Government Privilege: Loan Guarantees

[This is the fifth in a series of short commentaries on the Bridge that discusses the various types of privileges that governments bestow on particular businesses or industries.]

In 2009, the energy firm Solyndra received $535 million in loan guarantees from the federal government. Just two years later, the firm filed for bankruptcy, laying off its 1,100 employees and leaving taxpayers with the cost of the loan. But the problem with Solyndra, and loan guarantees in general, goes well beyond the dollar cost.

Our previous post on bailouts set the stage to discuss a related form of government granted privilege: loan guarantees. With a loan guarantee, the government agrees to pay a private lender for some portion or even all of the loan in the event that the borrower is unable to pay it back. When that happens, it is effectively a bailout for the lender. This makes a loan guarantee a privilege twofer: the borrowing firm obtains credit that it otherwise would not be able to (or at least not at such favorable terms), while the lender gets to offload some or all of the risk onto taxpayers.

The problems with government loan guarantees came to the forefront in 2011 with the Solyndra scandal. The Obama administration reportedly rushed the approval process so that Vice President Joe Biden could announce the deal at a ground-breaking ceremony for the company’s factory. Worse, politically-connected financial interests both outside and inside of the White House reportedly wielded strong influence over the administration’s decision-making process. As the Washington Post reported at the time, the administration’s green-energy program “was infused with politics at every level.” 

A number of firms and industries receive indirect support through loan guarantees, where the firm keeps the profit if the venture is successful, but lenders are bailed out by taxpayers if it fails. While Solyndra garnered a great deal of attention because there was overwhelming evidence of political influence, it is far from unique.

The Export-Import Bank is another example. It offers loan guarantees to foreign firms, mostly airlines, that are customers of American manufacturers, especially Boeing. Indeed, Boeing receives around 70 percent of the total long-term loan guarantees authorized by the Bank each year. Not surprisingly, Boeing, which had $93 billion in revenues last year, also benefits from having friends in high places. As our colleague Veronique de Rugy has repeatedly noted, the vast majority of US exports (98 percent) do not receive Bank assistance. That points to the inherent cronyism that comes with policymakers and bureaucrats effectively picking winners and losers with other peoples’ money.

Let’s look at another government agency specializing in loan guarantees, the Small Business Administration (SBA). The SBA is portrayed as a friend to “mom and pop” establishments that allegedly cannot obtain capital. The reality is that the SBA’s loan guarantees benefit a tiny share of small businesses and have become a lucrative source of money for major banks who, of course, lobby policymakers to keep the subsidies flowing.

Defenders of federal loan guarantee programs often portray them as a “free lunch” because they can come at little immediate direct cost to taxpayers. As the Congressional Budget Office has explained, however, that does not mean that these programs are without significant taxpayer risk.  Other costs are also easy for proponents to ignore because they aren’t as easily observed as, say, taxpayers paying for Solyndra’s loan. For example, Boeing benefits from the Export-Import Bank when it backs the financing of a foreign airline’s purchase of airplanes. But domestic airlines, who either lose out on financing or must pay higher market rates for financing, are thus put at an artificial comparative disadvantage. On a smaller scale, when a pizza restaurant receives a loan backed by the SBA, it means that potential or existing competing restaurants that didn’t receive government-backing have been disadvantaged.

Let’s say you’re a lender and two entrepreneurs come to you for a loan. The first entrepreneur qualifies for a loan guaranteed by the government, which means the bank will be reimbursed if the business fails. The second entrepreneur only qualifies for traditional financing, which means the bank is on the hook if the business fails. Everything else being equal, you’re going to choose the first entrepreneur because the default risk to your bank has been mitigated by the government-backed loan. And the damage isn’t limited to non-subsidized competition. Those in other industries who are seeking financing are also disadvantaged as they are either going to miss out on financing or will have to obtain it on less favorable terms.

Although we highlight the Solyndra scandal that happened on a Democratic administration’s watch, there is broad support in both parties for federal loan guarantee programs. Back in 2012, the Republican-controlled House of Representatives held votes on amendments that would have cut federal energy subsidies to business. Republicans joined Democrats in voting those amendments down, including one that would have eliminated the loan guarantee program that led to Solyndra. That program, by the way, was created under the Republican administration of George W. Bush.

Learn more: In The Pathology of Privilege: The Economic Consequences of Government Favoritism, Matthew D. Mitchell identifies multiple forms of government granted privilege (including tax privileges, contracting abuses, trade privileges, and bailouts), and explains their consequences. The full special report is free of charge via pdf, and is available as an ebook and paperback for purchase at Amazon.com. 

Photo credit: AP/Shutterstock