OMB analyzes the credit risk of federal loans very carefully. This is as you’d expect — most federal loan programs are intended for borrowers who don’t have many cost-effective private-sector alternatives. Credit loss will be the main factor in the cost of such loans.
But even for large, highly rated public sector entities with excellent access to short- and long-term sub-UST tax-exempt finance alternatives, OMB assesses potential credit losses, as small as they are, just as carefully. OMB apportioned the AAA Indiana Finance Authority SRF Tranche 1 with a credit subsidy rate of 0.30%, while the AA City of Fort Worth loan got a rate of 0.32%. Very precise analyses on very small numbers.
But could EPA WIFIA loans experience significant losses from other, non-credit factors? Like a highly rated borrower drawing a 1.45% loan commitment only when their short-term financing rates are above that level and 20Y UST funding costs are in the 4.25% area? This type of predictable behavior caused funding losses $2.1b on approximately $10b of WIFIA loans disbursements. Why wasn’t OMB as equally careful about this type of loss?
Funding loss on fixed-rate loans is not different than credit loss. Once a fixed-rate loan with scheduled debt service is issued, the principal amount is not relevant to its valuation — only the NPV of future cash flows is, a reality that FCRA law and even OMB’s own FCRA methodology recognizes. It does not matter whether a $2.1b federal loss in NPV value comes from a loan doing a Solyndra with zero recovery or a loan paying much less in interest than the Treasury is paying to fund it. In both cases, in economic terms, the taxpayer has to cover the NPV shortfall of expected borrower cash flows.
No Skin in the [Blame] Game?
Since I’m sure OMB understands funding losses, the question remains as to why they don’t consider this factor in apportionment for WIFIA loans. Perhaps the answer comes, ironically enough, from the ‘The Solyndra Failure’ (House Majority report August 2012), page 17:
OMB definitely has ‘skin in the game’ when it comes to credit risk assessment, something amply demonstrated in this report itself. But maybe they’re not so incentivized to care about possible funding losses — as ever with bureaucrats, a taxpayer loss is only a problem if you can be blamed for it. I think there are two reasons why OMB might expect that WIFIA funding losses, even at the current ‘Solyndra-times-four’ scale, won’t even be considered a ‘problem’, much less a source of blame.
- First, everybody understands a principal credit loss — you lend $100 and get less than that amount back. Bond-type NPV losses due to funding cost are obviously well understood by financial people, but not so well by most. The Solyndra loss was a borrower default, and that’s easy to describe in simple terms. That’s not the case for how performing loans to highly rated public water agencies lost $2.1 billion a few years after their execution, especially in opposition to the standard WIFIA ‘narrative’. As in, “The agencies build useful projects, create thousands of jobs, provide clean water and are paying back their loans — how can there be a problem?” and that kind of thing.
- Second, and much more substantive, is that through ‘technical re-estimates’ for loan disbursements, funding losses will be automatically covered by permanent indefinite authority to impose mandatory appropriations, as outlined in a prior post. PIA is available for credit losses too, but they’ll be preceded by a default and legal actions, so hard to hide and blame will flow. In contrast, a funding loss on a performing loan is self-contained within the FCRA mechanics and arcane details of the federal budget. Congress is not involved, no investigations are triggered, and likely very few people in EPA or OMB would even be aware of a funding loss or understand its nature. To an extent, this was perhaps by design. FCRA re-estimates were not meant to be an oversight or monitoring indicator of a problem with the loan. Such indicators would be operating elsewhere (e.g., a credit default’s legal consequences, incomplete compliance, etc.). Instead, the re-estimate process is an account-balancing adjustment mechanism to accommodate the presumably minor variations from original expectations that always occur in loan management, and keep this ‘noise’ out of the main budget. If no other alarm bells are ringing, no one needs to be officially concerned, and the funding loss numbers just are what they are.
Creating an ‘Indifference Deficiency’
Without ‘skin in the blame game’, EPA WIFIA and OMB can be indifferent to funding losses and the mandatory appropriations required to cover them. This ‘indifference deficiency’ in the apportionment of discretionary appropriations is subtly different from the classic ‘coercive deficiency’ prohibited by the ADA. There doesn’t need to be any active effort or planning to justify a future coercion — just don’t bother to think about the consequences of WIFIA loan commitment terms (“they’re unpredictable!”) and let the FCRA re-estimate machinery automatically do the coercive work a few years later, off-budget and off-stage.
Note that the characterization of funding losses as ‘unpredictable’ is key to the justifying indifference. Even with $2.1b of losses on $10b of disbursements, there’s a lot of scope in this defense. In standard WIFIA ‘narrative’ terms, it’s nearly bulletproof — the whole topic is far too complicated for most people to judge what was predictable or not. But even among the better informed, the extreme movements in interest rates during WIFIA’s operational period 2018-2025 seem to offer some defense. In the chart at the top of this post, the rise in 20Y UST rates off Covid-suppressed historic lows in 2020-2021 back to historical averages 2023-2025 was rapid. Yes, in retrospect the $2.1b loss was predictable, but was it at the time?
As with credit loss, exact funding losses will of course never be predictable. But I think there’s a strong case to be made that some funding loss was predictable when WIFIA was executing and resetting loan commitments in 2020 and 2021, and the failure to apportion anything for this cost is a specific violation of the ADA. Simply ignoring the probability of funding loss at any time in the interest rate cycle is a more general violation. The rationale for specific and general violations of the ADA is different, so I’ll sketch them out separately.
Apportionment for loans executed at a specific point in interest rate cycle: Look again at the chart at the top of this post. If an OMB official had looked at the interest rate data up to mid-2020, the average 20Y rate would have been 4.5% with a standard deviation of 1.65% — not appreciably different than the values through January 2026 (4.4% and 1.63% respectively). Even apart from the fact that low rates were due to active Fed rate suppression during Covid, the low 20Y UST rates in 2020-2021 were outside one standard deviation from the long-term average and might be expected to revert to the mean at some point when loans were being disbursed over the next five years. Not certain by any means, but at least somewhat probable? At least as probable as the tiny chance of a Aa3/AA- borrower defaulting a few years after loan drawdown?
The point is that just as OMB should (and apparently does) use all available data to assess probable credit losses, readily available data for probable funding losses on future disbursements should also be considered in apportionment at loan commitment execution.
Apportionment for loans executed at any point in interest rate cycle: A different type of defense for indifference deficiencies comes from the likely intention of FCRA re-estimate mechanics in the first place. The argument would roughly go: “Yes, loans executed at low points in the interest rate cycle will likely cause funding losses, but these losses will eventually be balanced by funding gains from loans executed at high points. On a net basis, this is budgetary ‘noise’ and ignoring it results in a better budget ‘signal’ for policymakers. In contrast, credit losses are always one-way, and a precise assessment provides a pure ‘signal’ for policymakers”.
This argument has a lot of merit for most federal loans. But not for EPA WIFIA’s Aa3/AA- public-sector borrowers. Consider what borrower behavior would be if the same scale of change in 20Y UST rates had occurred but in the opposite direction. This in fact happened between 2009-2010 to 2020-2021 — a 3.5% fall over ten years as opposed to a 3.5% rise over five years. If EPA WIFIA had been in operation and making loan commitments in 2010, could anybody credibly argue that a $2.1b funding gain on $10b of disbursements would have happened? That Aa3/AA- water agencies would have drawn 4.5% WIFIA loan commitments when 20Y UST rates were in the 2.0% range and tax-exempt bond rates even lower? Of course not. The commitments would have been cancelled or reset, as many 2018-2019 loan commitments were.
To think that EPA WIFIA borrowers will ever be the source of significant funding gains is as unrealistic as assuming that some borrowers will voluntarily be the source of ‘credit gains’ by overpaying their loans. Never happen. For this type of highly rated public sector borrower, funding losses are like credit losses — one-way only — and should be assessed in the same way.