Loans to Domestic Automobile Manufacturers

December 11, 2008

Today, CBO released a cost estimate for H.R. 7321, the Auto Industry Financing and Restructuring Act, as passed by the House of Representatives last night. We estimate that enacting H.R. 7321 would increase net direct spending by $1.7 billion over the 2009-2018 period, mostly for loans to domestic automobile manufacturers. An additional $7.0 billion in potential costs would be subject to future appropriation action.

The act would provide sufficient funding to cover the costs of up to $14.0 billion in "bridge loans" to the auto manufacturers. It would make available for that purpose $7.0 billion of federal funds previously authorized to cover the cost of loans to automobile manufacturers and component suppliers for the manufacture of advanced technology vehicles (often labeled "section 136 loans," referring to the provision of law that authorized them).

How does the $7.0 billion in previous funding relate to the $14.0 billion in loans to be made under this legislation? Under federal budgeting procedures, most loans and loan guarantees issued by the federal government are not recorded in the budget on a cash basis. Rather, estimates of the various cash flows (including, for example, disbursement of the loan principal, interest and principal payments received, and recoveries on defaults) are netted and discounted to the year of disbursement so as to show a net cost or savings to the government on a present-value basis; the amount of funding needed is not the total amount of the loan, but rather the net cost, if any, on that present-value basis. That net cost, as a percentage of the loan principal, is called the subsidy rate. For example, if the subsidy rate for a $1 billion loan is 50 percent, its net subsidy cost and the amount of funding necessary would be $500 million.

CBO estimates that the subsidy cost for $14.0 billion in loans would be about $7.0 billion (an averagesubsidy rate of 50 percent), the amount of existing funds made available for that purpose.

In CBOs judgment, the subsidy cost of the bridge loans authorized in this legislation could fall within a wide range depending on estimates of potential interest income, a significant probability of default (which could be different for different firms), and possible recoveries in the event of default. Under the Federal Credit Reform Act, the Administration determines the estimated subsidy cost of loans based on the procedures specified in that act. CBOs point estimate of 50 percent represents a weighted average of many possible outcomes and takes into account the possibility that subsidy rates assigned by the Administration could fall within a wide range.

There is, however, some likelihood that the net costs of the subsidy for the bridge loans would be higher. To the extent that the Administration assigns subsidy rates to loans that exceed CBOs current estimate of the average subsidy rate, total funding availablefor bridge loans would exceed the $7.0 billion reallocated from existing funds. Such an outcome would result in greater spending for bridge loans. If, on the other hand, the Administration assigns subsidy rates lower than 50 percent, there would be no corresponding reduction in spending for loans under the bill because any amounts not required for bridge loans would remain available to the Department of Energy for section 136 loans. As a result, there is a possibility that the total loan costs resulting from this legislation could exceed the $7.0 billion in existing funds, but no possibility that they could be smaller. (We sometimes label such a situations a "one-sided bet.")

Reflecting the significant uncertainty and the possibility that the Administration might assign subsidy rates other than 50 percent, authorizing the Administration to spend higher amounts if necessary yields about $1.0 billion inestimated additional spending for bridge loans in 2009.

Another $500 million in costs arises because the act would provide, out of the indefinite "such sums" appropriation, $500 million in new funding for the original section 136 loans to auto makers (for advanced-technology vehicles).

The Congress could, in the future, decide to provide an additional $7.0 billion in fundingto replace the $7.0 billion that had previously been appropriated for section 136 loans and that, under this legislation, would be used instead for the bridge loans. This act would authorize future appropriations for that purpose, but would not provide such funding.

The remaining almost $200 million in new costs stem from provisions that would provide government insurance for certain financing arrangements made by transit systems and authorize a cost-of-living increase for federal judges.