The Solyndra Loans as Liar’s Loans
William K. Black
September 27, 2011

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This column comments on Joe Nocera’s September 23, 2011 column entitled: The Phony Solyndra Scandal

Nocera’s column compares the statements of Solyndra’s controlling managers to Dick Fuld’s statements to the public about Lehman’s conditions and asserts with minimal explanation that neither could have been criminal. I have testified before the House Financial Services Committee at some length as to why Lehman was a “control fraud” so I disagree with Nocera. Lehman engaged in extensive accounting and securities fraud and caused massive losses by selling endemically fraudulent liar’s loans to the secondary market. It Soyndra’s controlling managers made false disclosures analogous to those made or permitted to go uncorrected by Fuld, then they too face a serious risk of criminal prosecution – it we ever replace Attorney General Holder with a prosecutor.

I also write to explain why Nocera is wrong to absolve the White House from scandal in the Solyndra matter. Nocera argues that it is inherently highly risky for the government to lend to companies the market will not loan to because their “green” projects are extremely risky commercial projects. He concludes that it is inevitable that many such loans will fail and that such failures do not demonstrate that the federally subsidized loan program for green energy companies is flawed. He concludes by warning that China dominates solar panel manufacture and that China will be the winner if the Republicans cut funding for the green energy programs.

Nocera is correct that the subsidized program is extremely risky. He identifies two of the risks. First, the technology developed may prove unmarketable. Second, entry by competitors may be so robust that the price of the relevant products (e.g., solar panels) suffer a “stunning collapse” and cause the U.S. Treasury-financed firm to fail even if the development of improved technology is modestly successful.

There are obvious economic arguments against Nocera’s play of the Red Menace card. China heavily subsidizes solar panel manufacturing. Other nations (including the U.S.) subsidize solar panel manufacturing. Solar panels are still a specialty application that is not cost-effective in general usage absent public subsidies. The subsidies to the purchasers are not large enough to develop a market that has kept pace with the tremendous growth of solar panel production. The result has been a glut of solar panel production and a sharp drop in solar panel prices. In sum, the Chinese government is taking the very large financial risks of developing a new technology and the financial losses that come from selling us the solar panels at a low and sharply falling price that is inadequate to defray the costs of production and the risks of new product development. Nocera states that China has provide a $30 billion subsidy to solar panel producers purchasers, which has helped produce a glut of solar panels and caused a “stunning collapse” in their “market” price. That means that the great bulk of the Chinese subsidy has flowed to purchasers of solar panels, including Americans. Even if the Chinese develop a solar panel technology that is cost effective in general residential and commercial real estate usage there is no assurance that the Chinese government or public will find the production subsidies desirable. China may lose its solar panel production lead to a lower-cost producer or a higher quality producer. Other nations’ producers may be less than vigorous in enforcing the intellectual property rights of the Chinese producers, allowing domestic competitors to skip the large risks and costs of the research and development stage.

This column, however, generally emphasizes financial regulation, and there are reasons to use the word “scandal” to describe the administration’s treatment of its regulators in the Solyndra loan. Here is Nocera’s defense of the administration’s behavior:

“Undoubtedly, the Solyndra “scandal” will draw a little blood: there are some embarrassing e-mails showing the White House pushing to get the deal done quickly so it could tout Solyndra’s green jobs as part of the stimulus package.

But if we could just stop playing gotcha for a second, we might realize that federal loan programs — especially loans for innovative energy technologies — virtually require the government to take risks the private sector won’t take. Indeed, risk-taking is what these programs are all about. Sometimes, the risks pay off. Other times, they don’t. It’s not a taxpayer ripoff if you don’t bat 1.000; on the contrary, a zero failure rate likely means that the program is too risk-averse. Thus, the real question the Solyndra case poses is this: Are the potential successes significant enough to negate the inevitable failures?”

Nocera’s effort to minimize the administration’s misconduct and his misstatements about risk are interrelated and they reprise the mistakes that the Bush administration made in its assault on financial regulation that led to the ongoing financial crisis. Life does not reward all risks. The quintessential risk that it does not reward in lending is failing to underwrite. A lender that fails to underwrite prudently is taking a severe risk, for the failure causes “adverse selection.” Lenders that make large loans (e.g., mortgages or loans to solar panel manufacturers) under conditions of adverse selection have a “negative expected value” – they are gambling against the house. Lenders that make loans with a negative expected value will suffer severe losses.

We are still suffering from a crisis driven by CEOs of lenders who deliberately destroyed essential underwriting in order to maximize the accounting control fraud “recipe” that I have explained many times. The result was “liar’s” loans. By 2006, roughly half of loans called “subprime” were also liar’s loans. Approximately one-third of U.S. mortgage loans made in 2006 were liar’s loans and the fraud incidence in studies of liar’s loans is 90 percent. Liar’s loans caused staggering direct losses and hyper-inflated and extended the residential real estate bubble, driving the Great Recession.

So the “real question” is not the one Nocera framed. The real question is why a lender (the U.S. government in this case) would gratuitously fail to underwrite a loan properly. The fact that the type of loan was inherently extremely risky makes it imperative that the lender engage is superb underwriting. The Obama administration, and Nocera, have failed to learn the most obvious and costly lesson of the ongoing U.S. crisis – liar’s loans cause catastrophic losses and failures and are “an open invitation to fraudsters” (quoting MIRA’s 2006 report to the members of the Mortgage Bankers Association).

Nocera does not explain what is embarrassing about the Obama emails. The government’s professional loan underwriters were worried about lending to Solyndra. They were warning the administration that they had not been able to complete the professional underwriting essential to making loans prudently. The Obama administration officials did not respond by backing their professional regulators. The administration did not stress that it was essential that the loan be approved only after it passed a rigorous underwriting process. The administration responded to the efforts of its professionals to protect the government from loss by abusing the regulators and pressuring them to approve the loans without completing the underwriting. The administration thought it was fine to make a liar’s loan to Solyndra.

The administration exposed the government to a gratuitous risk of loss of hundreds of millions of dollars in order to achieve an overarching priority – they wanted a presidential photo op. If that isn’t a scandal, if Nocera thinks it is merely business as usual, then our failure to hold Dick Fuld, President Obama, and a host of other elites to a higher standard of accountability is the scandal that will generate repeated scandal.

Bill Black is the author of The Best Way to Rob a Bank is to Own One and an associate professor of economics and law at the University of Missouri-Kansas City. He spent years working on regulatory policy and fraud prevention as Executive Director of the Institute for Fraud Prevention, Litigation Director of the Federal Home Loan Bank Board and Deputy Director of the National Commission on Financial Institution Reform, Recovery and Enforcement, among other positions.

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Bill writes a column for Benzinga every Monday. His other academic articles, congressional testimony, and musings about the financial crisis can be found at his Social Science Research Network author page and at the blog New Economic Perspectives.

Category: Bailouts, Credit, Think Tank

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

10 Responses to “The Solyndra Loans as Liar’s Loans”

  1. Greg0658 says:

    Mr Black see:
    http://www.ritholtz.com/blog/2011/09/10-wednesday-pm-reads-2/comment-page-1/#comment-586174

    specificaly to this here – fraud must be investigated – but don’t be so shallow (blind to TBP) .. you may not be in the camp of “get off foreign oil imports” but I am … you may not be in the camp of “hire local” but I am … you may not be in the camp of “create a green environment” but I am

    AND I DONT give a crap if it balances on a income/loss statement .. have you been awake – its a “private profits socialized losses” world .. talk your books to your generation faster – since your starting to die off (and not fast enough) the kids need your job

  2. Greg0658 says:

    ps – more stuff building less paper pushing .. thats what our problem is here in the good’ole USA .. our GDP of BS’g

  3. BS Articles like Black’s point to why it’s so hard for government to do anything about the economy. The big picture here is that we need to be doing more energy R&D, more loans to new energy companies etc. in order to rebuild infrastructure and put demand on the economy. Our media’s obsession with government’s occasional failures, and the demonization of those responsible for them, makes it virtually impossible for our government to take the kind of bold action we need to restart our economy without being swept into a ‘scandal’. The New Deal might be impossible today, since every failed experiment to restart the economy would have been a scandal with today’s media attention.

    None of this is to say, by the way, that Solyndra was a good investment idea, and that government malfeasance here shouldn’t be thoroughly investigated. But to think that the big story in the DOE’s loan program is Solyndra is to miss the forest for the trees. The big picture is that we should be making MORE loans, not less, and that we need to take on our economy and energy challenges with the full vigor.

  4. toombsie says:

    I’m glad you posted this. People on the Left who want to ignore this story simply because Fox News is being theatrical about it are doing a disservice to their own cause. This was an unforced error by the Obama administration. If they truly ignored emails from their own regulators suggesting that the vetting on Solyndra wasn’t complete and they needed more time, then whoever was responsible for that decision should be punished. Just because $500 million lost is less money than the hundreds of billions of waste in Iraq/Afghanistan doesn’t mean we should ignore it. You should hold your own side to the same standards you try to hold the other side.

    I think Black makes a good point in this article that this is a legitimate scandal that should be properly investigated. The Left would do better to ignore the GOP and Fox News making a hyperbolic deal about this and call for an independent investigation.

  5. dsawy says:

    Let’s put Solyndra on the back burner for now.

    Let’s instead just look at the loan guarantees announced yesterday (28 September, 2011). One was for $737 million to Tonopah Solar Energy, LLC to develop the Crescent Dunes project.

    https://lpo.energy.gov/?p=5246

    Where is Tonopah? On the western edge of Nevada. Look for a east/west road US-6 and find where it intersects with US-95 south of Yerington, NV. There’s not a whole lot of Tonopah there, and the economy goes up/down with mineral exploration, especially gold and now base metals (like moly).

    Back to the solar issue:

    Tonopah Solar Energy, LLC is wholly owned by SolarReserve, LLC:

    http://www.tonopahsolar.com/

    OK, so let’s go there:

    http://www.solarreserve.com/aboutUs.html

    Open up the tab on the left side for “Investment Partners.” What do we see?

    US Renewables Group, Good Energies, Citigroup, PCG Clean Energy and Technology Fund (east) LLC, Nazarian Enterprises, CalPERS Clean Energy & Technology Fund, Argonaut Private Equity, Credit Suisse.

    You can dig through the various names there as I have, but I’ll cut to the chase and give you the shiny nugget I found in the heap:

    http://www.pcgfunds.com/people.html

    “Ronald Pelosi.”

    Pelosi? Where have I heard that name? Oh, yes, House Minority Leader Nancy Pelosi. Any relation? Why yes, yes there is. She’s his sister-in-law.

    How did he end up at PCG? Good question:

    http://www.privcap.com/snowsnotes/2011/04/how-did-nancy-pelosi%E2%80%99s-brother-in-law-become-no-2-at-pcg/

    What’s the purge that PE posting is talking about? And why have I heard of PCG before? Oh, yes, they used to run money for CalPERS… until CalPERS sacked them:

    http://online.wsj.com/article/SB10001424052748704518104575546532549007978.html

    But wait… there’s another name I recognize on SolarReserve’s investor tab: Argonaut Private Equity. Hmmm. Wasn’t Argo involved in Solyndra? Yes, it was – Argo was one of the investors who put up the $75 mil in credit and is the PE firm where the George Kaiser connection comes in.

    I think there’s smoke here. A one-off investment that benefits DNC donors and insiders? OK, shit happens.

    Two solar projects tied back to major rain-makers and insiders? Yea, there’s something there worth investigating.

  6. TomO says:

    All hat, no cattle.

    Blah balh blah for 20 paragraphs, then an unproven allegation (The administration responded to the efforts of its professionals to protect the government from loss by abusing the regulators and pressuring them to approve the loans without completing the underwriting. “. then blah blah blah to the end. How is this any different from any other right wing rant?

    Rather than a condescending, tedious and tendentious lead up to an unsupported allegation that remarkably echoes the current right wing meme, why not why TRY TO MAKE THE POINT WITH REAL EVIDENCE!

    Another right wing attack comprised of equal portions of smoke and mirrors and hypocritical posturing. How many hundreds of billions of dollars were wasted in the last administration, and where was our good hearted patriot then?

    OK, I’m a Democrat, hardly in love with Obama, but beyond that I like to see FACTUAL articles based on EVIDENCE. Find the evidence, I’ll join you in hanging whoever was at fault, but there’s a big gap between wanting something done in time for a photo op and criminality, and the author has made no attempt whatsoever to bridge that gap beyond appealing toe the biases of a right wing audience.

  7. emaij says:

    Right wing rant? Hardly. There is no more important authority when it comes to corporate fraud. Look up his background. See what he has done. Listen to what he says. Demonizing Bill Black is an attack on truth.

  8. overanout says:

    There would be lots of private capital available for this industry if they could make a profit now or some date in the future, hell IPO’s are full of future profitable companies… anyway the point being that government cannot fund new technologies unless they are willing to have a very low percentage of winners and take the heat for there failures in particular during the election cycles. Government doesn’t fit the mold as a venture capital firm while venture capital looks toward the IPO market for quick payoffs rather then creating a highly profitable private company that takes 10 to 20 years to build. So most of they deals are really about political payoffs. This also should be pointed towards the Small Business Adm loans, more wasted dollars.

    Technology has been over hyped as a job creator if the government wants to create employment then they need to hire several million workers such as teachers, teacher aids, police, fire, street cleaners etc.

  9. wkevinw says:

    Yep, demonizing Bill Black outs you as a moron. He’s about as fact-based, down the middle as they come. He goes after all of the bad guys.

  10. theexpertisin says:

    The left is in a state of panic. The walls are falling upon them (shock!!) and data indicates an American public ready to give them a good old-time ass whipping in November of 2012. As during Viet Nam, the more the largesse, spolied brats protest in the streets, the more the average voter will see who the left really is – and will be repulse, the NY area and California excepted.

    If Hillary runs (towards the center) the metrics would change. Right?