This is the second post in the FCRA Non-Federal Series.

The 1967 Report of the President’s Commission on Budget Concepts is surprisingly interesting.  It’s certainly limited in some ways by its historical context.  But the writing is clear, the concepts are carefully derived from fundamental principles, and the recommendations are direct and far-reaching.  The Report appears to have successfully defined the way the federal budget works today, especially with respect to the FCRA concepts I’m familiar with.  As I noted in the prior post in this series, the Congressional directive’s instruction to follow the Report in conjunction with interpreting current FCRA law was a good call.

Two chapters in the Report are relevant to the FCRA non-federal issue.  Chapter 3, Coverage of the Budget, describes what should be included in the overall federal budget.  Chapter 5, Federal Credit Programs, outlines a separate section within the budget for federal direct loans and guarantees.

Coverage of the Budget

Chapter 3 begins with the statement of a principle that appears to guide the Commission’s approach to budget coverage but also may be important to specific FCRA non-federal solutions: Any federal activity that allocates the government’s resources must be subject to the internal ‘discipline’ of the budget if it’s not subject to external discipline.  The paragraph goes on to say that however clear that might be in theory, in practice it’s not easy to draw the line:

The next paragraph describes two examples (one of which is definitely historical) to illustrate the extremes of what should and should not be included in the federal budget. In a list of more ambiguous situations, the Report specifically mentions enterprises jointly owned by federal and private-sector participants (the context implies that the latter would also include non-federal public-sector participants):

After describing some other areas of ambiguity, the Report sums up an approach for ‘borderline’ situations – “when in doubt, include it”:

In the main section of the chapter, the Commission admits that it’s easy to fall into a rabbit hole when defining the budget’s theoretical boundary lines and therefore the Report’s practical scope is limited to a ‘few key agencies and programs’.  The rest of the chapter discusses those, none of which seem especially relevant to the FCRA non-federal issue:

General Observations About Chapter 3:

• If there is some ambiguity about federal budgeting for the activities of federally involved projects as a type of ‘enterprise owned jointly’ by federal and non-federal entities, then the Report’s ‘borderline inclusion’ recommendation would presumably apply directly.  But that’s not the case for the FCRA non-federal budgeting issue, which relates only to loan classification within the budget.  The two areas are fundamentally different [1].

• In contrast, there is no ambiguity about federal budget inclusion for WIFIA and all its activities, including its loans.  None whatsoever – WIFIA is a wholly federal program within a major federal agency and everything about it must be (and is) included in the federal budget.  The FCRA non-federal issue is solely about whether a program loan belongs either in the FCRA subsection or the general cash-based budget — one way or another, it will be included [2].

• Although Chapter 3’s inclusion concepts don’t appear to apply directly, the ‘discipline’ principle stated in the chapter’s first sentence can provide some guidance about the way the Commission might have looked at the FCRA non-federal issue.  If a program loan is not subject to external discipline, then some special consideration is presumably required to ensure that it will be subject to the internal discipline of the budget, as discussed further below.

Federal Credit Programs

Chapter 5 covers federal credit programs as a specialized area.  I was struck how closely the principles outlined in this chapter seem to have determined in some detail what FCRA law looked like 23 years later.

The Report admits that federal credit is a difficult area within their conceptual framework and recommends that program loans be put in a separate section within the unified budget.  The main objective of the separate section is to provide better information about the true cost of program loans in connection with their economic impact.  The Commission expected that ‘most’ federal program loans would belong in the separate section:

The chapter’s next bullet provides an accurate summary of how FCRA methodology would eventually work. The grant-like element in federal program loans belongs in the cash-based budget, while (implicitly here) the loan’s reversing cash flows do not:

Some types of federal program loans, however, should stay in the cash-based budget, primarily because they are effectively grants for which no repayment is expected or definable [3]:

The main part of Chapter 5 starts with the observation that a separate budget section for program loans is important because federal loan programs were steadily expanding ($30 billion in those days was apparently considered ‘real money’). Note that loan programs for large-scale public infrastructure aren’t mentioned in their list. I don’t think there were any at the time. Even today, such programs are a very small segment of total federal credit. However, their future expansion, including in sectors where federal involvement is frequent, is the same rationale for solving the FCRA non-federal issue:

Later in the main section, the Report provides an important insight into why the Commission considered federal program loans to be fundamentally different than other federal economic activities.  Unlike other cash transfers from the federal government, the borrower of a program loan has assumed an obligation to repay it:

General Observations About Chapter 5:

• The budget’s separate loan section (which eventually became FCRA) can be derived from two primary principles in the Report: (1) for overall inclusion, when an activity is not subject to external (that is, non-federal) discipline, and (2) for inclusion in the separate loan section, when there is a substantive and definable repayment obligation.

• Assuming that a program loan’s repayment obligation is subject to external discipline from a non-federal source, most of the loan’s cash flows should be excluded from a cash-based budget since they are not internally managed federal expenditures or revenues. The grant-like portions of the loan (the credit loss and funding subsidy amounts), however, are provided by the federal program and not subject to external discipline. Hence, that portion must be estimated and recorded as a net expenditure, as the Report described and as FCRA currently requires.

• If a loan’s repayment obligation, regardless of transactional form, is not substantive or definable, then it’s not subject to external discipline. In effect, all the loan’s cash flows then become internally managed federal expenditures and revenues, and the loan should be included only in the cash-based budget, not the separate loan section. This is consistent with the Report’s examples of loans that should be excluded from the separate section.

How Might the Commission Have Considered the FCRA Non-Federal Issue?

The above interpretation of how two of the Report’s fundamental principles define the separate budgetary treatments for loans is useful because it highlights one question that the Commission did not address but seems to be at the core of the FCRA non-federal issue: What if a program loan has substantive and definable repayment obligation that is not subject to external discipline — in other words, if the loan’s repayment obligation is from a federal source?

If this question was posed to the Commission in 1967, I think their response would have started with a description of two extremes, as they did at the beginning of Chapter 3. If the federal participant in a project is the direct recourse obligor or guarantor of a program loan, then obviously the loan completely lacks external discipline and should not be included in the separate section. At the opposite extreme, if the federal participant’s role in a project has no financial impact and the project loan’s sources of repayment are entirely outside the federal sphere (e.g., locally generated user-fees or taxes), then the loan is clearly fully subject to external discipline and ought to be included in the separate section.

The Commission would probably have continued by admitting that situations between the two extremes are ‘difficult’. And they likely would have supported the Congressional directive’s approach of developing budget classification criteria to be used by loan programs in these situations, at least until a FCRA statutory fix was available. But based on the Report’s emphasis on the budget’s unifying principles, and the successful application of their specific recommendations as the foundation of FCRA, I think they would have expected that any new criteria or statutory language for solving the FCRA non-federal issue would be narrowly focused and consistent with their concepts. It seems to me that this can be effectively accomplished by utilizing the two principles — external discipline and repayment obligation — that appear to determine the exclusion of certain loans from the separate loan section proposed by the Report.

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Notes

[1] A non-capital, cash-based accounting system doesn’t really include a FASB-like consolidation concept, and I assume that federal participants simply record their investments in a project as an ‘expenditure’ and any return of cash as a ‘revenue’.  Is it more complicated than that? If there is a budgeting issue here that doesn’t pertain solely to the project loan, doesn’t it require a solution regardless of whether the project has applied to a federal loan program? If the issue pertains solely to the budgetary treatment of the project’s loan by a loan program, then (as the next bullet above describes), it’s already within the budget.

[2] Interest rate re-estimates have an interesting treatment under FCRA law. They’re not included in the program’s discretionary budget but automatically receive budget authority for mandatory appropriations — in a separate account. This treatment might have its own issues, but in fact the cost of re-estimates is included, albeit a bit obscurely, in the federal budget, reflecting the comprehensive scope of FCRA.

[3] It’s worth noting that if such grant-like loans were subject to FCRA treatment, they’d almost certainly require a 100% subsidy rate. In effect, FCRA would automatically put them back in the cash-based budget.

In three prior posts, I described aspects of the limited buydown provision, which allows an infrastructure loan program to lower (within limits) a loan’s execution interest rate to what it would have been at the time the loan application was accepted.  CIFIA, the primary focus of the posts, has this provision, as does TIFIA, but WIFIA does not.  I explained that I thought that the limited buydown provision was likely to be an important feature for CIFIA borrowers because they face a lot of uncertainty before loan execution can occur.  Locking in a project’s interest rate at an earlier stage of development reduces one important element of that.  In contrast, WIFIA’s typical borrowers to date, state and local agencies financing drinking and wastewater projects, don’t have to manage nearly the same level of pre-execution uncertainty and the provision isn’t so important to them.  That difference might explain why CIFIA adopted and even refined the limited buydown provision in TIFIA, but WIFIA excluded it completely.

Now there’s a new development.  The Army Corps of Engineers is in the process of activating its part of WIFIA’s authorization.  The Corps’ part is intrinsically defined by current WIFIA statutes and operating procedures, but it has a new name (the Corps Water Infrastructure Financing Program, or CWIFP), its own rules for project prioritization, and – most importantly for this post – a very different type of expected borrower.     

As you’d expect from the Corps’ overall mission, CWIFP loans are intended for projects that reduce flood damage, restore aquatic ecosystems, and improve US waterways.  These projects are likely to be large-scale, involve multiple private and public-sector parties and jurisdictions, and require a long development period.  Before construction starts, they’ll need to obtain many authorizations, including those related to securing a revenue stream to qualify for financing and amortize the project’s cost.  I’d expect that in most cases, the necessary revenue stream will be primarily tax-based and generally subject to voter referenda, given the special nature, size and infrequency of these projects. The interest rate on the project’s permanent long-term financing will be a factor in the amount of taxes required.

If this turns out to be the typical profile for CWIFP projects, the amount of uncertainty that CWIFP borrowers will face before loan execution is likely much closer to that faced by CIFIA and TIFIA borrowers than by WIFIA borrowers.  As a result, CWIFP borrowers would also likely benefit from a limited buydown provision.  As I’d expect at CIFIA, interest rate volatility during pre-execution development might not stop a project, but additional certainty early in the process about the project financing’s final execution rate may help to accelerate the start of construction.  Acceleration is clearly an important policy goal of federal infrastructure loan programs.  Fundamentally necessary projects will necessarily get done, but the availability of finance with special features that work for specific project types and sectors can make them happen sooner.  I think the limited buydown is one of those features for the projects that CWIFP intends to support.

Adding a limited buydown provision to WIFIA’s statute (and thereby enabling it for CWIFP) doesn’t seem be an especially radical move.  The provision was established and apparently utilized at WIFIA’s model predecessor, TIFIA, and was included and refined at a WIFIA successor, CIFIA.  The fact that the provision was not included in the original WIFIA statute probably reflects only that the program’s advocates didn’t think it would be useful for drinking and wastewater agencies, not that there was any fundamental problem.  Since CWIFP’s expected borrowers have a very different profile, and might find a limited buydown provision useful, perhaps adding it should be considered.

[Note: This post is about the original 2020 Congressional Directive that initiated the WIFIA Criteria. A recent post about a possible new Congressional Directive to revise the current Criteria is here: FCRA Plan C: Directive to Update the Criteria]

This is the first post in the FCRA Non-Federal Series.

It is not clear from publicly available information what caused the FCRA non-federal issue to surface at WIFIA.  It may have started with a 2019 Letter of Interest for a $569 million loan to a major stormwater diversion project in which the Army Corps of Engineers is a participant.  A half-billion-dollar loan is large relative to WIFIA’s typical loan amounts, and the Corps’ involvement was financially and operationally significant.  This may also have been the first time that WIFIA received an LOI from a project with any material federal involvement. But other dynamics may have been setting the stage prior to the appearance of a specific case.

Regardless of origin, once the issue was identified, it was apparently decided at a high level that a fast-tracked solution was required, perhaps in the expectation that more federally involved projects would soon be applying to WIFIA if the first one was successful.  The Congressional directive to develop a solution was in the form of nine provisos in the WIFIA section of the Further Consolidated Appropriations Act of 2020, a large bill passed in December 2019.  Here are the three important ones for this post:

That the Administrator, together with the Director of the Office of Management and Budget and the Secretary of the Treasury, shall jointly develop criteria for project eligibility for direct loans and loan guarantees authorized by the Water Infrastructure Finance and Innovation Act of 2014 that limit Federal participation in a project consistent with the requirements for the budgetary treatment provided for in section 504 of the Federal Credit Reform Act of 1990 and based on the recommendations contained in the 1967 Report of the President’s Commission on Budget Concepts; and the Administrator, the Director, and the Secretary, shall, not later than 120 days after the date of enactment of this Act, publish such criteria in the Federal Register.

That, in developing the criteria to be used, the Administrator, the Director, and the Secretary, shall consult with the Director of the Congressional Budget Office.

That the requirements of section 553 of title 5, United States Code, shall not apply to the development and publication of such criteria. 

The other six provisos described various aspect of implementation and the consequences of a failure to publish the criteria by the deadline.  The latter were far from hypothetical, as later events proved.

On the surface, the Congressional directive is straightforward.  It simply instructs relevant parties to get to work on a specific budgeting issue at a loan program and deliver a solution within a specified time.  The directive was ultimately fulfilled according to its terms, and the solution, WIFIA’s FCRA non-federal loan criteria, is now operational.  If a more complex story was involved (which I think is likely), it might not really matter at this point.  But a careful look at the directive’s language as passed will provide some insights into why the solution took its current form and how it might be improved.

Project Eligibility

In its first sentence, the directive describes the sought-for solution in terms of ‘project eligibility’ for a WIFIA loan.  That seems innocuous, since the path towards the goal of excluding improperly budgeted loans from WIFIA’s portfolio would seem to start at the project level, where federal involvement occurs.

However, with respect to the specific FCRA issue and how an instruction’s words might shape its outcome, I think a more precise description of ‘eligibility’ was called for here. This is because the WIFIA Program has several layers of eligibility for different purposes, every one of which must be passed before executing a loan commitment for a project:

• Threshold Eligibility:  These sections in the WIFIA statute describe what sectoral categories of projects, borrowers and activities are fundamentally eligible for a Program loan [1].  This type of eligibility reflects core policy objectives – every other type of ‘eligibility’ primarily involves specific risk and operational aspects of the Program that are necessary to achieve its objectives.

• Transaction Criteria:  A proposed transaction with threshold eligibility is then evaluated with criteria in roughly two areas of focus.  The first area is about the project asset itself – size, public sponsorship, and O&M.  The second is financial, ultimately with respect to the quality of the specific loan being sought – creditworthiness, source of repayment and SRF alternatives.

• Selection Criteria:  After a proposed transaction passes the asset and financial tests, it is ranked relative to the other transactions that the Program is considering with respect geographic diversification, readiness to proceed, regional need, etc.  This process implicitly assumes WIFIA won’t have the resources to execute loan commitments with all the eligible WIFIA applications completed in a funding cycle, and prioritization is necessary.  So far, this has been the case, but only by a small margin.  A few projects each year have been put on a waiting list, some of which have then been done when higher ranked projects were delayed or dropped out.  Importantly for the FCRA issue, “the amount of budget authority required to fund the Federal credit instrument” is explicitly stated in this section.

In this more nuanced context of WIFIA ‘project eligibility’, where would a solution for the FCRA budgetary issue fit best?  Presumably not as a modification of the threshold eligibility sections or asset-focused criteria since only the project’s loan is subject to FCRA treatment.  That leaves the financial criteria or the selection process as ways to make a non-FCRA loan ineligible.  Either would seem to work.  Like creditworthiness criteria, FCRA criteria in the financial section would include looking at the physical and contractual aspects of the underlying project that are relevant to the specific loan’s ability to meet a certain minimum standard.  FCRA criteria applied to loans in the selection process wouldn’t be so determinative because it is theoretically possible that WIFIA might have the budget resources to fund a non-FCRA loan.  But as a practical matter, that’s effectively impossible [2].  For a minimalist approach to the solution, the selection process also helpfully includes a criterion for ‘budget resources’ – if the FCRA issue is a budget problem, that is a precise location for a budget solution [3].

The Congressional directive’s language about project eligibility could have been interpreted in a way that reflected the specific eligibility most relevant to the needed improvement.  But the problem with the language is that it can also be interpreted in a broader way.  Without the necessary depth of context, the directive could even be understood to ask for criteria that will determine project threshold eligibility based on FCRA budgeting concepts – an obvious category mistake [4].  Developing criteria for project asset eligibility is also a possible interpretation of the directive’s language – less obvious, but still the same category mistake.

Does any of this matter? As things turned out, I think it did. The lack of precision in the Congressional directive would seem to be a factor in the fundamental shortcomings of the eventual outcome.

Some Other Items

Although FCRA-based criteria for project eligibility is the core of the directive, a few other items should be noted:

• The 1967 Report: Apart from FCRA law, Congress directs the relevant experts to consult the 1967 Report of the President’s Commission on Budget Concepts. This makes sense because the fundamental ideas behind what eventually became the current methodology of federal budgeting — and its FCRA subsection for federal credit programs — are outlined in this report. Since FCRA is silent about how to determine whether a loan is federal or non-federal, it’s necessary to go back to the law’s origins to develop guidance consistent with its intent. The 1967 report will be the subject of the next post in this series — and it’s actually an interesting topic. But I wonder if Congress intended to limit the basic sources for the criteria to this report and FCRA law? There have been a few precedents and analogous situations for the non-federal loan budgeting issue in the relatively recent past– can they also be considered? If not, why not?

• Treasury and CBO: WIFIA and OMB are obviously the most involved parties in the FCRA issue and the best-positioned to develop the needed criteria. Why was Treasury also included in a headline role? Was some type of financial expertise expected to be required? That seems like overkill for most WIFIA project loans, but to the extent it seems to acknowledge that the financial aspects of the project are at the core of a loan budgeting issue, that might make sense. CBO’s consultative role is also a bit mysterious, but that might be standard operating procedure for anything that affects the budget, or validity thereof. And CBO does of course score WIFIA legislation, including at a granular level with respect to the Program’s tax revenue impact (I’m not sure that the JCT always gets it right — but that’s another topic).

• Section 553 Exclusion: The reason for this is not clear to me. Again, it might be SOP for fast-tracked directives or (apparently) minor technical matters. The important aspect of the exclusion was that there was no mechanism or time period for public comment on the criteria, which were simply published and became operational in June 2020. In retrospect, excluding formal input on the issue from the potential WIFIA stakeholders outside the Program’s current borrower base was probably not an optimal approach. This will be a topic for future posts in this series.

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Notes

[1] Interestingly, WIFIA’s Section 3904 about eligible borrowers explicitly includes federal entities. In contrast, the equivalent section in TIFIA includes ‘any’ governmental entities. In the newer, post-criteria CIFIA and the Corp’s CWIF programs, it’s limited to state entities. Does this reflect some evolution in policy direction that was curtailed by the budgeting issue?

[2] The typical WIFIA loan is about $150 million, and this is probably much lower than the amounts sought by the type of large-scale water management project that has federal involvement. WIFIA’s annual credit subsidy appropriations have been in the $50-60 million range. If a loan can’t receive FCRA treatment, it’ll require budgetary resources of 100% of the loan amount in the year made. Even if the non-FCRA loan was the only eligible application that year, it would need to be rejected at the selection stage.

[3] In a strict sense, the mechanism to exclude non-FCRA loans already exists at WIFIA. The statute’s boilerplate definition of ‘subsidy’ refers to FCRA as the methodology that must be followed to calculate the required amount. FCRA law defines a ‘direct loan’ solely as a ‘disbursement of funds by the Government to a non-Federal borrower under a contract that requires the repayment of such funds’ — in effect, a non-federal loan. If a WIFIA loan can’t fit that definition, the implication is that FCRA can’t be applied, and the subsidy calculation must default to the general cash-based budget. It strikes me that WIFIA and OMB could have quietly developed appropriate non-FCRA loan criteria in this context and informed potential borrowers in the usual way — e.g., Program guides, a notice in connection with a NOFA, etc.

[4] Perhaps such a modification of Program policy could only be done by amending the statute?

WIFIA Program stakeholders will recall that the Program ran into a serious-sounding issue about correct budgeting a few years ago.  The issue arises when a WIFIA loan is made to an infrastructure project that has some degree of federal involvement.  Federal activities cannot receive the same FCRA budgetary treatment that WIFIA invariably uses for its loans.  How was the Program ensuring that loans for federal activities were excluded from its FCRA-based budget?  Since this question didn’t have a clear answer at the time, Congress in late 2019 instructed WIFIA, jointly with OMB and Treasury, to develop classification criteria to distinguish loans that could receive FCRA treatment and those that could not, due to federal involvement in the project being financed.  Non-FCRA WIFIA loans, regardless of being completely eligible in every other way, would become ineligible due to the application of the criteria.

Apparently, there was some delay in producing the classification criteria by the spring 2020 deadline.  Congress, through the appropriations process, took a surprisingly hard line on the matter and threatened to effectively defund the Program.  That got some press.  But the criteria were duly published shortly thereafter, threats withdrawn, and the expected WIFIA appropriations delivered.  By the end of 2020, the issue was apparently resolved.

Not There Yet

In fact, the outcome of this issue in 2020 was closer to truce than a permanent solution.  The correct budgetary treatment of WIFIA loans to projects with federal involvement is not a settled matter.  WIFIA’s current classification criteria can basically be ignored by state and local drinking and wastewater agencies.  This sector forms the vast majority of WIFIA’s applicants to date and is represented by the Program’s original advocacy groups.  It’s not surprising that they’d be willing to accept a quick (and to them, irrelevant) fix to keep the Program funded.  But that’s not the case for those water infrastructure sectors where federal involvement, due to history or scale, is a constant factor.  Projects in these sectors have to date not been frequent WIFIA applicants.  But they’re clearly eligible for loans in WIFIA’s statute and would significantly benefit from their features.  Yet the Program’s non-statutory budget classification criteria could effectively render many of them ineligible.

There’s no question that financings for federal activities belong in the main cash-based federal budget, not the specialized FCRA sub-section.  But precisely defining ‘federal activities’ in complex situations is not straightforward, a fact that has been recognized since current federal budget concepts were established in the 1960s.  Financing for large projects in which the federal government is just one of the participants is especially complex and FCRA law, although quite detailed in other ways, provides no guidance at all in this area.  Perhaps such guidance was not considered necessary when the law was passed in 1990 because federal loan programs for large-scale US infrastructure projects weren’t anticipated at the time.  But as WIFIA’s experience shows, current and future programs will attract a material number of important projects with federal involvement, an area that I think is likely to expand as the needs of US infrastructure renewal become more pressing.  Clarification of FCRA law’s current budget ambiguity associated with loans to federally involved projects is undoubtedly necessary and will ultimately benefit both federal taxpayers and infrastructure project stakeholders. 

But does WIFIA’s 2020 classification approach provide that clarification?  Or does it represent only a useful first step towards better solutions?  Is a process that involves a series of sixteen, primarily qualitative, questions going to produce clear results in an efficient manner?  Or would a statutory fix provide greater clarity and more equitable treatment for potential applicants?   Most importantly, are the concepts underlying the current classification approach the only possible interpretations of the intent of laws which determine federal budgeting methodologies but are silent on this issue?

Recent Developments

The above questions are not academic at any time, but three recent developments introduce an element of urgency in addressing them.  Unlike the single Congressional directive that framed the issue in 2020, these developments have multiple, disparate sources:

• GAO Report:  In July, the GAO published a long report on the issue, Transparency Needed for Evaluation of Potential Federal Involvement in Projects Seeking Loans.  The report primarily describes OMB’s thought processes and conclusions in developing WIFIA’s current criteria.  GAO did not question any of OMB’s interpretations or consider alternatives but recommends that “OMB should publish government-wide criteria…to help determine whether the project is eligible for the special budgetary treatment under FCRA.”  These would presumably be closely based on WIFIA’s current criteria and applicable to all current and future federal infrastructure loan programs.

• CWIFP Implementation:  In June, The Army Corps of Engineers published a proposed rule for implementing its WIFIA authorization, the Corps Water Infrastructure Finance Program, and applications are expected in the first quarter of 2023.  WIFIA’s current criteria are applicable to the CWIFP and may limit the scope of the Corp’s ability to utilize its authorization.

• HR 8127:  Also in June, HR 8127, The Water Infrastructure Finance and Innovation Act Amendments of 2022, was introduced in Congress.  Section 7 of this bill proposes a simple statutory fix to WIFIA’s FCRA issue based on the non-federal sources of loan repayment. 

FCRA Non-Federal Series

FCRA treatment for federal loans to federally involved projects is a big, multifaceted topic.  It needed to be examined in depth and in a methodical way to provide substantive criticism of WIFIA’s current classification approach and develop credible alternatives.  I tackled it in a series of posts, each based on one of the relevant documents, in a sequence that builds to overall conclusions at the end.  Posts in this series all include ‘FCRA Non-Federal’ in the title because that’s a succinct way to reflect the goal, which is to ensure that only non-federal loans receive FCRA treatment.  Here’s the sequence:

• The Congressional Directive
• 1967 Budget Commission Report
• 2017 CBO Report
• 2022 GAO Report
• The WIFIA Criteria
• HR 8127
• Tax Code Precedent
• Conclusion

In a prior, unexpectedly long, post, I explored the relationship between the intent of various laws underlying WIFIA’s budget and the ‘FCRA loss ratchet’ that made the Program’s actual, presumably unintentional results possible.  At the end of that post, I outlined some ideas to solve the issues going forward in a constructive way:

• The FCRA loss ratchet is probably an inevitable result (under current budget law and oversight methodology) of federal lending to highly rated borrowers with excellent financing alternatives who are building projects with long construction periods – two factors that practically define the state & local public agencies that do large-scale infrastructure projects in the US.  If federal infrastructure loan programs are going to have any significant impact on US public infrastructure, they’ll need to offer loans to this group.

• It’s not easy to develop loan features that are simultaneously attractive to these borrowers and fair to taxpayers when properly reflected in the budget.  The first thing to do, which is immediately applicable to WIFIA’s case, is to improve disclosure of a features’ real cost, especially with respect to future mandatory appropriations.  Disclosure will take the unintended fun out of offering ‘free’ products and encourage the development of less fun, but more impactful products.

• Innovation is the key to this kind of development.  An important principle should guide the process: Federal infrastructure loan features should always be based on deploying a federal lending strength, relative to private sector debt alternatives.  These strengths exist, even in times when the debt markets are operating normally.  If a loan feature deploys a federal strength, then a true increase in national economic welfare is possible along the lines of the benefits of ‘comparative advantage’ in trade theory.  If not, the feature probably involves some form of zero-sum transfer payments.  Transfer payments are the delight of rent-seekers and power-hungry bureaucrats, but in this context (loans to borrowers with excellent alternatives), the economic outcomes will be at best negligible, at worst significantly misallocating.

Innovation for federal infrastructure programs will be a central theme here.  This post will be limited to identifying two distinct paths to the goal.

I’ve written before about the potential for innovation at WIFIA and its implications for other programs.  Below is a presentation from about three years ago.  This was before I understood the scale of the FCRA loss ratchet issue, but I did highlight the fact that WIFIA was lending to highly rated borrowers, and many of the basic concepts are still relevant.

Wifia-Transformational-Development-Discussion-Outline-12302019

Two Paths: Project-Focused and Borrower-Focused

It’s useful to make a distinction between two areas of innovation that can improve federal loan products for large-scale public infrastructure because there are intrinsically two different elements involved – the physical projects themselves and the borrowers that make them happen.

Project-focused innovation should center on federal strengths that are relevant to specific infrastructure sectors or sub-sectors and don’t have efficiently accessed analogues in private-sector.  Some quick examples:

• Loan Term:  The most obvious and probably most substantive federal strength relative to any private-sector market is the ability to take a very long-term view of an investment.  It’s not universally relevant since many projects have useful lives well within standard tax-exempt bond market terms.  But where project life exceeds those, especially by a wide margin, loan programs should seek to maximize their ability to lend for the longest term possible.

• Specific Risks:  I don’t think the federal government has any unique comparative advantage in infrastructure risk assessment compared to private sector investors.  Probably the opposite, to be honest.  Certainly, a large government can simply absorb bad outcomes to a much greater extent, but then we’re back to transfer payments.  However, there are areas where the federal government already has an ineluctable risk position for basic policy reasons – disaster relief, for example.  To the extent that loan features can be designed to ‘hedge’ this risk by having contingent repayment terms that work in the opposite direction, real economic benefits could be realized.  I wrote about an example here: Contingent Loans for Climate Adaptation. Bit theoretical, no?  Well, innovation always starts like that – and there are probably more straightforward situations, especially at the infrastructure sub-sector or region-specific level.

• Interaction with Other Federal or State Policy:  When infrastructure projects need to conform with federal or state requirements anyway, that resets the ‘economic baseline’ on which the value of financing can be measured.  Who better to design federal loan features that exactly dovetail with such requirements than the government itself?  An example would be federal mandates for CSO improvements where WIFIA could specifically specialize in the financial aspects of compliance.  Not exactly a ‘federal strength’ in Pareto optimal terms perhaps (since the government created the economic friction that its loans seek to reduce), but close enough to our basic guiding principle here.

Project-focused innovation is very specific to different project types and sectors.  It can’t easily be centralized and ought to be kept at the individual agencies that host infrastructure loan programs.   

Borrower-focused innovation should center on federal strengths that are relevant to the financial goals and limitations of the type of borrower that typically implements US public infrastructure — highly rated public agencies. Quick examples:

• Interest Rate Management: The long construction periods of large-scale infrastructure projects require interest rate management products. Yes, I know — when they’re ‘free’, borrowers will snap them up, as they did at WIFIA. But I don’t think the development needs to be based on a budget loophole. Treasury has huge economies of scale, expertise and existing risk positions, all of which can be the basis of attractive loan features that are both based on federal strengths and properly budgeted for.

• Balance Sheet Management: Financing for large-scale infrastructure projects will put pressure on even the largest investment-grade balance sheet. I think the federal government has relative strengths in adding flexibility to large federal loans that wouldn’t be possible in the private-sector debt markets — single investor, buy-and-hold, deferral options, etc. A few are already deployed at WIFIA — more can be developed.

• Wholesale Lending to Retail Lending: There’s another type of highly rated infrastructure borrower that doesn’t in fact build projects itself — leveraged state-level infrastructure programs. Economies and efficiencies of scale are the fundamental strengths that federal loan programs could share with these lenders. I think there’s a lot of scope for purely financial innovation in this area.

Borrower-focused innovation can be centralized because the financial concepts and mechanics will generally be applicable across sectors. And because that type of innovation requires sophisticated financial and market expertise, it shouldn’t stay in silos at the host agency level, bureaucratic turf questions notwithstanding. The agency innovators should be busy enough with the project-focused features.

I think a natural center for borrower-focused innovation will be Treasury, since they’re funding the loans anyway. Here’s a diagram I had included in the 2019 presentation, updated to include CIFIA the new Corps’ program, CWIFP: