA’s flagship 7(a) loan guarantee program’s volume. Wells Fargo & Co. alone accounted for 7.3 percent of the total 7(a) loan volume. Other large banks in the top ten include J.P. Morgan Chase, U.S. Bancorp, and PNC Financial Services Group. Although lawmakers portray the SBA’s loan programs as a boost for small businesses, the programs are actually a form of corporate welfare for some of America’s largest banks.

See this Cato essay for more on why the Small Business Administration should be abolished.

The Curious Case of Lloyd Chapman

Last week, I flayed the American Small Business League’s Lloyd Chapman for his absurd claim that legislation introduced by Sen. Richard Burr (R-NC) would close the Small Business Administration (see here). As I expected, Chapman’s response is equally absurd.

In an ASBL press release, Chapman actually threatens to take me to court over my calling him a “conspiracy theorist”:

The next time you call me a conspiracy theorist, be ready to back it up with facts. You just might find yourself in court.

Good luck with that, Lloyd. In the meantime, let’s allow the court of public opinion to decide if the following claim you recently made is the stuff of a conspiracy theorist:

Clearly Republicans like Senator Burr, his supporters and groups such as the CATO Institute are directed like puppets by the defense and aerospace industry.

I can’t speak for Sen. Burr, but Chapman’s assertion that the Cato Institute is being “directed like puppets by the defense and aerospace industry” is ridiculous. Cato’s Downsizing Government website, which I co-edit, lays out the case for cutting the Department of Defense.

My Cato colleagues past and present have consistently advocated for a limited U.S. presence abroad:

Cato’s foreign policy vision is guided by the idea of our national defense and security strategy being appropriate for a constitutional republic, not an empire. Cato’s foreign policy scholars question the presumption that an interventionist foreign policy enhances the security of Americans in the post-Cold War world, and maintain instead that interventionism has consequences, including the formation of countervailing alliances, the proliferation of weapons of mass destruction, and even terrorism. The use of U.S. military force should be limited to those occasions when the territorial integrity, national sovereignty, or liberty of the United States is at risk.

Does that strike the reader as anything the defense and aerospace industry would direct Cato to advocate? Clearly, Chapman is hopelessly lost in a fantasy world of his own creation.

Perhaps realizing that he embarrassed himself by threatening me with legal action, Chapman now says that he wants to take a different approach:

I am sure that Tad DeHaven and the staff at the CATO Institute have seen my press release in response to their attack on my credibility. I’d like to take this opportunity to try a different approach and appeal to their sense of patriotism, logic and reason.

He then proceeds to talk about all of the jobs that small businesses create and the fact that federal contracts set aside for small businesses sometimes end up instead benefiting large businesses. Uh, Lloyd, in my “attack” on you, I never said otherwise. I even noted that “Chapman is correct that government contracting is fraught with fraud and abuse.” In my testimony on the SBA before the Senate Small Business Committee, I discussed examples of fraud and abuse in government contracting, including federal contracts set aside for small businesses that ended up benefiting large companies like General Electric and Lockheed Martin.

As I noted in my “attack,” Chapman is focused on the contracting issue whereas I’m primarily focused on the SBA’s loan guarantee programs. I frankly don’t care what firms receive federal contracts so long as work is performed at the lowest cost to taxpayers. I’m more concerned with reducing the size and scope of government, which would mean lower taxes and fewer burdensome regulations for small businesses. Moreover, does Chapman not understand that those government contracts are paid for, in part, by other small businesses through taxes? I would argue that the strength of the small business community should be measured by the goods and services produced for private consumption, not government consumption.

Finally, if Chapman is so pro-small business/anti-big business, why isn’t he concerned with the SBA’s loan guarantee programs? I challenged Chapman on this issue:

I’m all for a serious discussion and debate on the SBA. The SBA’s loan guarantee programs benefit a relatively tiny number of small businesses at the expense of the vast majority of small businesses that do not receive government support. Moreover, the biggest winners from these loan guarantees are big banks who reap the profits but get to kick the bulk of any losses to the government. One would think a pro-small business/anti-big business guy like Chapman would be concerned by this. Instead, Chapman consistently resorts to wild exaggerations and conspiracy theories. As a result, I can’t take him seriously. It’s too bad policymakers do.

The silence from Chapman on this matter is deafening. In addition to resorting to wild exaggerations and conspiracy theories, we can now add the threat of legal action. Until Chapman dispenses with the antics, policymakers should stop taking him seriously.

Radioactive Corporate Welfare

A good default proposition regarding the government’s role in the economy would state that the government should not loan money to an enterprise if the enterprise in question cannot find one single market actor anywhere in the universe to loan said enterprise a single red cent.  It might suggest – I don’t know – that the investment is rather … dubious.

Alas, like all good propositions regarding the government’s role in the economy, this one is being left by the roadside by the Obama administration.  Unfortunately, the only complaint being made by a not insubstantial segment of the political Right – frequently, the political crowd that is busy decrying “Bailout Nation” – is that the loan guarantees are not fat enough.

I write, of course, about the $8.3 billion federal loan guarantee announced by President Obama this week for Southern Company to build two new nuclear power plants.  The money will be used to guarantee the loans being made by the federal government (via the Federal Financing Bank) to partially cover the cost of Southern’s projected $14 billion nuclear construction project at their Vogtle plant near Waynesboro, Georgia.  The loan guarantees were authorized by Congress in the 2005 Energy Policy Act and, we are told, are the first installment on a total package of $54 billion that the President would like to hand out to facilitate the construction of 7-10 new nuclear power plants (Congress, however, has only authorized $18.5 billion to this point).

The claim being made by some – that the loan guarantees are necessary to jump-start investor interest in new nuclear power plant construction – is not quite correct.  Even these lavish loan guarantees aren’t enough to do that.  In a letter to the U.S. Department of Energy dated July 2, 2007, six of Wall Street’s s then-largest investment banks – Citigroup, Credit Suisse, Goldman Sachs, Lehman Brothers, Merrill Lynch, and Morgan Stanley – informed the administration that, contrary to the government’s expectations, anything short of a 100 percent unconditional guarantee would be insufficient to induce private lending.

Why is it risky to build nuclear power plants?  Because new nuclear projects tie up more capital for longer periods of time than its main competitor, natural-gas fired generation.  Nuclear power makes economic sense only if natural gas prices are very high.  Then, over time, the high initial costs of nuclear power would be offset by nuclear power’s lower fuel costs.  Moreover, as noted by Moody’s in an analysis published in July of last year, there is uncertainty associated with construction costs, regulatory oversight, technological developments that might reduce the cost of rival facilities, and the ability of utilities to recover costs and make a profit over the lifetime of the plant – a risk tied up in the economic prospects of the region being served by the plant.  And those risks have been increasing, not decreasing, as time has gone on.

In short, even during the go-go days prior to the September 2008 crash – a time when Wall Street was allegedly throwing around money left and right to all sorts of dubious borrowers – the banks that stand accused of recklessly endangering their shareholders on other fronts were telling utility companies that they would not loan them anything for new nuclear power plant construction unless the feds unconditionally guaranteed every last penny of those loans.  That’s how risky market actors think it is to build nuclear power plants.

And it’s not as if the federal government disagrees completely.  The Congressional Budget Office pegs the chance of default (program-wide) at 50 percent or better and the Government Accountability Office likewise thinks that default risks are quite high.  Energy Secretary Stephen Chu says that he thinks the chance of default is much lower.  We can only speculate about who’s right given that no one has tried to build a nuclear power plant in the United States for over 30 years.

Regardless of what the risk actually is, the loan guarantees do not reduce that risk.  They simply transfer the risk from the bank to taxpayer.  In this particular case, however, the loan guarantee transfers risk from one arm of the state to the other, so it doesn’t really count.  But if such loan guarantees  ever were to induce actual private lending for plant construction, that’s how it would work.

Plenty of arguments have been offered to justify these loan guarantees.  Most of them are flimsy on their face.

For instance, we’re often told that we “need” new power plants.  But with electricity demand declining over the past couple of years, it is unclear when that need might arise.

Regardless, when the market “needs” more electricity, that need will be manifested in price signals that will carry with them profit opportunities.  Profit-hungry investors will be willing and able to meet that need without the help of government.  Of course, if market conditions don’t radically change, those needs will be met with gas-fired power plants, but hey, if that bothers you, take it up with someone else.

Others argue that we need the jobs that will be produced by new nuclear power plants.  Well, building big new reactors will certainly employ a lot of (largely unionized) construction workers.  But that’s one reason why building a nuclear power plant is not very economic compared to building gas-fired generators.  If creating jobs is the idea whether the project makes any economic sense or not, then let’s just ban food imports and farm equipment and put everyone to work with hand plows and scythes.

Two somewhat more serious arguments have been offered to justify these loan guarantees.  Neither of them stands up to much scrutiny either.

The first argument – the argument most often heard from the nuclear power industry and some segments of the political Left – is that we need nuclear power to reduce greenhouse gas emissions.  Of course, the best (that is, most efficient) way to reduce greenhouse gas emissions is to internalize the cost of greenhouse gas emissions in the retail price of electricity and then allow market actors to adjust their production and consumption decisions accordingly.  That price internalization exercise, however (whether directly through a carbon tax or indirectly through a cap-and-trade program), does not appear to be in the cards in the foreseeable future.  Hence, the loan guarantees are advanced as a “second-best” solution, one that will get us the technology and economic efficiency that would be delivered by a properly crafted carbon tax or cap-and-trade program without the retail price increases associated with either.

One of several problems with this argument is that it would take one hell of a carbon tax – or one hell of an onerous cap-and-trade program – to get anyone interested in building nuclear power plants.  If natural gas prices remained roughly where they are at present (that is, if they were to remain at historical norms) then it would take a $90 per ton carbon tax or a cap-and-trade program that delivered carbon emission credits at $90 per ton on the open market to induce investment in nuclear power plants.  Few economists who study climate policy believe that a carbon tax of that size is defensible given what we know about climate change.

And that’s if construction costs are as low as advertised.  Were they to double (as they did from 2003 to 2009) – either because of endogenous increases in the cost of capital, labor, or construction-related resources or because of cost overruns – then it would take at least a $150 per ton carbon tax (or a cap-and-trade program that delivered $150 carbon credits to the market) to induce investment.

You might ask yourself what the historical relationship is between final (inflation-adjusted) nuclear power plant construction costs in the United States and construction costs as projected at the onset of the project.  Happily, the CBO has done your homework for you.  They found that final construction costs averaged 207 percent of projected costs.  Hence, a doubling of construction costs is probably more likely than not once a project is underway … if past is prologue.

The upshot is that there are many more efficient ways to respond to greenhouse gas emission constraints than to go on a nuclear power bender.  This observation is heresy on the Right, but almost every credible analysis of the matter backs up that observation.

The second argument one hears to justify federal loan guarantees is that they are necessary to counter-balance the excessive regulatory costs associated with new plant construction.  Now, put aside the fact that the Nuclear Energy Institute – the trade association of the nuclear power industry – has often expressed near-total satisfaction with the current federal regulatory regime.  If the regulatory regime is truly “bad” and, accordingly, is imposing steep and unnecessary costs on the industry, then the correct remedy is to improve said regulatory regime, not to subsidize the industry.

The counter-complaint that positive regulatory reforms are impossible is difficult to swallow.  After all, if there is sufficient political will to bestow tens of billions of dollars worth of tax money on this industry, then surely there is enough political will to reform the bad and unnecessarily costly regulations allegedly bedeviling the object of those very same legislative affections.

I will confess to being skeptical about the argument that high construction costs are largely the fault of regulators.  Building a light water breeder reactor is a technologically challenging and costly undertaking whether regulators are on the scene or not.  Moreover, it is not obvious to me that the regulations that are in place are a priori objectionable from a libertarian perspective.

One rarely, if ever, hears of particulars in this bill of complaint offered about nuclear regulation.  But if a persuasive bill of complaints is ever presented, then the appropriate response is regulatory reform and then to leave the decision to build or not to build to markets.

In the course of announcing these loan guarantees, President Obama said this week that “The fact is, changing the ways we produce and use energy requires us to think anew. It requires us to act anew.”  Well, there’s nothing new about throwing subsidies at nuclear power.  Economist Douglas Koplow calculates that federal nuclear subsidies have totaled $178 billion from 1947-1999.  The promise of a nuclear economy with rates too cheap to meter has been made for over half a century.  What would be new would be a policy of “just saying no” to industries with their hands out in Washington.

[Cross-posted at MasterResource]