Last month, the solar energy company Solyndra went bankrupt and defaulted on a $534 million federally-backed loan. Many were quick to label it a lesson in the inherent failings of government directed investment. The Obama Administration guaranteed Solyndra’s loan under an American Recovery and Reinvestment Act program that expanded a prior initiative to subsidize clean energy. But critics of the Department of Energy program that backed the loan haven’t realized that the program is set to quietly impose billions of dollars of losses on taxpayers, all of which will be hidden from the federal budget thanks to a massive accounting gimmick.
The DOE loan guarantee program backs private financing for innovative projects that produce energy with low greenhouse gas emissions. Congress has provided most of the lending authority in the program ($34 billion to date) under something called “self-pay.” It is the only federal loan program with such a rule.
An energy project that wins a loan guarantee from the DOE under the self-pay program has to pay the government a fee that DOE and the Office of Management and Budget estimate will fully cover the cost of the guarantee. In other words, Congress doesn’t need to budget a single penny for DOE to back billions of dollars in loans for clean energy projects, and that is where the budget gimmick comes into play. To date, the DOE has made conditional commitments to back over $10 billion in loans under the self-pay program and is reviewing a number of other applicants. (The fee for Solydra’s loan guarantee was funded with a federal appropriation, so it didn’t have to pay under the self-pay program.)
Accounting rules for loan programs in the Federal Credit Reform Act of 1990 (FCRA) effectively require that budget analysts at DOE and OMB exclude market risk from their calculation of loan program costs. Market risk is the risk that loan defaults will be more frequent and severe in times of economic stress. All lenders charge a premium to bear that kind of risk, and there’s no reason why taxpayers wouldn’t too. But the FCRA requires that budget analysts discount the expected performance of a federally-backed loan using risk-free U.S. Treasury interest rates, thereby stripping out any market risk premium that lenders would charge. The risk is excluded despite the fact that the federal government cannot make market risk go away when it backs loans, nor can it reduce it.
So when DOE and OMB calculate the fee on a self-pay loan guarantee, accounting rules ensure that it won’t cover the fair value of the risk the government takes on. Even so, accounting rules will show that taxpayers have been fully compensated for the risk they are bearing. A company developing a clean energy technology, on the other hand, can easily see that the DOE loan guarantee provides it with a subsidy – the fee is less than what private lenders would charge to make the same loan.
According to a 2011 Congressional Budget Office study, the DOE program charges self-pay fees that are 8 to 16 percentage points below fair value to guarantee loans for construction of nuclear power plants. That means the self-pay fee levied on a $10 billion loan would undercompensate taxpayers by as much as $1.6 billion. That’s an immediate, guaranteed loss for taxpayers. These losses are systematically built into the program and a borrower doesn’t have to default for taxpayers to lose money.
The self-pay program creates another heads-the-borrowers-win-tails-the taxpayers-lose dynamic. Even if federal accounting rules didn’t understate the self-pay fee, no energy project would choose to pay a fee that fully captures the cost of the benefit it gets from a loan guarantee. The project would secure financing in the private market instead.
The self-pay fee that DOE charges an energy project must reflect the fair value of the loan guarantee if it is to fully cover the risks that taxpayers take on. The fair value of a loan guarantee incorporates a cost for bearing market risk and mirrors what the DOE would have to pay in the private market to buy full reinsurance on the loan guarantees it issues. That price is also what taxpayers would charge an energy company if they were making the guarantee with their own money, and taxpayers are indeed making the loan guarantee with their own money in the DOE program.
But if the DOE charged a project the same price private lenders charged to assume the same risk, then the DOE’s guarantee provides no financial advantage for the company. That is why a project is most likely to buy a loan guarantee from DOE only when the agency has underpriced the self-pay fee, thereby providing the project with a real financial benefit compared to what private lenders charge.
Here is how the nuclear power industry – one of the biggest beneficiaries of the DOE loans – uses the self-pay gimmick to its advantage. The industry’s trade association, the Nuclear Energy Institute, published a white paper last year arguing that DOE’s self-pay fees for loans guarantees are too high. Then, a few months later, an official with the association boasted that the loan guarantees “are executed at truly no cost to the government.” Both of the industry’s arguments cannot be true.
Constellation Energy applied for a loan guarantee under the program, but pulled out last year after DOE and OMB calculated a self-pay fee of $880 million to back a $10 billion loan for a nuclear power plant in Maryland. Constellation Energy called the fee “dramatically out of a line with our own and independent assessments of what the figure should reasonably be.” Such jawboning is a good indication that the fee was pretty close to covering the full cost of the loan guarantee subsidy, but then, of course, it wouldn’t have provided Constellation with any financial benefit, so the company balked.
Members of Congress have been more than willing to put pressure on OMB and DOE when the agencies estimate a fee for a lawmaker’s favorite energy project that the project says is too high (i.e. the fee isn’t low enough to provide a subsidy). DOE can only be too willing to give in to these pressures and set a fee low enough to subsidize borrowers, and therefore, too low to fully compensate taxpayers as the self-pay program requires. Otherwise DOE would be running a program that can’t find any takers for its loan guarantees because it requires companies to pay full freight to use a federal program.
All in all, the $534 million that a bankrupt Solyndra cost taxpayers is far less of a scandal than the massive budget gimmick Congress uses to hide the DOE loan program’s even bigger losses. How about a congressional hearing on that scandal?
Jason Delisle is the Director of the Federal Education Budget Project at the New America Foundation.