This post looks at CBO’s rationale for rejecting the WIFIA FCRA amendment language in S.3591, a 2020 Senate bill. This is worth revisiting in some detail for two reasons. The first is that the soon-to-be-reintroduced HR 8127 and current HR 2671 House bills use very similar language in their FCRA amendments as S.3591 did [1]. If CBO scores that language again at some point in the process, presumably they’ll apply the same rationale.

The second, more fundamental reason, is to review the New Approach in a context of the amendment proponents’ intentions and CBO’s basic reasoning.

The analysis begins on page 3 of CBO’s 11/20/20 Cost Estimate (emphasis added):

S. 3591 would limit the criteria used to determine the budgetary treatment of the anticipated net cost or savings of loans or loan guarantees made under EPA’s Water Infrastructure Finance and Innovation Act (WIFIA) program.

This is indisputably correct on the surface, because that’s the way the amendment language is written. But did that language accurately reflect fundamental intent? Was the amendment intended to limit any additional FCRA criteria being applied by WIFIA for loans to federally involved projects? Or just definitively get rid of the seriously flawed current Criteria? I think it was the latter, primarily because by that point the issue had become (and remains) contentious, and the amendment’s proponents likely wanted to stake out an unambiguous position. That’s understandable, especially because FCRA law and principles seem so clear that’s it’s hard to imagine why additional criteria would be needed other than to keep the issue in a bureaucratic rabbit hole. It took me a year of thinking about this issue to come up with a possible, if vanishingly rare, scenario that appears to require additional FCRA criteria, as described in the in the New Approach post.

If getting rid of the current Criteria was and still is the sole goal, the first task of the New Approach is to show amendment proponents why additional criteria are (at least theoretically) necessary and how they can be incorporated in WIFIA’s statute in a way that won’t impede truly eligible applicants. Admitting to CBO and other oversight agencies that additional criteria are necessary is not only objectively valid but a critical first step in making progress on this issue by establishing some common ground.

Now back to the CBO side. The paragraph continues:

Under the bill, any budgetary impacts would be recorded on an accrual basis if the borrower is a nonfederal entity and would be repaying the obligation with nonfederal funds. This provision would allow the costs or savings for loans to federal projects that meet those two criteria to be recorded on an accrual basis.

The two criteria, a non-federal borrower and a non-federal repayment source, are all that FCRA law and principles would seem to require in an honest world. The 1967 Report makes it crystal clear that the purpose of FCRA is very narrow: to get non-federal loan repayment cash inflows out of the cash budget due to their distorting effect and gaming potential. How many criteria are required to determine that a large investment-grade loan to a sophisticated non-federal borrower with an extensively analyzed non-federal repayment source is exactly what the 1967 Report was talking about? Not many. Absent the current Criteria, I think CBO would find it as difficult as the amendment’s proponents likely did to imagine exactly what additional criteria are needed. In fact, the difficulty of the exercise is probably what led OMB down the rabbit hole in the belief that there had to be something there that could be used to limit statutory eligibility.

The final sentence in the paragraph looks like an innocuous technical reminder:

That budgetary treatment [FCRA accrual] is not allowed for federal projects under current law.

In fact, it’s quite misleading, though probably unintentionally so. FCRA accrual treatment isn’t allowed for anything other than intangible federal financial assets, certainly not manifestly tangible federal projects. I think what’s meant here is that FCRA treatment is not allowed for federal loans that finance federal projects. But that’s also misleading. As a matter of fundamental statutory eligibility and policy purpose, a federal loan program like WIFIA should never be financing a federal project in the first place. To suggest that FCRA treatment is the program’s sole restriction on loans to finance federal assets, and that inadequate WIFIA FCRA criteria will therefore open the floodgates to all sorts of intra-agency mischief, is simply nonsense.

CBO knows this. What we’re seeing in the above sentence is an echo of the current Criteria’s rabbit hole, where questions are ‘criteria’, FCRA budgeting is applied to projects, a federally involved project is almost always a ‘federal project’ in accordance with undisclosed consolidation principles, consolidation is the only relevant topic for FCRA in the 1967 Report, law can be amended by footnoted diktats, and on and on.

This points to the next task of the New Approach: to demonstrate to CBO that the current Criteria are seriously and fundamentally flawed by proposing criteria that are in fact clearly based on FCRA law and foundational principles. CBO will never openly admit it, of course, but they don’t have to. Raising doubts about the validity of the current Criteria should be enough for CBO to quietly move on from their 2020 scoring, especially if a better alternative is proposed.

The next relevant paragraph again echoes the Criteria, but two specific phrases can be used as the entry point of New Approach concepts:

However, the status of a borrower as a nonfederal entity repaying a loan with nonfederal funds is not a sufficient basis for the loan or loan guarantee to receive FCRA treatment under current law. In directing this budgetary treatment under S. 3591, EPA could make loans and loan guarantees for federal projects or assets and record the costs on an accrual basis—which would be reflected in a subsidy cost—rather than on a cash basis, thus understating the initial funding required for those commitments.

The New Approach agrees with CBO that a non-federal borrower and non-federal repayment source are a necessary, but not sufficient basis, for FCRA classification. The applicant has also to demonstrate that its proposed loan is free from crookedness and imbecility [2]. That shouldn’t be hard. If it is, rejection is probably warranted for reasons that go far beyond FCRA budgeting.

The demonstrations of value and independent decision-making will also confirm that the asset being financed by the WIFIA loan is non-federal because why else would a non-crooked, non-imbecilic non-federal borrower be paying for it?

It is as simple as that. If an honest and intelligent non-federal entity spends $100 million on a federally involved project in its own interest, there will be a $100 million non-federal interest in that project. It’s that asset WIFIA and CWIFP loans are financing, not some sort of mysterious ‘federal’ Chesire cat in the rabbit hole.

The final and most important task of the New Approach is to focus CBO and other oversight analysis on the intrinsically non-federal nature of an asset that a non-federal borrower pays for. That will bring us back to the real-world where FCRA classification, with a few minor confirmations, is as straightforward as the 1967 Report and FCRA law intended it to be.

The Numbers

If CBO is persuaded that the additional criteria proposed in the New Approach are sufficient for FCRA budgeting purposes, their cost estimate should go back to the accrual basis normally applied to WIFIA and other loan programs [3]. The amendments themselves shouldn’t cost anything, as they simply enable the utilization of funding already provided by Congress and I don’t think CBO has ever scored that on the basis it wouldn’t be used.

Still, a couple of things are worth noting. CBO’s 2020 cost estimate assumed that if S.3591 was enacted, there’d be restored eligibility for $150 million per year of WIFIA loans to federally involved projects, which seems low. Now that CWIFP is being implemented and has funding for dams and levees, the estimate looks unrealistically low, based on the potential borrowers I’ve written about here and especially here. Might CWIFP’s implementation change something in CBO’s cost estimates for new WIFIA law? I can’t think of anything at this point, but perhaps the change in WIFIA’s scope since 2020 ought to be kept in mind.

Interestingly, CBO had a view of what would have happened to the current Criteria if S.3591 had been enacted. Here’s their footnote 5:

The Further Consolidated Appropriations Act, 2020, provided subsidy budget authority for the WIFIA loan program but required EPA to develop criteria to determine project eligibility and apply those criteria for projects selected in the 2020 cohort. CBO estimates that [the current Criteria] would effectively prohibit EPA from selecting projects for WIFIA loans that would receive accrual treatment under S. 3591 but cash treatment under current law. CBO expects those criteria to remain in place through fiscal year 2021. As a result, CBO estimates that the provision would have no effect on direct spending for funds provided in that fiscal year.

They seem to be thinking that the Criteria can remain in force even after new WIFIA law is enacted, at least for a period. I wrote about this scenario in the last section of the New Approach post. But what’s CBO’s basis for assuming that the Criteria go away after one year? Automatically, or are they assuming some additional future action? I wish they’d explained their thinking — perhaps they’d be on board with the kind of graceful exit recommended in the New Approach?_____________________________________________________________________________________________

Notes

[1] HR 8127 and HR 2671 have the same language:

‘‘If the recipient of financial assistance for a project under this subtitle is an eligible entity other than a Federal entity, agency, or instrumentality, and the dedicated sources of repayment of that financial assistance are non-Federal revenue sources, such financial assistance shall, for purposes of budgetary treatment under the Federal Credit Reform Act of 1990 (2 U.S.C. 661 et seq.)—
‘‘(1) be deemed to be non-Federal; and
‘‘(2) be treated as a direct loan or loan guarantee (as such terms are defined, respectively, in
Act).’’.

The Senate bill which CBO scored, S.3591, differs only in referring to “the project or asset for which financial assistance is being provided” in place of “such financial assistance“. As discussed above, this older language is incorrect (FCRA doesn’t apply to projects, only loans), probably echoing (as CBO’s statement did) the Criteria’s basic error. The fact that it’s fixed in the newer House bills is positive, of course. I doubt that change in itself would lead to a different conclusion, since presumably CBO will again apply the same Criteria-based framework, other things being equal. But the change (and especially why it was considered necessary) is a good opener for a discussion that’s very much on the right path.

[2] It’s worth noting that the relevant crookedness here is fundamentally related to an exercise of federal sovereign power, apparently an important factor for CBO’s general scoring principles. That should be highlighted to help establish some common ground outside the current Criteria.

[3] Unfortunately, that will probably include CBO’s previously used assumption that a WIFIA loan for 49% of the assets being financed will necessarily entail the issuance of additional tax-exempt debt for the 51% balance, leading to a hit on federal tax revenue. While that’s demonstrably not true for most EPA WIFIA loans to date, it might be more valid for CWIFP’s lower-rated and more contingent projects. In any case, a separate issue for another day.

It’s a simple change. WIFIA’s current maximum loan term is 35 years post-construction. That should be extended to at least 55 years for long-lived water infrastructure projects. Now more than ever.

The topic has been covered in previous posts: Same Story, Different World (July 2022), WIFIA 55-Year Loan Term (September 2020) and Extended Term for WIFIA Loans (February 2021).

Different Story

This time, the basic story has in fact changed over the past year. Interest rates are again significantly higher than before, but the important factor is that the UST yield curve is even more inverted. That means a primary benefit of a WIFIA loan, avoiding the negative arbitrage of a construction escrow, is not too valuable in the current environment [1]. Relative to just financing the whole project with tax-exempt bonds, the borrower will save about 3% of project cost on an NPV basis for the current 35-year term. Not immaterial, but much lower than the 5-10% range WIFIA was able to provide in the past. A lot of potential applicants might take a pass.

A 55-year term gets the NPV benefit back up to about 8%. The other numbers (very slight FCRA cost increases, lower tax-expenditure) are also about the same:

The primary driver of the preserved level of benefit is the longer term’s relatively greater utilization of US Treasury flat-forward pricing. This factor is always important for federal infrastructure loans. It is an intrinsic strength of long-term federal lending which enacting a 55-year term will make possible to explicitly recognize and highlight. Much more sustainable and broadly applicable than periodic and potentially costly program benefits based on construction escrow negative arbitrage.

Even More Different World

What I wrote in last year’s post about the importance of the extended term seems even more applicable today:

“In the relative optimism of recent years [up to 2020], extending the maximum term of certain loans in a small sectoral program for large water utilities might have seemed…well, not exactly a compelling priority, regardless of logic or potential benefits. I think it was seen as a minor change for some Western water management projects that had other issues with the WIFIA program (federal budgeting) and useful only to a regional constituency. The WIFIA Improvement Act of 2020 went nowhere.

A pessimistic outlook will – or at least, should – change that perception. Yes, it’s still a minor change and only applicable to long-lived water projects. But more relevant in a tough environment:

• Local funding will be even scarcer, especially for types of infrastructure where it’s easier to kick the can and defer renewal – like stormwater systems. These projects tend to be mainly composed of long-lived, structural assets which could support and benefit from a 55-year loan term. As more water agencies look for WIFIA loans to mitigate the effects of higher interest rates and inflation, they’ll be plenty with long-lived assets. And they’ll be looking for every penny of benefit they can get. That constituency will be national in scale and highly motivated.
• Federal infrastructure loan programs will need to expand their capacity but also their capabilities. Not big, transformational changes (that’ll be impossible) but many small, specific modifications to loan products that have predictable benefits. Extending WIFIA’s maximum term is a perfect example of what’ll be required. As such it can serve as a demonstration that, despite overall political polarization and dysfunction [even worse now], at least one area of federal policy can be successful. It shouldn’t be difficult — TIFIA just extended their maximum term (to 75 years, no less) in the 2021 IIJAA. A win for WIFIA’s maximum term will encourage more of what will work.
• More subtly, longer terms for infrastructure loans help shift the focus to the long run, where it belongs, and away from a business-as-usual mindset. That focus matters for evaluating investment in climate change, long-term environmental sustainability and quality of life for future generations. It’s no secret that the ESG agenda doesn’t seem to have the kind of consensus behind it as it did recently – a trend that is likely to get worse [it has, dramatically]. An extended term for WIFIA loans is a small step in the right direction.“

_____________________________________________________________________________________________

Notes

[1] Just mathematically, higher absolute levels of interest rates also erode a WIFIA loan’s value relative to a tax-exempt bond with a comparable term because the tax exemption is applied to a larger amount of income. Post here describes the numbers: Subsidized Debt and Term, Interest Rates. Beyond the 30-year term in the muni market, however, uncertainty about the tax code and income will likely outweigh this advantage — hence another reason for a 55-year WIFIA term.

As outlined in Chapter 5 of the 1967 Budget Report, the foundational principle of FCRA is that a federal loan has a substantive non-federal source of repayment. The loan is an outflow, like other federal payments. But repayment from non-federal sources is an inflow that reverses, to a precisely calculated extent, the initial outflow. Recording such reversing cash flows as expenditures and revenues would seriously distort the federal budget. Hence there is FCRA, which records federal loans on an accrual basis in accordance with well-established financial accounting procedures. It is not mysterious, nor much open to gaming, which is unsurprising since the sole purpose of enacting such special treatment for federal credit was to prevent budget games.

A substantive non-federal source of repayment is something that should be straightforward to establish objectively. It’s worth noting, however, that another federal inflow also comes from non-federal sources — federal taxes. The difference is that in a federal loan the repayment obligation is undertaken voluntarily, and loan proceeds are used (within the limits set by the loan program) in the borrower’s own self-interest. In contrast, the federal government uses its sovereign power to force tax inflows from non-federal sources and allocates the proceeds to general public goods. The former process is recorded under FCRA, the latter exclusively in the federal cash budget. The distinction is important, but I think in the overwhelming majority of federal loans it will be so glaringly obvious as to not require much, if any, confirmation.

Non-Federal Cost Shares in an Honest Land

As discussed in a recent post, FCRA Non-Federal Issue: A New Approach, federal loans for non-federal cost shares in federally involved infrastructure projects are a bit more complicated because the borrower’s self-interest is mixed with federal interests. But in an honest land, the distinction between a non-federal source’s repayment of a federal loan and payment of federal taxes should be abundantly clear even in a cost share financing.

In a normal deal, the non–federal interest may be complex, but the character of a FCRA-classified repayment (versus federal taxes) can be determined from an examination of the non-federal borrower side alone. Did they voluntarily agree to undertake the loan’s repayment obligations in order to pay for the cost share? Did they get specific, commensurate value for themselves? If ‘yes’ to both, the cash inflows to the federal government from the borrower are voluntary and self-interested. They can’t be recorded as taxes and instead belong under FCRA.

A World Devoid of Crooks?

The lapidary amendment language in HR 8127 and HR 2671 appears to be assuming that with respect to FCRA classification, the world is necessarily an honest and straightforward place. That’s somewhat understandable. Aren’t the reversing cash flows from a non-federal repayment source in themselves sufficient to force the loan into FCRA, whether or not anyone wants that, per the section’s founding principle and anti-gaming purpose? All the relevant facts confirming a non-federal characterization of the loan’s repayment source will certainly be surfaced by the credit rating agency’s extensive review. Plenty of other mischief might be occurring in the deal, but how could any of that alter such visible and objective facts?

Sadly, under current WIFIA law, I can see a way that crookedness could result in FCRA misclassification, not as a primary goal but rather as a minor side effect. This is because even manifestly non-federal sources apparently repaying a federal loan might in effect be paying federal taxes.

There are two varieties of a con that have this effect, both involving federal sovereign power, the unique factor in non-federal cost shares in federally involved projects. The first was described in the New Approach post. If an unethical federal participant leans on a non-federal source to pay for a share in a project they don’t want or find beneficial, the source is being forced through the misuse of sovereign power to pay for a federal asset, which might even look like a national public good. The payment is an unauthorized yet de facto form of federal taxation, and if there’s a federal loan in the middle, all loan repayment will in effect be federal tax payments, too. The transaction doubtless belongs in criminal (or in less extreme and more realistic cases, civil) court, but for as long as it stands, it should be recorded in the federal cash budget, and the loan can’t be classified under FCRA.

The second variety works the other way around. A non-federal crook bribes the federal participant with some unrelated quid-pro-quo to deliver to its cost share an amount of value far in excess of what the non-federal source pays. The federal participant redirects resources from tax sources to create the excess value. The cost-share payment, such as it is, can be seen as a minor, on-the-books part of the purchase price for a redirection of federal taxing power. Hence, the payment is primarily related to federal tax, not the project. I have no idea how this would be recorded in the federal cash budget prior to various well-deserved indictments, but that’s where it belongs. Definitely not under FCRA.

I hope this kind of thing is vanishingly rare. I assume it is for large scale infrastructure projects. Nevertheless, the theoretical possibility of a misuse of federal sovereign power shows that a non-federal source of repayment is a necessary but not quite sufficient condition for the FCRA classification of a federal loan to finance a cost share in a federally involved project.

A World Full of Imbeciles?

The current WIFIA Criteria don’t appear to be too concerned about crooks. Instead, they apparently assume that the world is full of imbeciles.

The so-called Criteria determine, through a series of questions and an undisclosed process (that may or may not include actual criteria), whether the project or asset being financed by the federal loan is ‘federal’ or not. The asset’s value and utility with respect to loan amount or the borrower’s motivation don’t seem to be relevant. Instead, the objective appears to be an accounting classification along the lines of subsidiary consolidation per private-sector GAAP. In a cost-share situation for a large infrastructure project, there will be many undivided and intangible assets where federal and non-federal interests interact in complex ways, but the Criteria assume the whole thing to be ‘federal’ unless proven otherwise, apparently beyond the slightest shadow of doubt. I think we know how that will turn out. The Criteria publication helpfully notes that cost shares in USACE or Bureau of Reclamation projects needn’t bother to go through the process at all — they’re simply presumed to be ‘federal’.

I’ve discussed this rabbit hole in several prior posts, most directly here. For this one, I’ll focus on the bizarre implications of the Criteria classifying (however erroneously) a cost share as a ‘federal’ asset with respect to the characterization of the loan’s proposed non-federal source of repayment. In one sense, this is an academic exercise, since the inevitable ‘federal’ classification of the cost share will result in immediate rejection of the loan application, likely the intent all along. Still, the implications are worth considering, not so much to add to the list of the Criteria’s shortcomings (they’re damning enough already), but as context for some aspects of the Criteria’s possible replacement. It’s also oddly amusing, to be honest.

Most glaringly, the non-federal participant will certainly be very surprised to learn that the cost share it planned to finance with a WIFIA loan won’t actually be theirs, but a ‘federal’ asset instead. All those months and years of planning and analysis about the critical value the cost share will provide to the community and investors? All those hard-fought negotiations with a federal participant vigorously defending federal interests? All those presentations, public meetings, council approvals and voter referenda about investing a large amount of money into an important infrastructure project? Stacks and stacks of contract documents, engineering studies and benefit-cost analyses detailing tangible and intangible value, precisely defined undivided interests and countless rights and obligations?

Delusional! Pointless! The Criteria have determined that there is no non-federal asset in this project! What you thought was yours is in fact a national public good! You get nothing!

Since the Citeria have pronounced that WIFIA loan proceeds applied to the putative non-federal cost share will in fact be paying for a national public good, loan repayment will be a form of federal taxation, as in the case of federal extortion described above. Interestingly, extorted federal taxes should get the same treatment in the federal budget regardless of the method of payment — illicit or not, they’re tax revenue, pre-indictment anyway. But unwitting federal taxes apparently do not. If the non-federal participant paid for its cost share in cash upfront or financed it in the federally subsidized tax-exempt bond market, presumably the payment to the project would not be recorded as revenue in the federal budget, perhaps being only indirectly reflected as a reduction in the federal participant’s budget for project cost.

However, if the non-federal participant financed the same cost share with a WIFIA loan (theoretically speaking, of course), the Criteria would spring into action and in due course discover a new ‘federal’ asset that (per cash accounting) can only have been paid for by, well, federal tax revenue. Specifically, the WIFIA loan’s principal amount would (via a 100% credit subsidy) be a tax expenditure for the new-found asset, to be balanced by a new federal tax revenue stream that covers the full cost, even including UST interest on the initial deficit financing. Substantively, WIFIA isn’t really making a loan (all the initial flows are now intra-federal) but acting as a tax collection agency specializing in long-term contracts that deliver new revenue in the nominal form of ‘loan repayment’.

In a twisted way, this actually doesn’t sound so bad for the federal government. If the Criteria’s agency operators really believe that the proposed non-federal cost share is a federal asset that an imbecile is willing to pay additional taxes for, and that this reality is uniquely surfaced for inclusion in the federal budget by said imbecile’s use of WIFIA financing, why aren’t they encouraging it?

As I said, bizarre. Isn’t this the kind of budget game-inducing irrationality that FCRA was enacted to prevent?

Back in the Real World, Common Ground

Of course, the proponents of the amendment in HR 8127 and HR 2671 know that no technical financial classification or definition can be completely crook-proof, especially when there’s big money involved. My guess is that they simply couldn’t conceive of any concrete way that mischief could be involved in this case, and that generalized or vague restrictions would allow the worst elements of the Criteria to enter through the backdoor. The proponents’ basic sense that FCRA classification is straightforward and would be harmed by unnecessary qualifications is correct. But if shown a precise scenario for FCRA misclassification, I think they’d agree to include specific and limited criteria to address it.

Likewise, I am certain that the Criteria’s authors did not intend to imply that non-federal cost-share participants are imbeciles volunteering to pay more federal tax. Frankly, I’m not sure how much they thought through the FCRA issue or the Criteria’s consequences, other than what was required to obviate the issue by effectively denying all applications. My impression is that there was lot of confusion, not much real-world financial knowledge and some elements of a hidden agenda going on. But I believe that they were also motivated by a genuine feeling that the FCRA classification of WIFIA loan for a cost share in a federally involved project requires some extra steps, though they didn’t understand exactly why or what the steps should be. That feeling is justified. Again, if shown what’s actually required and how that would be consistent with FCRA law and principles, they (or some of them, anyway) might quietly agree to allow the current Criteria to be replaced if it can be done in a face-saving way.

The important point here is that there is non-controversial common ground, solidly based on FCRA law and principles, between the pro-amendment and the pro-Criteria sides. Both sides are partly right and partly wrong, and both can claim a win if the common ground is tacitly agreed to be the basis of a solution. If FCRA was less of an abstract and specialized area, the common ground would likely be more obvious. But it’s clearly not. The first challenge is to get there, the rest might be easier.

1. A non-federal asset is created when a non-federal participant pays for a share of a federally involved project with upfront cash from non-federal sources, right?

2. If the non-federal participant finances the same share by issuing a federally subsidized tax-exempt bond to be repaid from non-federal sources, that’s OK too, right? The cost share is still a non-federal asset, yes?

3. But if the non-federal participant finances 49% of the same share with a federally subsidized WIFIA or CWIFP loan to be repaid from non-federal sources, that’s — not OK? The cost share is now not a non-federal asset, but a federal asset, because — why, exactly?

4. Because the current WIFIA Criteria say so?

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WIFIA’s current FCRA Criteria for financing non-federal cost shares in federally involved projects are seriously and fundamentally flawed. A radical fix is needed. But what should it look like?

A New Approach

Attempting to revise the current Criteria would amount to rearranging teacups in a rabbit hole. But the simple amendment language approach in HR 8127 and HR 2671, though clear and indisputably correct with regard to FCRA law, has its own theoretical and practical problems. I think a new approach is necessary.

Any approach to a solution at this point will certainly require amendments to WIFIA’s statute, but this is not necessarily bad. In the amendment process, Congress should also effectively be confirming its intent that WIFIA loans are meant to support water infrastructure sectors outside of state and municipal water agency projects. Such a general confirmation is important, I think, not only for CWIFP but other potential classes of WIFIA borrowers, as well. However, the amendments themselves should be narrowly focused on addressing the specific FCRA issue faced by non-federal cost-shares in federally involved projects, an area that realistically concerns only CWIFP and perhaps a few other federal infrastructure loan programs. A minimalist solution is all that’s needed in this case and has a better chance of getting through the process.

A Cost-Share is a Non-Federal Asset, not a Donation

The specific problem for non-federal cost shares in federally involved projects is that FCRA law does not define a ‘non-federal borrower’. The law’s drafters probably didn’t think it was necessary. The absence of a precise definition is not a problem for the vast majority of federal credit programs where the borrower is clearly using the loan proceeds solely for its own, manifestly non-federal purposes, and for which it agrees to be on the hook for repayment from its own, non-federal resources.

Things are inevitably more complicated in an infrastructure project cost-share situation where federal and non-federal interests are mixed. However, I think it still can be presumed that the non-federal partner is acting in its own interest and will only agree to undertake project obligations (e.g., the repayment of a WIFIA loan) to the extent they’re confident that they’ll receive, in commensurate amount, their own, non-federal value. That value, no matter how intangible or undivided within the project, will be an identifiable, measurable and contractually enforceable non-federal asset. The non-federal partner is not financing a patriotic donation, after all.

But No Funny Business

Nevertheless, the presumption of a borrower’s true and unadulterated non-federal self-interest should be validated in the application process. Large-scale infrastructure finance involves big money, complex arrangements and a lot of politics. Shocking, I know, but in the real world, budgeting games are sometimes played, undue pressure may be applied, participants are not always above-board, costs and assets may be incorrectly valued, etc. Such shenanigans can conceivably taint the character of the borrower with respect to FCRA’s implicit assumptions about non-federal self-interest being the pure motivation behind non-federal repayment. For example, an unethical federal participant might decide to ‘persuade’ a reluctant local community to pay for a share in its project with some sort of veiled threat. The intimidated locals cave to the shakedown and finance the extorted amount. Assuming the federal participant is not crooked in other ways, the resulting cost-share asset may well have value equal to the loan, but not for the local community, who can’t use it and didn’t want it. The share is, in effect, an ill-gotten federal asset. The loan’s source of repayment is nominally non-federal, but substantively federal, as a type of taxation made possible by the misuse of federal sovereign power. Obviously, this is not an arms-length deal, unless twisted arms count. And it’s not at all what FCRA law and principles were assuming.

In our imperfect world, it is therefore simply common sense to require that a WIFIA applicant for a loan to finance a cost share in a federally involved project be asked, in addition to all the other due diligence questions, to demonstrate that (1) the value of the non-federal asset it expects to receive is commensurate with the loan, and (2) that its decisions are being made independently, on an arms-length basis in accordance with its normal procedures. Honestly dealing and freely deciding applicants shouldn’t have a problem with that.

Two Low-Impact Amendments

A focused and commonsense validation process, as opposed to an amendment of eligibility, for non-federal cost-shares is what WIFIA’s FCRA Criteria should have been designed to do, and probably what Congress intended in the 2020 Directive. The current Criteria are far too deep in the rabbit hole to be salvaged, but in any case, amending WIFIA’s statutory eligibility is a more transparent path to definitively resolving what has effectively become an issue of fundamental WIFIA eligibility.

The necessary modifications will take the form of two short, low-impact amendments. The first goes to the heart of the issue and adds a specific definition for “non-Federal borrower” to WIFIA’s Section 3902 list of defined terms. The definition will start by essentially restating FCRA law and principles (i.e., a non-federal borrower using non-federal resources for loan repayment) but goes on to add the special validation provisions required for non-federal cost shares.

To avoid any ambiguity, the last part of the definition will deem a non-Federal borrower successfully complying with the rest of the definition to also be a ‘non-federal borrower’ under FCRA law, a characterization that will dovetail into WIFIA’s existing statutory budgeting procedures without further action. Note that the foregoing compliance steps (A) through (D) are substantive and certainly not deemed. Only this final step has an automatic consequence, as a way to confirm a direct connection to FCRA law, the sole goal of the definition.

Importantly, this definition is not meant to be used throughout WIFIA (where the existing term ‘obligor’ is sufficient) but only in Section 3908 (b)(8) where specific eligibility for non-federal cost shares is located. Eligibility there is already limited to an obligor with a non-federal source of repayment, which might be good enough for original policy intentions but is insufficient for FCRA purposes. The second amendment therefore replaces the qualification with the more expansive requirement that the borrower be a non-Federal borrower per the defined term, as determined by the Program.

That last item is important. Status as a non-Federal borrower shouldn’t be automatic, but subject to programmatic discretion, no matter how objectively clear that status might be in particular cases. This is not unusual. The same is true with respect to credit approval for very high-quality applications that obtain a AAA rating in their agency opinion letters. Broad lender discretion just goes with the territory in project finance. Of course, it also means that OMB will have to sign off on the program’s decision. That’s as it should be, and they doubtless will ask very hard questions. However, OMB’s FCRA grilling now will necessarily be guided and bounded by the requirements of a precisely relevant statutory definition. This won’t be a rabbit hole. There are rules.

What the Amendments Will Do

Operating together, the amendments outline a process to establish eligibility for a specific sub-set of applicants. Most EPA WIFIA and perhaps many CWIFP applicants can ignore it. But if you’re planning to finance a cost share, you’ll need to go through Section 3908 (b)(8), as before. Now, however, just showing that your source of repayment is non-federal isn’t sufficient. You must be a qualified non-Federal borrower to be an eligible obligor of a WIFIA or CWIFP loan. The definition shows what you’ll need to demonstrate for the program to consider approval.

I’m assuming that the typical non-federal cost share here involves a relatively big loan to pay for a substantial (though not majority) share of a major project, though I think the process established by the amendments should be workable for a range of possibilities. In a typical situation, the applicant should have the material necessary for the non-Federal borrower demonstration mostly in hand. The credit agency review for the opinion letters will naturally focus in-depth on the loan’s repayment sources. A thorough benefit-cost analysis of the cost share will almost certainly have been completed, either for private-sector investors or public-sector authorities representing local taxpayers. Those distinctly non-federal folks expect to see a convincing case for the value they’ll receive from the cost share relative to their money expended, which is the same case required under the definition.

It should also be straightforward for the applicant to show that its decisions were made independently on an arms-length basis, especially for a public-sector applicant that has had to obtain council approvals or successful voter referenda to proceed with the deal. If this isn’t straightforward for any reason — well, the applicant will need to expect more questions and possible rejection. An ‘above suspicion’ standard is not an unreasonable position for the program to take under the circumstances — there are likely plenty of honest and straightforward infrastructure cost-share situations out there that need financing. The program should prioritize these and let more marginal or complex situations find financing elsewhere.

What the Amendments Won’t Do

Perhaps as important is what the amendments won’t do. They won’t require an unnecessary and completely FCRA-unrelated determination of whether a federally involved project is a ‘federal project’ or something else — the amendments’ minimalist focus is solely on the non-federal share for which the non-federal applicant is seeking a loan, and specifically with respect only to the FCRA classification of the loan itself. They won’t alter WIFIA’s FCRA procedures or deny OMB the final word in this aspect of the program’s budgeting matters. They won’t establish a FCRA precedent for anything other than non-federal cost share situations in federally involved infrastructure projects, a very specialized area covered by only a few loan programs. And hopefully, enacting them won’t require a zero-sum fight in which someone must be publicly proved wrong, and where only one side can win, but both may lose. The amendments will occupy a small, commonsense-oriented place in the middle ground, which is where this issue belongs. Why make any solution a bigger deal than it has to be?

A Graceful Exit for the Current Criteria?

I may be missing something about the way laws work here, but I think that even if these amendments (or the ones in HR 8127 and HR 2671) are enacted, the current Criteria will still be out there and in force. Recent ‘until expended’ appropriations for WIFIA and CWIFP contain specific conditions about certified compliance with the Criteria — they’ll still be on the books, right? Couldn’t the pro-Criteria side simply say that the new definition and modified cost-share requirements are all very nice, but the applicants will have to jump through the Criteria’s hoops as well? And mention, oh by the way, the non-statutory modification of 3908 (b)(8) in footnote 4 is still applicable?

I’d be fairly certain that an additional step is required to defuse the current Criteria and close the rabbit hole for good.

The simplest way, and perhaps what the proponents of HR 8127 and HR 2671 were thinking of, is for Congress to add more law that essentially deems approval by the program and OMB under the new amendments to be compliance under the Criteria wherever that’s required in existing funding authorizations, and then exclude funding conditions (or anything else) related to the Criteria from new legislation going forward. Simple and definitive — but very public and a bit harsh to the pro-Criteria side, no?

It may make sense to consider face-saving alternatives for this step, if only to preserve political energy for substantive battles about WIFIA eligibility. One approach is simply to note that if FCRA-related parts of WIFIA law are amended, the Criteria should naturally be modified to conform to that new law. A short, judgement-free Congressional directive could instruct the relevant parties work together off-stage to produce criteria that are consistent with the processes outlined in the amendments. Some useful refinements and clarifications to the approval process may even come out of that, though the real point is to give the pro-Criteria side an opportunity to gracefully back down in private. Since the new criteria will be consistent with the new law, there needn’t be any further fuss about the issue. Everybody wins.

But if the pro-Criteria side wants to continue fighting to preserve their rabbit hole version of FCRA reality — well, then it’s back to the public arena, where they will likely lose. This is because while WIFIA and CWIFP eligibility for real public infrastructure matters to real people, the current Criteria aren’t worth defending for any reason since they can easily be replaced by something that’s demonstrably better. I believe the pro-Criteria side knows this, and if they’re offered a diplomatic off-ramp, they’ll take it.