A Trillion Dollars for Infrastructure Left on the Table

While legislators and policy makers wring their hands over the condition of our nation's infrastructure and waterways, there is over $1 trillion -- conservatively at hand -- to fix the problems.
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As you read this, a House/Senate Conference Committee is considering the Water Resources Development Act, one of the principal sections of which creates a federal guaranty to stimulate investment in water projects. In addition, on Thursday, November 14, ten U.S. Senators introduced "The Building and Renewing Infrastructure for Development and Growth in Employment Act ("BRIDGE Act") to create yet another new public authority, funded with $10 billion, to guaranty bonds issued to fund infrastructure projects.

The irony of all this is that while legislators and policy makers wring their hands over the condition of our nation's infrastructure and waterways, there is over $1 trillion -- conservatively at hand -- to fix the problems. These enormous resources lie in the EPA's Clean Water State Revolving Fund. The motto of the Fund is "Tapping the Untapped Potential." The absolute greatest amount of untapped potential in the entire Fund lies in its financial guaranty powers. And, since $1 trillion is more than even the wildest need estimates for clean water, the Fund could easily be broadened to include other infrastructure, specifically the $300 billion of needs in the BRIDGE Bill.

The Environmental Protection Agency was founded in 1972, the same year Congress passed the Clean Water Act. Over the next 15 years, Congress pumped about $72 billion into a construction grants program for sewage treatment plants. By 1987, most of the needed good had been done. So, the Congress amended the Clean Water Act to replace the grant program with a revolving loan program, which is the Fund. (There are actually individual "funds" in all 50 states plus Puerto Rico.)

The Fund is now 25 years old. It has financed over 33,000 projects. And, it has provided over $100 billion of financial assistance. It is by far and away the most successful environmental finance program on this planet.

The BRIDGE Act sponsors believe that their $10 billion will generate another $290 billion of investment. This is called leverage. The BRIDGE Authority will have 30:1 leverage. At present, the 51 Funds have combined net assets of about $50 billion. Using the BRIDGE Act's 30:1 leverage ratio would mean that the Funds could collectively finance over $1.5 trillion of projects. But even a more conservative 20:1 leverage ratio will mean that the Funds can finance over $1 trillion of projects. All that needs to be done is to change the name to something like the "Clean Water and Infrastructure State Revolving Fund" and add some management capacity to deal with the non-water infrastructure programs.

In each of the last 25 years, Congress has appropriated money for the Fund. The money goes to EPA, which passes it onto the states under a formula. The states cannot use this money to make grants or otherwise dissipate the capital in their funds. This concept is crucial to the program. The money must "revolve". No matter how it is used, it must return to the Funds. It must revolve back to the state Fund.

Fund money can be used in three ways. They can make direct loans for no more than 20 years. Second, the Funds can purchase debt of local governments issued for eligible projects. Third, and most importantly, the Act authorizes the Funds to guaranty debt. It is this subsection, dealing with the issuance of financial guaranties that offers - by far - the most untapped potential in the entire program.

Of the 33,000+ projects financed by the Fund in the last 25 years, only three - yes, three - have been funded with a guaranty.

Why aren't the financial guaranty powers of the Fund more widely used?

There are several probable answers.

When Congress replaced the grants program with the Fund, the cheapest source of funds disappeared. So, there was huge political pressure to make the terms of any Fund programs as cheap as possible. The local sewer agencies might have to repay principal, but they certainly didn't want to pay interest. And, if they did have to pay interest, they wanted to pay as little as possible.

In addition, and more importantly, there was a competition factor, or probably more accurately, a fear of competition factor.

Most Fund borrowers are local sewer authorities. Most such authorities have excellent credit ratings, above investment grade. As such, they have the capacity to independently access the municipal bond market. If they could do so on their own, why bother with the Fund? Besides, the Fund has certain federal requirements -- called crosscutters -- that are not applicable to municipal bond financing. So, the Funds' administrators and other state officials convinced themselves that if the Funds didn't offer attractive, i.e. subsidized, rates, all of the systems with superior credit ratings would shun the program. And so, this folklore took on a life of its own. The Funds began to make loans at subsidized rates, generally about half of the AAA rates that the Funds themselves could borrow for.

Here is how to "Tap the Untapped Potential" of the Fund.

The Clean Water Act limits direct loans to 20-year terms. There is no such time limit on the debt that the Funds can guaranty.

If AAA bonds are selling for 4%, a Fund would make a subsidized loan for 20 years at an interest rate of 2%. If the market rate is 5%, they'll lend for 2.5%.

The annual payment on a 20-year $1,000 loan at 4% is $73.58. The annual payment on the same loan at a subsidized rate of 2% is $61.16. This savings is very real and very important to the local governments and their agencies that borrow from the Funds.

Now, let's look at the same transaction as a 30-year guaranty as opposed to a 20-year direct loan.

Using a $1,000 loan again as an example, the payment on a 2% subsidized loan for 20 years is, as noted above, $61.16. The payment on an unsubsidized 4.5% loan for 30 years is $61.39. The difference between $61.16 and $61.39 is negligible. It is $0.23 per $1,000. Therefore, the key to using the guaranty power of the Fund lies in replacing 20-year, subsidized, direct loans with 30-year, unsubsidized, guaranties.

(When the interest rate on a 20-year bond is 4%, the interest rate on a 30-year bond would be about 4.5%.)

Thus, the Fund can serve its sewer authority clientele with virtually the same low rates by guarantying their debt as opposed to direct lending.

Does the country need to create another government agency to guaranty debt on clean water projects? No. Does it need to create another government agency to guaranty bonds for $300 billion of other infrastructure projects? Definitely not. All the country really needs to do is to restructure the Fund so that all kinds of infrastructure projects can take advantage of their $1+ trillion of guaranty capacity. The country just needs to "Tap the Untapped Potential" of the Fund.

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