Among the many troubling provisions of the costly farm bill signed into law by President Bush in 2002 were several to provide even more federal subsidies to rural electric cooperatives, which are already heavily subsidized. These co-ops produce and distribute low-cost power and telephone service to those lucky enough to live in the rural areas they serve. When these new debt guarantee subsidies are finally implemented, they could expose taxpayers to billions of dollars in prospective loan losses. The President should ask Congress to amend the law and eliminate these risky and unnecessary subsidies.

An Old Deal

The federally subsidized system of electric co-ops was created in 1935 during the depths of the Great Depression, which was especially severe in the rural parts of America. At that time, the availability of electric power was still largely confined to urbanized areas, and many rural and farm families still relied upon kerosene for light and wood for heat.

In an effort to get the economy going and provide relief for rural areas, President Roosevelt signed an executive order that authorized the USDA to provide low-cost federal loans to build the infrastructure - power plants and lines - to provide subsidized electricity to unserved farms and rural areas. To be eligible for these new loans, rural electric suppliers had to be organized as cooperatives, that is, owned by their customers. As cooperatives, these new utilities also benefited from other valuable government subsidies, such as exemption from federal income taxes and low-cost federal hydropower.

By the early 1970s, these electric cooperatives had accomplished their mission: electrification had reached about 99 percent of rural households and farms. But rather than declare the mission accomplished and disband the expensive subsidy program, Congress continued it and allowed it to become even more generous, as the gap between the government's subsidized co-op lending rate and market rates widened. Adding to taxpayers' burden were periodic co-op loan defaults and bankruptcies that have cost billions of dollars.

Wholly dependent upon government largesse and privilege and subject to increased scrutiny of some in Congress and the White House looking for opportunities to trim federal spending by reducing corporate welfare, the electric co-op industry diversified its source of loans in 1969 by creating the private, not-for-profit National Rural Cooperative Finance Corporation (CFC). The CFC acts as a bank for co-ops, using its borrowing clout to raise money in private financial markets at favorable interest rates. It uses these funds to provide loans to the thousands of electric co-operatives scattered around the country. As such, CFC loans are an alternative to the subsidized federal loans that co-ops still receive from USDA's Rural Utilities Service (RUS). Today, the CFC is a $20 billion private financial institution with ready access to private credit markets and acts wholly independent of the federal government.

While the CFC has grown to be an important source of private credit for rural electric co-ops, the federal government remains their largest lender. Today, the RUS holds over $40 billion in co-op loans financed with funds made available from the U.S. Treasury and made at the U.S. Treasury's own borrowing cost or less. Various reports by the U.S. General Accounting Office reveal that the RUS has suffered billions of dollars in loan losses over the years.

Although several recent Presidents have successfully reformed the subsidization of electric co-ops, the process has not been one of smooth progress. Thanks to industry lobbying and congressional interference, two steps forward have often been followed by several steps back. For example, a program was initiated in the late 1980s that allowed co-ops to repay their government debt at a generous discount if they promised to leave the public RUS system forever and rely solely of the private CFC for all future loans. Many co-ops took the money and left the RUS, but Congress later limited the period of exile to ten years. Thus, many co-ops that took the money and left are now back on the federal dole. At the same time, co-ops that defaulted on their loans in the past - at a cost of billions of dollars to the taxpayer - are also now back and borrowing again from the government.

Risky Business

But none of these lapses are quite as bad as a new privilege slipped into the 2002 Farm Security Act that requires the U.S. Treasury to grant the full faith and credit of the U.S. Government to $3 billion of debt issued by the heretofore independent, self-reliant, and private CFC. Unlike the other setbacks, which only partially undid important program improvements, this would be an expansion of the federal government into an area that has been fully independent of federal government involvement or direct subsidy since 1969. So far, the required guarantee privilege has not yet been granted due to delays in developing regulations and an effective system of oversight, but it will be soon.

In congressional testimony from late February 2004, Federal Reserve Chairman Alan Greenspan warned of the potential risks to the economy and to U.S. financial markets created by the large government sponsored enterprises Fannie Mae and Freddie Mac. The U.S. financial system and the federal government already confront unacceptable risks from privileged lenders, he said. Greenspan urged Congress to address this problem before it is too late - in other words, before the government is on the line for a costly bailout.

Congress should recognize that guaranteeing the CFC's loans expose the government to the same sort of risk. How much in losses are at stake through all of this federal credit market exposure? It is impossible to say in advance, but it is worth noting that the savings and loan bailout of the 1980s cost the federal taxpayers over $130 billion.

Under the circumstances, there is no justification for increasing the government's financial market risk by exposing the taxpayer to yet another major, private lending institution whose chief borrowers have had their fair share of financial problems in recent decades. To this end, the President should ask Congress to amend the law to delete the guarantee provision, and Congress should act on that request.       

Charli Coon is Senior Policy Analyst in the Thomas A. Roe Institute for Economic Policy Studies, and Ronald C. Utt, Ph.D., is Herbert and Joyce Morgan Senior Research Fellow, at The Heritage Foundation.