A Guarantee for Failure: Government Lending Under Sec. 1705

Testimony Before the House Committee on Oversight and Government Reform, Subcommittee on Regulatory Affairs
Veronique de Rugy | Jul 18, 2012

In 2009, renewable energy company Solyndra received $535 million through the federally backed 1705 loan guarantee program of the Department of Energy (DOE). Two years later, the firm filed for bankruptcy and had to lay off its 1,100 employees, leaving taxpayers to bear the cost of the loan. For obvious reasons, more than any other recent events, this waste of taxpayer money has attracted much attention.

But Solyndra isn’t the only company to fail after receiving a loan through this particular program. Back in October, Beacon Power Corp., an energy-storage company that received $43 million in backing from the 1705 loan program, filed for bankruptcy. More recently, Abound Solar, Inc, a U.S. solar manufacturer that was awarded $400 million through the program, announced that it would suspend operations and file for bankruptcy. Abound borrowed about $70 million against the guarantee, which is likely to result in a cost of $40 million to $60 million to U.S. taxpayers after Abound’s assets are sold and the bankruptcy proceeding is completed.

In addition, there are signs that other companies may follow in the steps of Solyndra and Abound. First Solar’s Antelope Valley project, which received a $646 million 1705 loan in 2011 through its partner Exelon, is one likely casualty; SunPower’s California Valley Solar Ranch— now owned by NRG Solar—is another. The ranch received a $1.2 billion loan guarantee last September. Whether these companies will fail or not is not yet clear, and the potential cost to taxpayers is not known. However, the precarious situation of these companies exemplifies the risk faced by taxpayers when the government extends loan guarantees to high-risk companies.

Now, the important question is whether or not these examples are representative of the 1705 loan program. What we find is that loan guarantees in this program go to two types of projects:

• Projects that would not have been funded in the open market without a government guarantee because they are too risky, and

• Projects that could have gotten a loan but were happy to benefit from the lower interest rate available through a DOE loan guarantee.

The failure of Solyndra has attracted much attention, but the problems with loan guarantees are much more fundamental than the cost of one or more failed projects. In fact, the economic literature shows that every loan guarantee program (a) transfers the risk from lenders to taxpayers, (b) is likely to inhibit innovation, and (c) increases the overall cost of borrowing. At a minimum, such guarantees distort crucial market signals that determine where capital should be invested, resulting in lower interest rates that are unmerited and a reduction of capital for more worthy projects. At their worst, these guarantees introduce political incentives into business decisions, creating the conditions for businesses to seek financial rewards by pleasing political interests rather than customers. This is called cronyism, and it entails real economic costs.[1]

Yet these loan programs remain popular with Congress and the executive branch. That’s because in general most of the financial cost of these guaranteed loans will not surface for many years. Consequently, Congress can approve billions of dollars to benefit special interests with little or no immediate impact to federal appropriations, because these dollars are almost entirely off budget.

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