The True Cost of Government Guarantees — Take 2

As part of the fallout from last August’s bankruptcy of the Federally-backed solar firm Solyndra, the Obama Administration appointed Herbert Allison, a Republican banker and former Treasury official to review the Department of Energy’s loan guarantee program. His report was completed at the end of January and released earlier this week. It contains many useful observations and recommendations and is criticized as well for what it doesn’t contain.

I want to use this post to focus on one specific issue: the correct measure of the cost of a government loan guarantee. In an earlier post about a recent CBO report on the nuclear loan guarantees I described how the current, legislatively mandated method for calculating the budgetary cost significantly understates the cost because it ignores the full cost of the risk imposed on taxpayers. Future payouts on the guarantees are discounted at US Treasury rates, but the true cost of those future payouts should include a market risk premium. I used the CBO report to estimate that the underestimate of the cost of the guarantees for the new nuclear plant at Vogtle amount to $640 million. The Allison Report tells us something about the underestimate on other parts of the portfolio.

The key comparison is between the last column of figures in Table 4, where the cost is estimated using the legislatively mandated FCRA method that ignores the price of risk, and the last two columns of figures in Table 6, where the cost is estimated using the FMV or fair market value method that uses the market price of risk. In total, the FCRA subsidy cost is $2.682 billion whereas the FMV subsidy cost is between $4.970 and $6.839 billion. Taking the FMV cost as the benchmark, the FCRA cost ignores between 46 and 61% of the full cost to taxpayers because it ignores the price of risk.

These figures aggregate loans and loan guarantees in two DOE programs that support clean energy projects.

The Title XVII program, established under the authority of Title XVII of the Energy Policy Act of 2005 (“EPAct”) and the American Recovery and Reinvestment Act of 2009 (“ARRA”), provides loan guarantees for loans made to support certain types of clean energy projects. The Advanced Technology Vehicle Manufacturing program (“ATVM”) was established by the Energy Independence and Security Act of 2007 (“EISA”) to make direct loans to manufacturers of advanced technology vehicles.

The Allison Report groups these loans into three categories:

Utility-Linked Loans. The first category includes loan guarantees supporting utility linked projects for the generation or transmission of alternative sources of energy (the “Utility-Linked Loans”). The Portfolio includes 20 Utility-Linked Loans.

Non-Utility-Linked Loans. The second category includes cellulosic ethanol projects, solar manufacturing companies, and small, start-up automotive manufacturing companies that comprise the non-utility-linked projects (the “Non-Utility-Linked Loans”). These loans on average are smaller than the Utility-Linked Loans and bear greater risk. The Programs include eight Non-Utility-Linked Loans, excluding loans made to Solyndra Inc. (“Solyndra”) and Beacon Power Corporation (“Beacon”), which are both in bankruptcy.

Ford and Nissan Loans. The third category comprises the loans made to Ford Motor Company (“Ford”) and Nissan North America, Inc. (“Nissan”) (the “Ford and Nissan Loans”).

These figures estimate the cost as of the date the Report was compiled, and not at the origination of the guarantees.

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