The Great Deformation

by David Stockman

  But that was the great exception. In the main, the vast money drop stemming from the vicar’s $800 billion napkin permitted state and local officials to simply kick the can to Washington. They were thereby enabled to avoid the wrath of their own voters or, better still, the need to face down the real culprits behind their fiscal squeeze: the teachers and other municipal unions and the legions of crony capitalist health care providers who feast off the Medicaid program.

  Bernanke’s spurious depression call thus cast a long shadow of fiscal mayhem. It created a twenty-two-day sprint to fashion a stimulus bill in the new Obama White House that amounted to policy by pandemonium. In that context, the vicar was empowered to launch the giant Keynesian experiment that his Uncles’* textbooks had only pined for decades back.

  Once he had scribbled “$800 billion” on the napkin, it meant that the nation’s check-writing pen would be handed off to Speaker Nancy Pelosi and Harry Reid. Not surprisingly, they used it to pay off the National Education Association (NEA), the school superintendent’s lobby, the textbook publishers, the school construction industry, the special education complex, the preschool providers, and dozens more. For good measure, they threw in another $16 billion so that millions of middle-class college students could get their Pell Grant handouts topped up by about $1,000 each. And these money drops only constituted the $100 billion education piece of the bounty.

  To be sure, apologists for the Obama stimulus who are of the “progressive” persuasion would undoubtedly insist that even if the NEA and Head Start lobbies have offices on “K Street,” they do not belong in the same camp as the mortgage bankers, oil and gas drillers, or private-jet leasing companies. Yet, whether they were doing God’s work or lining their own pockets, as the case may be, the NEA’s impact on fiscal governance is of the same character as the notorious business lobbies that raid the tax code.

  In fact, the Obama stimulus was insidious precisely because it mobilized scores of organized special interest groups that happened to be in the social uplift business to lean hard on Washington for debt-financed fiscal subventions. Whether the $1.22 trillion that state and local governments had spent on education and public welfare in 2008 was squeaky clean and not amenable to reduction, or riddled with excesses and waste and therefore capable of deep cuts was actually not the question at hand.

  The truth was that the massive fiscal due bill at issue had been built up over two decades of faux prosperity. The issue in February 2009, therefore, was how the federal system of governance would face up to cutting these programs or raising new taxes to fund them or some combination of both. The overwhelming bulk of these outlays went to permanent programs and clients: school budgets and nursing home patients, not recession-induced caseloads. Accordingly, there was simply no justification for deficit finance of the fiscal gap which emerged when bubble-era revenues fell away.

  Yet that’s exactly what happened. The $160 billion health and education package was simply an end-run around fifty state constitutions which prohibit deficit finance of ongoing operating budgets. So four years have been lost and the fiscal gap is now greater than ever owing to Washington’s endless game of shuffling the fiscal pea from one pod to the next.

  But the giant state and local fiscal gap that the Obama stimulus temporarily alleviated is a menacing overhang which will continuously impinge upon the already paralyzed machinery of fiscal governance in Washington. The K Street lobbies mobilized by the vicar’s napkin will never stop coming back for second and third helpings.

  This is implicit in the truly shocking bottom-line fiscal equation for state and local budgets during 2010, when the Obama stimulus was having its maximum impact. Own-source tax revenue amounted to $1.27 trillion. This was 8.7 percent of GDP, meaning that the state and local tax claim on GDP had lapsed all the way back to its pre-bubble-era level recorded in 1990.

  At the same time, total general government spending (excluding pensions and insurance funds) reached a record level of $2.54 trillion, representing 17.5 percent of GDP. This was a dramatic gain from 1990 when state and local spending had been only 14.3 percent of GDP. So after the two-decade bubble finally collapsed, the state and local tax take had not budged at all, while the overall spending claim had soared by 3.2 percent of GDP—a staggering $475 billion gain.

  The point had now been reached where state and local governments were only funding half of their general budgets with broad-based local taxes on income, sales, and property. Half of the balance, or $625 billion, was coming from Washington; that is, from grants and transfers that were drastically swollen by the Obama stimulus.

  Furthermore, the balance was being obtained by a mushrooming array of user fees, service charges, permits, licenses, and especially soaring tuition charges at state colleges and universities. In theory, these user-based revenue sources are the preferred way to finance local government services, but they also measure the level of fiscal desperation and instability now embedded in state and local finances.

  At the end of the day, the vicar planted a fiscal time bomb. It is evident that state and local officials are failing miserably at the task of raising general tax revenues commensurate with their massive spending commitments, and may be reaching the limits of their political capacity to extract fees and charges. So the pressure on Washington to continue to fill this cavernous fiscal gap will be overwhelming—until the next recession ensues, and then there will be a fiscal catastrophe.

  *Summers’ uncles were Paul Samuelson, who won the Nobel Memorial Prize in Economics in 1970, and Kenneth Arrow, who won the Nobel in 1972.

  CHAPTER 29

  OBAMA’S GREEN

  ENERGY CAPERS

  Crony Capitalist Larceny

  THE FISCAL NOAH’S ARK ERECTED ON CAPITOL HILL DURING THE first twenty-two days of the Obama administration contained upward of $60 billion for green energy and was additive to about $30 billion of loan guarantee authority already in place. Yet every dime involved an unnecessary and inappropriate fleecing of American taxpayers and constituted a warning sign of the nation’s true fiscal peril. Indeed, corporate welfare this egregious, sponsored by a purportedly left-wing White House and promoted by famous venture investors like John Doerr, virtually proves that free market capitalism has been abandoned in the United States.

  GREEN ENERGY:

  CRONY CAPITALIST LARCENY IN PLAIN SIGHT

  Wholly apart from the technological virtues and economic prospects of the various flavors of green energy—solar, wind, electric-battery cars and biofuels—that landed a berth on the Obama stimulus ark, there exists an underlying truth that literally shuts down the debate. The evidence that the private market is providing prodigious amounts of risk capital to both develop and commercialize new energy technologies is overwhelming. The “market failure” meme mainly comes from promoters of perpetual “science projects” and from scofflaws peddling technology and entrepreneurial failures.

  Indeed, the Obama green energy extravaganza implicates a stunning case of taking coals to Newcastle. Financialization has done vast harm to the American economy, but that it has produced the greatest class of speculators and fortune seekers that the world has ever known cannot be gainsaid. What has been true at least since the early 1990s is that there is no speculative project in any field of commercial endeavor—internet advertising, mobile telecom, social media, online services, conventional retailing, software-based gadgets, and countless more—that cannot attract capital and even a large crowd of momentum-chasing speculators if it is even remotely meritorious or viable.

  Indeed, the Obama green energy boondoggle seems to have been flung out of some ideological time warp. It’s as if Amory Lovins had come back to the White House to see if Jimmy Carter was still wearing his cardigan sweater and took the opportunity to peddle the virtues of solar power to the new incumbent he found there. In the interim, however, there occurred the saga of First Solar Corporation and dozens like it. These stories are dispositive; they both prove Lovins was a prophet in 1979 and
also that the Department of Energy has been a sinkhole of waste ever since.

  First Solar was started in the late 1980s by entrepreneurs focused not on exotic science, but on the practical problem of relentlessly driving down the delivered cost of solar power to the point where it would attain so-called “grid parity” and thereby become competitive with conventional fuels. The company’s pioneering inventor, Harold McMaster, believed this could not be achieved with the expensive crystalline silicon wafer technology of the day, and so he experimented with various thin-film photovoltaic processes, settling on a cadmium telluride (CdTe) coating on a glass substrate.

  By the late 1990s, the venture capital arm of the (Wal-Mart) Walton family became convinced that McMaster was on the right track. So the Waltons bought the company and funded an aggressive plan toward commercialization, launching production in 2002 and reaching a respectable 25 megawatts (MW) of capacity by 2005.

  More crucially, First Solar made consistent, impressive strides driving down the cost per watt to below $2 by 2003, and then to $1.20 by 2007, below the $1 barrier in 2011, and to around $.70 at the present time. It is this cost-reduction riff that is the pathway to alternative energy commercialization. First Solar’s success with the relatively exotic second-generation technology, cadmium telluride coating, powerfully demonstrates that real entrepreneurs do not need a K Street lobbyist to locate grants for their science or capital for their plants.

  Owing to these cost breakthroughs First Solar’s thin-film technology took off like a rocket, permitting the company to launch an IPO in late 2006 at a market cap of nearly $2 billion. But then came the dramatic proof that the financial markets are crawling with punters. This reality obliterates the case for a Department of Energy nanny, whether the power-hungry Dr. James Schlesinger back in 1979 or the befuddled Professor Steven Chu today. To wit, during its first sixteen months as a public company, First Solar’s market cap soared from $2 billion to $22 billion.

  That amounted to an eleven times gain in almost as many months, and meant that the company would never again be wanting for capital. Nor would it need to lean on taxpayers to build plants and develop and launch products, as have the serial scams which emerged from the Obama stimulus. Indeed, First Solar’s manufacturing capacity went parabolic from its 25 MW in 2005, reaching 300 MW in 2007 and 2,400 MW by 2011; that is, a hundred times expansion in seven years. Today, the company has eight thousand employees, $2.8 billion of revenue, and a $6 billion globe-spanning asset base.

  Even more telling, its stock price has dropped by nearly 90 percent from its 2008 peak, meaning that the world is so full of punters and speculators that even out-and-out barn-burner successes frequently attract way too much capital and investor confidence. In this case, the Waltons made a killing from their perspicacity as venture capitalists. Yet the market is so rife with speculative capital that short sellers, too, made a fortune on the retraction of First Solar’s stock price to an earthbound valuation.

  It borders on the criminal to saddle future taxpayers with tens of billions of new debt in order to fund First Solar imitators. In the latter case, even the short sellers made fortunes the honest way—by being at risk. But under the Obama stimulus, the fundamental deal is that insiders get to short the US treasury without taking any risk at all.

  That’s the lesson of Solyndra which ended up a spectacular $850 million waste of taxpayer dollars (including tax benefits). In fact, however, Solyndra was not that different from First Solar: it had also been developing what it hoped would be an alternative to crystalline silicon cells using an even more exotic copper-indium-gallium-selenide (CIGS) coating and also tubular rather than flat-panel collectors.

  The short story is that it did not scramble down the cost curve far enough or fast enough, and was left high and dry in 2011 when Chinese solar producers flooded the market with what had become dramatically cheaper conventional silicon panels. Yet whereas First Solar achieved dramatic cost reductions first, and then built up manufacturing capacity incrementally with several dozen conventional fabrication sites around the world, Solyndra made a huge role of the dice. Even before its manufacturing process had been proven, it constructed a single giant manufacturing works to produce its exotic thin-film coatings and fabricate its tubular panels.

  Needless to say, even the great Wall Street speculators were unwilling to pony up $500 million for a vast green field plant based on what was still a speculative technology. But the earnest Professor Steven Chu raised the taxpayers’ hand for that honor, and a perfectly useless factory was built that has never even opened. Worse still, this never-started factory had cranked up its supply chain full tilt before it had orders or shipments. Accordingly, its subsequent bankruptcy filing showed it had purchased more than one million glass tubes from a lucky firm in Germany called Schott Rohrglas.

  It thus turns out that a goodly portion of the half billion dollars of taxpayer money had actually helped to build the German trade surplus: the massive glass tube inventory shipped by Schott Rohrglas to the Solyndra plant in California would have stretched six hundred miles end to end. All of this high-purity glass was now useless, however, and was ordered destroyed by the bankruptcy court to avoid storage costs. In a final insult to injury, the court’s disposal order undoubtedly also bolstered China’s trade surplus: the fleet of lift trucks used to move these mountains of glass to the dump were made in China.

  Still, the full rancid odor of crony capitalism did not materialize until the aftermath. Throwing good money after bad, Professor Chu agreed to subordinate the government’s $535 million loan to $75 million of “rescue” money provided by affiliates of George Kaiser, the oil billionaire and Obama fund-raiser who controlled Solyndra. Coming from the oil patch, Kaiser obviously knew a thing or two about tax dodges and operating loss carry-forward schemes.

  It now turns out that Kaiser and his cronies were more than happy to have the factory dismantled because as the senior creditor they ended up with the tax NOLs (net operating losses). The latter are worth about $350 million and can be used in one of Kaiser’s profitable businesses, perhaps shielding oil production profits. In other words, by essentially “shorting” Uncle Sam, George Kaiser stands to harvest a 4.6 times return on his sham investment to “rescue” the company.

  The obvious point is that the punters who bid up First Solar’s market cap to $22 billion had no clue about whether the correct route to thin-film solar was CdTe or CIGS. Professor Chu apparently knew all about that topic. But his knowledge was irrelevant because the issue was the pace of manufacturing cost reduction per watt, not the science of photovoltaics.

  Likewise, the firm’s outlook for profitable survival was embedded in the quarterly path of orders, shipments, margins, and working capital ratios—the very thing that financial markets, even speculative ones, are designed to assess. By contrast, the Department of Energy apparently failed to notice that something was radically amiss with a 500,000-square-foot factory which had no output, shipments, or even orders, but was stacked with six hundred miles’ worth of glass tube inventory. It is no wonder the CEO of Solyndra referred to the company’s White House sponsors as “the Bank of Washington.”

  The case of First Solar versus Solyndra makes clear why the whole green energy program is a pointless waste. Each had a thin-film route to grid parity, but the entrepreneur behind the former attracted gobs of speculative capital, while the promoter behind the latter bagged White House staffers looking for ways to quickly spend down the vicar’s $800 billion. Indeed, given that the CdTe route had already been a resounding marketplace success, having the taxpayers put up $850 million for its first cousin, CIGS, amounts to grand larceny, crony capitalist style.

  FISKER AND TESLA: GREEN VANITIES OF THE BILLIONAIRES

  The solar boondoggles are modest compared to the crony capitalist capers in the electric vehicle (EV) sector. Here the Obama administration has guaranteed loans of $530 million for Fisker Automotive and $465 million for Tesla Motors and provided $270 million in
stimulus money for a company called A123 that makes electric vehicle batteries. The first two of these are essentially failing vanity projects of Silicon Valley billionaires that are now being bailed out by the taxpayers for no discernible reason. The third has already filed for bankruptcy, taking the taxpayers down the drain with them.

  The US treasury was put in harm’s way in all three of these cases not simply to boost the debatable concept of electric-battery vehicles. The global automotive industry is already rife with efforts in that direction by incumbent car companies including the Toyota Prius, the Nissan Leaf, the Chevy Volt, the upcoming (2013) Ford Escape electric vehicle, and countless more.

  Instead, the big bucks from Washington are being used to prop up billion-dollar bids by venture capitalists to create totally new car companies. Yet unless you believe in tin-foil hat theories about Detroit buying up all the patents on magic carburetors which get a hundred miles per gallon, the last industry that needs start-up companies fostered by government is autos. In fact, the global automobile industry is hungry for new product markets owing to its vast overcapacity and is endowed with all of the engineering and manufacturing competence that could ever be needed to bring electric cars to market—that is, if consumers wanted to buy them.

  Since gasoline still sells at 1973 prices in real terms, however, there remains only a tiny market for hybrid and electric vehicles. Thus, notwithstanding approximately $1.2 billion of venture capital funding, mainly from Kleiner Perkins Caufield & Byers, Fisker Automotive is literally going down in flames: in addition to massive financial losses, many of the five hundred gasoline-electric hybrid cars it has actually sold have ended in fiery destruction in their owners’ driveways. Indeed, the folly of Washington’s Fisker caper could not have been more poignant than when Hurricane Sandy hit the New Jersey docks with its vast storm surge; more than a dozen Fisker cars ignited and burned to rubble when washed over by sea-water.