Solyndra Could Teach Us Something

But will we learn?

It seems unlikely we will learn anything from Solyndra, and that’s not a reference to the Company’s use of the 5th amendment. When there is a potentially juicy scandal or blame is in play, no one, least of all the media or politicians, is going to resist posturing. However, any scandal and who is to blame are irrelevant to the important issue.

There are two important lessons. First, the government should severely limit its use of loan guarantees. Second, development of technology firms is based more on the availability of equity than credit. They need more owners investing, not loans.

Solyndra provides plenty of material for entertainment, FOR SURE. Just for starters, Congressman Henry Waxman defending businessmen’s use of the 5th amendment to stiff Congress is a true laugh-out-loud moment. If hypocrisy were an impeachable offense, he’d be out in a moment; but then we do expect California to generate entrainment. On a serious note, we definitely need to repeal whatever law creates a punishment for Contempt of Congress. Otherwise, public polling data indicates, we’re going to have to punish the entire nation.

Unfortunately, those media that aren’t dominated by Democrats are focused on who knew what and who did what. The Treasury Department warned that the loan to solar-panel maker Solyndra LLC might be illegal. So what? We all know the Obama administration may have brushed aside warnings, prudence, and conflict of interest. Others question the administration’s quasi-religious belief in solar. However, those aren’t the important issues. The mistake isn’t that the government didn’t do its due diligence or may be tilting at windmills. Set those issues aside; just file your opinion as yours. The real issue is not what people in government did; it’s whether government should have been doing anything special at all.

The government should stop doing things it is bad at doing. It’s wise to remember that the entire Solyndra mess began with a loan guarantee. Someone needs to recognize the parallel between Solyndra, Freddie Mac, Fannie Mae, failed banks and thrifts (e.g., Indy Mac, WAMU), government-backed student loans, and the legion of government guarantee borrowers.

On July 18th, in a discussion of the tendency of the blame game to distract from productive activities (see: “More Fireworks”), this blog noted that:

“With few exceptions, The Hedged Economist doesn't like government loan guarantees as a policy. They move a liability of unknown size to the treasury. The preferred approach is the cut and dry of either making the loan or not. But, loan guarantees can make sense in a panic.”

Why? It’s very hard to determine the subsidy the guarantee implies. Basically, the government is providing a benefit of an undetermined size with a cost that is uncertain. Further, the government is lousy at assessing credit risk and default risk. Interesting thing is that the government employees at the regulatory agencies that do credit assessment for a living (e.g., bank examiners) realize how difficult credit assessment is.

There is one important exception: That’s during a legitimate panic that is creating a liquidity crisis. During a panic it gets a bit easier to determine who is insolvent as opposed to who is illiquid. The panic and its impact on liquidity are the problem, not the solvency of most firms. It’s still hard to determine solvency. In fact, it is hard enough to expect some errors, but that’s life. The object is to be right most of the time, not every time.

The unfortunate thing is that the public has a mistaken belief that a loan is a bailout rather than an investment. Thus, we may end up dependent on loan guarantees as the only option during liquidity crises. That, however, only reinforces the need to avoid using them for other reasons.

Even government loans, as opposed to guarantees, should be avoided. The reason is simple. As noted back on September 15, 2010 in “Stimulus more or less? A failure not being acknowledged. PART 3:”

“… some observers object to loans that made a profit, but applaud those that will be written off and vies-a-versa, often with no justification based on differences in benefits.”

Not only do a lot of people think loans are a bailout, many think that they should be. You’d think the mortgage bubble would have taught us that making loans that can’t be paid back isn’t sustainable.

But, you say, the government can identify good things to do: why shouldn’t it direct resources toward those good things? That’s totally irrelevant to the issue. Governments have budgets. Let them tax and spend. The issue is the false efficiency of loan guarantees and loans that aren’t paid back.

Now to the second point, loans are NOT always the right solution, although one can understand why governments that can’t balance a budget might not see that. Talk to entrepreneurs, and more than likely equity will come up. That’s especially true of entrepreneurs in new types of businesses (e.g., new business models or new technologies). It’s invariably the case with entrepreneurs who are focused on having a significant impact.

In that environment a loan is a totally inappropriate approach. From the lender’s perspective, it bares the same risk without the potential return. From the borrower’s perspective, it drains cash flow on debt service that the entrepreneur needs to grow.

The problem in start-ups isn’t credit availability as much as equity capital. The government seems incapable of recognizing the damage it does by directing excessive credit to pet fascinations (be they housing, solar, small business, etc.). These activities need equity capital not credit. Combine that with its focus on protecting equity investors from the risks inherent in start-ups, and the government has forced many entrepreneurs into relying on the wrong forms and wrong sources for cash.

If government wants more new solar technology it should focus on the obstacles it places in the way of entrepreneurs seeking equity. One obstacle was discussed from the investor’s perspective in “Investing PART 12: Angel Investing.” Specifically it noted:

“Angel investing is just one of many potentially beneficial financial behaviors the government makes difficult.”

For a broader discussion, “The discussion Congress should be having: PART 1 Angels, entrepreneurs, and diversification” addresses a number of obstacles. It is not a policy prescription. Rather, it discusses obstacles.

The key mistake and the one that is essential to understanding how Solyndra relates to the failures of our current economic policy was summarized in this blog’s first posting on entrepreneurs on April 9, 2010, “Angels, entrepreneurs, and diversification: PART 1.” After relating how the issue explained the anemic recovery and would result in continued slow growth, three points were noted:

"First, equity capital is particularly hard for entrepreneurs to access.”
“Second, equity capital and borrowed capital, like bank loans or SBA-backed funds, have differential economic implications.”
“Finally, access to angel investors and early stage equity capital has different impacts on different industries.”

The last point is particularly relevant to Solyndra. The market supports solar applications that pay for themselves. In 1978, the first solar-powered calculator appeared. Since the 1950s, solar has dominated the powering of satellites in earth orbit. In almost every state, homes that aren’t on to the grid have found it cost-effective to combine solar with diesel generation. Many decades ago The Hedged Economist invested in a solar firm with quite acceptable results. It generated hot water. That was before photovoltaic was the rage.

Solar is a big industry, with a long history and lots of expertise. The expertise and experience to figure out where solar opportunities lie is there. There is no reason to believe government can successfully outsmart an entire industry of solar experts. But, worse yet, one has to wonder at the hubris that also led them to believe government could better structure the financing than the entrepreneurs and investors involved. Clearly, they got it wrong. Solar deserves more equity, and government loan guarantees or loans are a silly substitute. They may even retard the development of viable solar applications.

Note that other than the disclosure about a previous investment, nothing said above represents anything positive or a negative about solar. Further, if Solyndra had turned out to be a roaring success, everything said above would still be equally true.