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July 13, 2009

Leveraged Stimulus

Q. When does $72,000 equal $1 million?

A. When leveraged, of course.

The US Department of Agriculture (USDA) is taking advantage of this financial magic trick. The stimulus bill (aka American Recovery and Reinvestment Act or ARRA) allocated $2.5 billion to USDA to encourage broadband buildout in unserved and underserved rural areas. If USDA gave out all this money as grants, there would be $2.5 billion to be divided among applicants from various states. But USDA has announced that it will give them money out as a combination of grants and low interest loans and will actually be able to give out between $7 and $9 billion. The catch, of course, is that most of this money will have to be paid back. Still, for both stimulation and broadband penetration purposes, this isn't a bad idea because more actual money will go into projects than would have been possible with grants alone. If things go well, more and bigger projects'll get done and more people'll be put to work.

Here's how the leverage magic works: USDA takes some portion of the money and uses it to set up a loan loss reserve. For this calculation they assume that there will be $72,000 in losses for every million dollars they lend; this $72,000 is the COST to the USA of lending $1 million. Of course the USA also has to pay interest but the borrower is expected to pay interest approximately equal to the federal borrowing cost so there is no net interest cost to the treasury. So let's do some math:

First divide one million by 72,000. That answer is approximately 14 meaning that one dollar in loss reserves will "pay for" $14 in loans. Another way of saying this is that RUS believes that it will get back $13 in principal repayments for every $14 it lends. So, if USDA takes $500,000,000 million of the $2.5 billion which it has been allocated and uses this as a loan loss reserve, it can make $7 billion in loans and expect to "lose" no more than $500,000,000. That's apparently what USDA intends to do and, assuming they are discerning enough in making their loans so that their losses aren't higher than anticipated, this is a pretty good way to get lots of programs going.

But now suppose you're a telco which formerly didn't find the reward of building in a rural area worth the cost; will this program convince you to build affordable broadband in areas you previously bypassed? Obviously if you get grants – free money – that can be pretty persuasive. You invest less but get back the same return. But loans have to be paid back. Couldn't you have just borrowed before and built? Why would you want to do that now?

My guess is that the loans will help to incent the development of projects which wouldn't have happened otherwise. I know that there are companies prepared to apply for them in Vermont. One reason these loans are so attractive is simply the fact that they're available. This recession began as a credit contraction and, to a large degree, still is. Credit is very, very hard to get; patient money even harder to find. The rewards from building in a rural area take time. People who didn't have broadband before don't have a perceived need to get it immediately; their neighbors aren't posting to YouTube or living in Facebook; the schools aren't giving online homework. People who couldn't get broadband may not have the equipment to use it. The market develops but it takes time. The availability of any money at all is an incentive; the availability of money which can be paid back slowly as the market develops is further incentive.

Also the interest rate on the USDA loans is approximately the borrowing cost of the US government – just over 3% for five years and under 5% for ten years. On their own, if they could get loans at all, many of the companies who might build in rural areas would have to pay interest rates which are at least twice that. The difference between what loan applicants pay USDA and what they would pay in the open market is just as good as a grant – it's cash that stays with them instead of leaving.

The rules for broadband funding were published last week. The forms and instructions are available online at http://broadbandusa.sc.egov.usda.gov/. The deadline is August 14th. The scramble is on. USDA making some of its (our) money available as loans means that there are more funds nationwide and more potential for bringing Vermont closer to its goal of universal broadband penetration – a key component of SmartVermont.

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