Economics has its own urban legends.
They usually don’t involve alligators, Pop Rocks, stolen kidneys or other interesting stuff, but they are out there. And, like the other urban myths, they wouldn’t stay in circulation if some people didn’t believe them.
One of the more popular econo-legends is that taxpayer money was used to bail out the Chrysler Corp. in 1980. It is certainly true there was a risk that taxpayer money would be spent, but in actuality this never happened. The bailout was structured in the form of loan guarantees. Chrysler got itself turned around faster than anyone expected and paid the loans off early. While the risk was there if Chrysler had failed, the eventual cost to the taxpayer was zero.
As if to prove that nothing in economics is simple — certainly not when the government is involved — the net cost of the Chrysler bailout was actually less than zero.
In putting together the bailout deal. federal negotiators had forced Chrysler to cough up a large quantity of stock warrants. At the time of the bailout agreement itself, of course, these warrants were worthless pieces of paper. They gave the holder the right to purchase Chrysler stock at a price set considerably higher than the market value of the failing company’s shares.
After the turnaround, though, Chrysler’s stock price soared and, much to everyone’s surprise, the warrants were worth a lot of money. Chrysler itself eventually bought them back from the U.S. Treasury for a cool $311.1 million.
There are no provisions for stock warrants in Title XVII of the Energy Policy Act of 2005, but it does authorize the use of loan guarantees to support the development of innovative, clean energy sources. Energy Secretary Samuel Bodman has now issued the final rules for these loan guarantees, clearing the way for an array of energy development projects.
Washington state has just one of the initial set of projects now being reviewed for approval, described by the U.S. Department of Energy as “a highly energy-efficient process for manufacturing paper.” Other projects around the country include a manufacturing plant for the Tesla automobile — the hot, hot, hot electric sports car that rich celebrities are impatiently waiting to buy — and a variety of coal gasification, solar energy, ethanol, hydrogen and biomass development enterprises.
These loan guarantees differ from the Chrysler deal in several significant ways. First, of course, they do not involve failing companies — at least not yet. At the time of the Chrysler bailout, the auto manufacturer was on bankruptcy’s doorstep and Congress viewed the deal as a last-ditch effort to save the jobs of 140,000 workers.
Second, the program contains a more explicit recognition of the financial risks involved. These are essentially research and development projects that have, on average, substantial failure rates. Reserves are created to ensure that the financial risks are correctly accounted for in the Department of Energy’s budget and not simply dumped on Treasury’s desk with an “Oh, look what happened” when projects go bust.
Third, the loan guarantee rules ensure that the firms involved have a lot at stake, too. That was not an issue for Chrysler, of course, which had everything on the line. But there have been instances where government loan guarantees allowed firms to gamble with other people’s money. Although they would keep the profits if the venture succeeded, there was little or no cost to them if it failed. The new rules require substantial private investment to be at risk in these ventures.
But while the federal government has obviously learned something about the loan guarantee business, the fundamental economic issues involved haven’t changed. Loan guarantees of this type are what economists call, industrial policy — essentially a way for the government to favor some types of businesses over others.
There is no doubt that a loan guarantee program of this magnitude, which is $2 billion now and the Energy Department requesting double that for the coming year, is a market distortion. Essentially, it will cause investments to be made that would not otherwise be made under free-market conditions.
There is also little doubt that should energy prices climb high enough, these investments, or similar ones, would eventually be made in the private sector. As a matter of economic policy, though, the government has decided that the pain and economic damage done by oppressively high energy costs would be too high a price to pay for waiting for the free market to go into action.
The Energy Department loan guarantee program is an attempt to impose some free-market discipline on an alternative energy development effort that years ago would have been a trough of government grants. This is a good thing.
James McCusker is a Bothell economist, educator and consultant. He also writes “Business 101” monthly for the Snohomish County Business Journal.
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