Silver lining

My former boss, Ambassador Angus Friday, who represents Grenada at the United Nations, updated his Facebook status on October 3 shortly after US President George W. Bush signed the Emergency Economic Stabilization Act of 2008, which has been described by the American news media as a "bailout" of the US financial system.

In Friday's status update, he wonders "Where do we go from here: we have the financial crisis, the food crisis, the fuel crisis and the climate crisis. There MUST be a SILVER LINING!" Indeed, as difficult as it is to comprehend the negative implications of these crises, an optimist must hope that there will be some positive outcomes as well.

The bailout authorizes the United States Department of Treasury, under Secretary Henry (Hank) Paulson, to spend up to $700 billion to purchase distressed assets, especially mortgage-backed securities, from several of the nation's banks. The bailout bill was created under great time pressure, and many people are concerned that it won't be effective or fair. The public has been informed that the governmental bailout is the only way to avoid a modern day depression. According to Secretary Paulson, the bailout is not pleasant, but it is necessary.

I wonder: how did we get here? And where will this bailout plan lead the financial and economic system? How will it impact an emerging industry such as renewable energy?

Mortgage problem

This financial crisis is the culmination of a domino effect, which has been happening over the past several years. During the Clinton administration, the government policy became lax at its sponsored agencies Fannie Mae and Freddie Mac, and required them to loosen their underwriting standards. The less strict regulation had enabled many mortgage brokers, motivated by commission, not to scrutinize potential borrowers' incomes and credit histories, and not to explain the fine print about the mortgages to the borrowers, including the fact that the mortgage interest rates and monthly payments would increase drastically after a few years. At the same time, the Fed - the central bank of the United States - lowered interests rates. All those facts made mortgages seem to be affordable to everyone.

Financial institutions saw those mortgages as a great way to impress the capital market. Therefore, those mortgages were bundled into complicated securities such as Collateralized Mortgage Obligations (CMOs), which were sold to Wall Street and overseas firms; they were then traded like stocks but without any oversight by the US Securities and Exchange Commission. In other words, the combination of cheap mortgages and investor demand for financial products created an unregulated housing bubble.

Many subprime borrowers, who have a shaky credit history, began to default on their mortgages, which caused home prices to start to fall. Lenders saw this trend and were afraid that they would lose money on these investments, so they started to tighten credit.

The tightened credit market made it difficult for borrowers with good credit to get loans for new mortgages or for financing businesses. In addition, Wall Street had invented a new financial instrument called Credit Default Swaps (CDS). These were, in essence, insurance policies in which investors purchased to the risk of default. By the middle of 2008, these were over $50 trillion of CDS in existence and risks of default had spread like a cancer all through the banking system. This caused big lenders nationwide to fail, when the "asset value" of the CDS was discounted.

In March 2008, Bear Sterns, one of the largest investment banks on Wall Street, collapsed because of its large subprime securities holdings. The Fed arranged for the acquisition of Bear Sterns by JP Morgan Chase in May 2008. After that, mortgage giants Fannie Mae and Freddie Mac were seized by the Fed at a cost of $5.4 trillion. Lehman Brothers went bankrupt, while Merrill Lynch, AIG and others were standing in a line to be rescued by Uncle Sam.

This brought us to a point where the illiquidity of major financial institutions caused those institutions that were liquid were afraid to lend their money to any institution and individual. The spooked public believed that they'd better take their money out of the bank and out of the market. The US economy is based on borrowed money, so when banks stop lending money, private sector growth began to stagnate and unemployment began to rise. Hilary Clinton explained: "If you can't borrow money to buy a car, to replenish inventory, to do payroll, you can not do business on a day-to-day basis." Therefore, the subprime crisis turned into a broad financial crisis, which is impacting every sector of the economy.

The $700 billion bailout plan is designed to boost confidence among investors and banks. However, the real impact that it will have is unknown. Taking the renewable energy sector as an example, the bailout's impact on this emerging industry might be mixed.

From a positive perspective, tax incentives for renewable energy, which had been awaiting renewal by the Congress for months, were bundled onto the bailout plan. These tax credits extension for wind, solar, and other renewable energy development will have immediate positive effects.

The wind and solar projects which were planned for 2009 were put on hold as developers waited for Congress to act. Now the law has been passed, developers can begin to move forward. Meanwhile, the Fed has lowered interest rates, which will decrease the cost of developing renewable energy projects, potentially making renewable energy projects more attractive to investors as compared to coal and nuclear projects, because they provide a quicker rate of return on investment.

Nevertheless, we remain in the midst of a financial crisis. Tighter credit markets make it more difficult for developers to get senior loans, which are necessary for wind farms, geothermal plants and other renewable energy power plants.

Tax credits

In addition, Wall Street's crash makes the tax credits for renewable energy project less effective than they otherwise would have been. Eric Silverman, a partner at Milbank, Tweed, Hadley & McCloy LLP, a global law firm, points out, "the only kinds of people who would take advantage of tax credits are the largest, most profitable corporations, like JP Morgan Chase and Goldman Sachs, or big players like GE". In the past, bankers or companies have bought majority stakes in projects in order to leverage the tax credits associated with them, providing project developers access to money to implement planned projects.

However, Lehman's bankruptcy and a conversion of Merrill Lynch, Goldman Sachs and others to "commercial bank" status caused a loss of the important providers of tax equity financing for US wind farms.

As the capital market dries up, developers in various sectors will compete for the limited money offered by surviving banks and financial institutions. This competition increases the cost of doing business. The tighter credit market also impacts consumers, and will make it more difficult for them to finance energy efficiency upgrades and alternative technologies such as solar panels for their homes and businesses.

Furthermore, the instability in the stock market makes it harder for companies to float IPOs and generally to raise capital in the public capital market.

In the context of such a large and complex economic crisis, it is difficult to predict what will happen to an emerging industry such as renewable energy.

The author is the China Program Associate at the American Council On Renewable Energy (www.acore.org ). She can be reached at su@acore.org . Michael Eckhart and Robert Dacosta contributed to this article which represents the author's views only.

(China Daily 10/20/2008 page11)