Federal Financial Interventions and Subsidies in Energy Markets 1999: Energy Transformation and End Use

Report Contents
Report#:SR/OIAF/2000-02

A longstanding issue in financial markets has been the degree to which the U.S. Government would prevent a default of the debt of Government agencies, such as the TVA, and government-sponsored entities (GSEs), such as the Federal National Mortgage Association (FNMA) and the Farm Credit System (FCS). The debt of these agencies carries no explicit guarantee by the U.S. Treasury. In fact, TVA bonds explicitly state that their debt is not a legal obligation of the U.S. Government.^a However, financial markets have strongly assumed otherwise, believing that the U.S. Government would not (and could not) allow any of this unbacked debt to ever default. Although the financial community's assumptions are subject to debate, there is evidence suggesting that their view is correct.

For example, according to a study completed by the Federal Reserve Bank of Richmond, Virginia,^b during the 1980s the U.S. Treasury twice initiated actions that were designed to provide support to two GSEs—the FNMA and the FCS—during times of financial difficulty. The Federal Reserve Bank study noted that in both cases action was undertaken because the GSEs saw a sharp widening of the spread on their debt instruments against similar Treasury debt, thus significantly raising their cost of funds. In both cases, the Treasury made the "implicit guarantee explicit by providing Federal Government loans to the GSEs. Once the loans were made, the interest spread of the GSE securities and comparable U.S. Treasury securities narrowed."

When rating TVA's debt, major credit agencies assume that the government would provide support if needed. According to Moody's Credit Service: "Although TVA's debt is not an obligation of the U.S. government, the company's status as an agency and the fact that the government is TVA's only shareholder, indicates strong `implied support' [that] would afford assistance in times of difficulty . . . . This implied support provides important bondholder protection." Similarly, according to Standard and Poor's: "The [AAA] rating reflects the U.S. government's implicit support of TVA and Standard and Poor's view that, without a binding legal obligation, the federal government will support principal and interest payments on certain debt issued by entities created by Congress. The rating does not reflect TVA's underlying business or financial conditions." Standard financial texts also describe Federal agency debt as carrying a "de facto backing from the federal government."^c

In addition, TVA's chairman has also made note of the implicit guarantee arising from potential pressure on the Treasury to prevent any agency default. According to a quote appearing in a March 5, 1997, Wall Street Journal article, TVA chairman Craven Crowell stated: "If Congress does anything that devalues us, you always have the potential for the Treasury having to get involved."^d

Were the Federal government to allow a default on one agency's (or one GSE's) debt, the ability of all Federal agencies and GSEs to borrow money at favorable rates could be affected. An unchallenged default could cause financial markets to downgrade the value of all agency and GSE debt, an action that could greatly affect their borrowing costs and their ability to carry out their government mandates. In all likelihood this potential hazard weighs heavily on the U.S. Government to prevent even one default. TVA may have an even closer relationship with the U.S. Government than do the GSEs, which may increase whatever implicit support its debt derives. For instance, unlike the GSEs, the U.S. Treasury carries TVA debt as gross Federal debt. In fact, TVA's borrowings accounted for 92 percent of $24 billion in U.S. Government agency debt outstanding in 1998.^e GSEs had, however, $2.0 trillion in debt (1999 dollars) outstanding at the end of 1998, which makes them a considerable component of total U.S. credit markets.^f Total U.S. Treasury debt, for instance, equaled $5.5 trillion in 1998.

In this report, "implicit support" is included in the estimates of total support provided by the Federal Government to TVA and the PMAs, because the ratings and yields on their debt instruments would be different if the Federal Government did not support them.

Alternative viewpoints on the issue of implicit interest support may exist. These viewpoints question whether a support without any binding legal basis is really a support. According to these views, market expectations that the Federal Government would act to prevent a default, should that possibility ever arise, are just expectations and not necessarily a reality. Although the market views a TVA debt default as "highly unlikely," there is no absolute guarantee that the market view is infallible. On the other hand, the U.S. Government remains the sole equity owner of the TVA, and the fact that TVA's government ownership status has a substantial impact on the utility's borrowing costs is an advantage that EIA believes constitutes support.

_____________________________^aU.S. General Accounting Office, Tennessee Valley Authority: Financial Problems Raise Questions About Long-Term Viability, GAO/AIMD/RCED-95-134 (Washington, DC, August 1995), p. 29.
^bT.Q. Cook and R.K. Laroche, eds., Instruments of the Money Market (Richmond, VA: Federal Reserve Bank, 1993).
^cM. Stigum, The Money Markets: Myth, Reality, and Practice (Homewood, IL: Dow Jones-Irwin, 1978), p. 161.
^dJ. Ball, "TVA Plan Seen by Critics as Unfair Grab for Power," Wall Street Journal (March 5, 1997), p. 1.
^eOffice of Management and Budget, Analytical Perspectives, 2000 (Washington, DC, 1999), p. 264.
^fOffice of Management and Budget, Analytical Perspectives, 2000 (Washington, DC, 1999), p. 202.

TVA's 1998 Debt Cost Reduction

Interest on TVA's Federal Financing Bank debt was unusually high relative to market rates in 1998, when it had an outstanding $3.2 billion (nominal dollars) in relatively high-priced debt held by the Federal Financing Bank.^a From 1985 to 1989, TVA issued a nominal $6.2 billion in noncallable debt to the Federal Financing Bank^b at rates between 8.5 percent and 11.7 percent, or an average interest rate of 9.7 percent. As a result of the sharp decline in interest rates since the late 1980s, those rates were significantly higher than TVA's average 1998 borrowing costs. Market interest rates in 1998 reached their lowest level since at least the mid-1970s. The Treasury's 30-year bond, for instance, averaged 5.58 percent in 1998, its lowest level since the instruments were first introduced by the Treasury in 1978. In 1998, passage of the Fiscal Year 1999 Omnibus Appropriations Bill (H.R. 4328) allowed TVA to refinance its $3.2 billion in high-interest debt at par value. The yield on the newly issued debt averaged 6 percent. As a result of the refinancing, TVA expects to save $1.6 billion in borrowing costs out to the year 2016.^c TVA estimates that its savings from the refinancing in the first year will save the utility $117 million.^d This saving can be viewed as Federal support to the TVA to the extent that it reduced the interest on TVA's overall indebtedness to the U.S. Treasury.

_____________________________^aTennessee Valley Authority, Annual Report 1998 (1999), p. 35.
^bThe Federal Financing Bank is an agency under the supervision of the U.S. Treasury. Its role is to provide financing assistance to selected Federal agencies (such as TVA) in order to lower their borrowing costs. In essence, the Bank raises money through the sale of Treasury securities and then lends the money to Federal agencies.
^cA General Accounting Office study estimated that TVA's $14 billion of nonproductive nuclear assets accounted for $833 million of its $1.9 billion in annual interest expense in 1994. See U.S. General Accounting Office, Tennessee Valley Authority: Financial Problems Raise Questions About Long-Term Viability, GAO/AIMD/RCED-95-134 (Washington, DC, August 1995).
^dTennessee Valley Authority, "TVA Pays Off $3.2 Billion in High Interest Debt, Savings Begin Immediately," Press Release (October 23, 1998).

If you are having technical problems with this site,
please contact the EIA Webmaster at wmaster@eia.doe.gov