Power Failure

In 1990, when 98.8 percent of farms have electricity and 96 percent have phones–compared with 93 percent of households overall–the REA’s work somehow doesn’t seem so necessary anymore. In fact, these days it’s giving 25 percent of its telephone loans to five enormous holding companies like Alltel and losing money in the bargain. On the electric side, the REA has subsidized companies that provide power to resorts like Hilton Head, Aspen, and Vail. The REA’s work “was done a long, long, long time ago,” says Harold Hunter, the agency’s administrator from 1981 to 1988, today a farmer near Enid, Oklahoma. “Yet it has continued now for so many years–like so many federal agencies do.” This is why the history of the REA also sheds some light on how the American government functions at its worst–on how we ran up a $ 160 billion deficit in the first place, and on why Congress and the White House, trying to address it today, will do anything they can (monkey with the numbers, raise hidden taxes, maybe open a lemonade stand) to avoid cutting programs.

All the demons that have pushed the budget so far out of balance can be seen at work propping up the REA: The borrowers, though few in number, are widely dispersed over many congressional districts; they have grown up over the years and developed sophisticated lobbies in Washington that jealously guard their benefits; the regulations governing the programs have become arcane and complex, mastered only by their staunchest congressional defenders; the programs once served a noble purpose, so attacking them today is considered heretical; and they are small enough (“concentrated benefits and diffuse costs,” as one analyst puts it) that few congressmen are willing to take the political heat involved in trying to fight them. “It’s a classic case of how a program gets started and everyone agrees with the intention–and to this day I think it was a good program–but once the benefits start to flow and the beneficiaries get used to them, it’s virtually impossible to terminate,” says Randy Davis, who was an associate director of the Office of Management and Budget under Reagan.

The result is that 10 years of administration efforts to cut or scale back the REA have gone nowhere. When Frederick Khedouri, another former associate director of OMB, talks about going up against the lending programs’ backers, it sounds like he’s describing a mugging: “There were so many … They had support everywhere … It was hopeless.” “They were quite successful,” Davis says of the electric and telephone lobbies, “in beating my head in whenever they got the chance.” “That’s one of the reasons I left OMB,” says another former official. “You bang your head against the wall and you finally realize you’re not going to get anywhere … They’re just so powerful.” Frustration over the REA, he says, “is probably one of the things that led to my divorce.” It’s not as if OMB fought this good fight to the death, however. “You look at the limited resources you have to do your political negotiations on the Hill, and you have to focus on the higher-priced items,” says a Reagan administration official. The REA just wasn’t pricey enough to be considered a priority. “From my standpoint,” he continues, “that was a mistake, because I think these are some of the most abusive programs in the United States government.”

It’s certainly true that the REA by itself isn’t a budget buster: Even if Congress killed all the lending programs, it would save only about $ 5 billion over the next five years, which is small change inside the Beltway. That’s no reason to preserve a bad program, however. And, equally important, small change can add up. The budget is stuffed with REAs and–despite OMB’s “focus on the higher-priced items”–with larger wasteful programs that are pinned in place by the same sort of interlocking interests. Recall the congressional gridlock over cutting even a few superfluous military bases. Look at how Cheney’s efforts to give up a handful of procurement programs last year, like the F-14 fighter, were stymied by representatives trying to preserve any federal spending on their turf. And consider the array of perverse regulations, subsidies, and price supports by which Americans pay their farmers not to cultivate their land and their dairy farmers to kill their cows in order to drive up everyone’s food bills. These agriculture programs are basically the REA writ large: revered for their early work, consecrated by time, protected by fierce interest groups, and almost impossible to understand. They were first jury-rigged under Roosevelt as “temporary emergency measures.” From a high of $ 5.6 billion under Carter, they blossomed under Reagan to a record in 1986 of $ 26 billion.

If Congress were able to overpower the interlocking interests that make the REAs uncuttable, it would do more than just blot out a lot of red ink. It might actually remind people of how much good an efficient government can do. Restoring that faith is the key to convincing people to go along with the progressive income tax increases required to move the budget fully into the black and to do what really needs doing, from paving the roads to caring for the sick. As a further dividend from this investment of political courage, maybe Americans would move beyond adoring Democrats only as their pork-producing congressmen and start trusting them as national leaders again. But don’t hold your breath. this spring, the House passed a bill that would sweeten the deal for the telephone borrowers with some new rules that would seem outrageous … if only they weren’t so predictable.

In an age of fax machines and modems, it’s hard to imagine life without a telephone, let alone without electric power. But in 1935, barely 1 in 10 American farmers had electricity. That meant no refrigeration. No radio. Water had to be hauled into the house by hand. Ironing required heating up a six-pound chunk of iron on a smoky wood stove. Reading by the dim, flickering light of a kerosene lamp quickly wore out the eyes (in fact, rural students’ grades greatly improved on the heels of the introduction of electricty). During this period, rural and urban standards of living in the U.S. were probably as far apart as they have ever been. Despite the constant pleas of farmers, utilities wouldn’t supply power to the farms because, they claimed, it would be too expensive to string wires through such thinly populated areas. So the federal government stepped in.

Originally, the REA loans didn’t cost the taxpayers anything. The loans were heavily “subsidized,” in that they were available at rates far below what the cooperatives could hope to get from private sources, but they were still above the rates that the government itself had to pay to borrow from the public by issuing Treasury bonds (the government’s “cost of money”). That meant that as long as the borrowers didn’t default, the taxpayers would make a small profit on the loans. And they didn’t default, since the electricity proved to be affordable after all. By 1952, almost 9 in 10 farmers had electric power. In other words, taxpayers didn’t have to spend a dime to electrify rural America. They started spending in earnest after rural electrification was a fact.

The REA was scheduled to go out of existence in 1946. But not only did it keep lending to electric cooperatives, beginning in 1949, Congress charged it with lending to telephone companies, too. Putting the government–the “lender of last resort”–in the rural telephone business made sense. Even more than in the city, where there’s always a neighbor right next door, a telephone can be a lifesaver on a farm. When a horse drives a hoof into a farmer’s head or a child develops appendicitis, help may be miles away. Once again, existing companies refused to run lines to outlying areas; only 35 percent of farmers had phones. The big companies “wouldn’t come out to serve our area because the population just wasn’t big enough,” says Phil Johnson, assistant general manager of the Grand River Telephone Cooperative, which serves 18,000 residents of northern Missouri and southern Iowa. The co-op was founded in 1953; each new member still must buy one share of $ 5 common stock. “As far as I’m concerned,” Johnson says, “everything we have today is because of the REA.”

Shortly after the REA began putting up capital for telephone companies, its lending habit started becoming expensive. In 1944, with the government’s cost of money at 1.7 percent, the rate for REA loans was pegged at 2 percent. Gradually, the cost to the government crept up, until by 1952 it had climbed above 2 percent forever–and the REA was guaranteed to start losing money on its loans.

The REA’s lending practices have been revamped several times. Each “reform” made the rules more byzantine, but none changed–in fact, most exacerbated–the basic fact that the REA was losing money. From making extremely risky loans above government cost to embryonic borrowers with nowhere else to turn, the federal government started making extremely safe loans at below government cost to longstanding institutions that could easily raise money elsewhere. This is the free market reflected in a fun house mirror; it would make sense only if the government were desperately competing with private sources of capital to lend out money. Here’s a layman’s guide to the three principal types of loans the REA makes today and to some of the shenanigans that made them possible:

* The Rural Electrification and Telephone Revolving Fund. From the beginning, the funding for REA loans was appropriated each year as part of the federal budget. But in 1973, supposedly in an effort to wean the borrowers off federal support, Congress ordered that all outstanding loans–$ 7.9 billion worth–be paid back, not to the Treasury, but into a “revolving fund,” from which the money would be loaned out again to other electric and telephone borrowers. “It’s sort of a gimmick to make it look like the co-ops are paying their own way, but of course they’re not,” says a congressional analyst. At the same time, the lending rate was raised to 5 percent–closer to the government cost–with some 2-percent loans still offered to “hardship cases.” Now, that $ 7.9 billion is supposed to be returned–without interest–to the Treasury beginning in 1993. Here’s the catch: The borrowers’ lobbies managed to get several technical amendments attached to the original law that essentially forced the REA to lend out more money than it got back each year in repayments; to make up the difference, it has had to borrow from the Treasury–at government rates, which are higher.

It’s pretty tough to break even when you borrow at 10 percent (or, during the late seventies, as high as 12.4 percent) and lend at 5. So each year, Congress pumps more money into the fund–over $ 1.2 billion worth. At long as the Revolving Fund keeps lending beyond its means, it probably won’t be reabsorbed by the Treasury starting in 1993, and the borrowers will not be weaned off federal money. The House already tried once to make the revolving fund permanent by forgiving the $ 7.9 billion debt to the REA, but the Senate killed the legislation. As the 1993 deadline approaches, watch for a renewed effort.

* The Rural Telephone Bank. Since the RTB was set up in 1971, the federal government has funded it with more than half a billion dollars, which, supposedly, the borrowers will eventually pay back in order to privatize the bank. At one point, a buy-back seemed possible. In the mid-eighties (when the bank was originally supposed to go private), the RTB was making loans at just above the cost of money to the government, so it was running a surplus, building up enough cash to pay off Uncle Sam.

But if the RTB were privatized, its lending rates would have to increase, since the federal government would no longer be backing it up–not an attractive proposition to the telephone borrowers. So guess what happened. A Democratic congressman from Oklahoma named Glenn English, one of the greatest friends of REA borrowers in the House and then chairman of a government operations subcommittee with oversight of REA, held a series of hearings investigating the “illegal profits” that the RTB was making. The result was what one former REA official refers to as the “greed and access provisions” of the Omnibus Budget Reconciliation Act of 1987–A bill the president literally couldn’t afford to veto. Congress ordered the RTB to lend out the surplus it had built up (that’s the access), and English worked a complex rate-setting formula into the legislation that has held the lending rate to 5 percent ever since (the greed). This means that for next year, instead of being paid back for their initial investment, the taxpayers will eat about 20 cents of each dollar loaned by the RTB. If you believe the RTB will actually go private by the new target date, 1995, I’ve got a great 5-percent lending opportunity for you.

* Also in 1973, the REA got the authority to fully guarantee loans made to electric and telephone borrowers by the Federal Financing Bank (which lends money at a rate barely above cost) and by private sources. Like the deposit insurance that drove the crazy S&L lending, this was a great deal for everyone except the taxpayers. The REA is now trying to negotiate some $ 6 billion worth of bad loans.

Up until 1971, when the Rural Telephone Bank was created, the REA had never loaned out more than $ 500 million in a given year; in 1974, after the RTB, the revolving fund, and the guarantees were all in place, it approved almost $ 2 billion worth, most of it from the Federal Financing Bank. That figure surged to more than $ 7 billion in 1980 before tapering off to an average of about $ 1.5 billion for the last three years. Naturally, defending this explosion in lending after the agency had accomplished its goals required some changes in rationale. Now that a higher proportion of farmers have telephones than do Chicagoans, supporters of the REA no longer talk too much about stringing communications and energy lifelines into the heartland. Instead, they talk about “protecting universal service” while improving it–essentially, making sure that rates stay affordable for rural users. There are a couple of holes in their logic.

First, according to the Congressional Budget Office and the FCC, there’s no proof that it’s more expensive to provide electricity or telephones to rural areas. Common sense would suggest that it is, since, all other things being equal, a company out in the sticks will have many fewer subscribers per mile to defray the high costs of putting up poles and stringing wires. But everything else isn’t equal. It turns out that rural companies save money where urban ones can’t: They tend to have lower labor costs and to require less investment in central plant equipment, for example. Similarly, a CBO analysis of electric companies, in the words of a government analyst who tracks the REA, “didn’t find any correlation between how rural they are and how high their rates are. . . . A lot of other factors tended to be more important in the aggregate than how dispersed the area was.” Those factors included such exotic considerations as whether or not the company was efficient and had good management.

Second, now that universal service is pretty much a fact, the urban/rural split is an outdated way to approach assisting telephone and electricity users who can’t afford their bills. Not only does the government pay part of the bills of rural users regardeless of their income, while offering the urban poor no such breaks; it taxes the urban poor to pay those rural bills–a move that adds injury to insult. In fact, according to the FCC, telephone rates in rural areas tend to be lower than those in the cities. If the government is really concerned about people being able to afford electricity and telephone service–and it should be–why doesn’t it just give the benefits directly to the needy users (through, say, a tax credit), instead of handing them to big cooperatives and corporations whosmear them across the countryside?

When you examine the REA’s lending programs in theory, they seem merely dumb. It’s when you look at them in practice that they become offensive. Consider the rural/urban split again. That division has gotten a little fuzzy since the cities began to sprawl. The REA, however, has resolutely ignored any changes in demographics: It will lend to any co-op or company serving an area that has ever been designated as “rural”–originally defined as a town with under 1,500 inhabitants. “Once you’re in, you’re in,” explains a congressional analyst. “Once rural, always rural,” says a Reagan administration official. “Once a borrower,” summarizes a former REA official, “always a borrower.” So where most of us see a thriving suburban bedroom community in Manassas, Virginia, the REA still sees horny-handed farmers trying to coax their exhausted wives to pedal just a little faster so they can get the sheep sheared on time. In other words, it subsidizes their electric bills with some $ 150 million worth of below-market loans.

Alltel’s 1989 annual report features a glossy photo of two telephone company workers examining some wires. They are standing on a broad lawn strewn with autumn leaves, before a colonial mansion, two pumpkins perched on the porch. Through the trees, another, identical mansion looms in the background. The caption reads: “In the Piper Glen development near Charlotte, N.C.–one of the many growing suburban markets Alltel serves–the Company is testing the use of fiber optics to provide enhanced communications services.” It’s hard to tell from this picture that the residents of posh Piper Glen are on the dole. But the Alltel subsidiary that provides service to this area qualified for $ 54 million in cut-rate loans and managed to get the REA to fully guarantee $ 22.7 million more at Treasury rates.

The fundamental reason that the REA’s lending programs should be drastically scaled back is that most of the borrowers simply don’t need them. Between 1980 and 1988, the REA telephone borrowers’ net operating profit margins doubted; a 1989 Kidder Peabody analysis showed that the average telephone borrower could easily attract lenders on the private market. Sure, the Silver Star telephone company of Freedom, Wyoming may need its $ 2.1 million in REA loans to keep up service to its 1,324 subscribers. But last year, Contel, a company that owns subsidiaries across the country, launched its third satellite off the space shuttle Discovery and racked up revenues of $ 3.1 billion. Why on earth does it deserve almost half a billion dollars in cut-rate loans?

In building an electricity and communications infrastructure through rural America, the REA also created a powerful grassroots political structure that has gotten richer and smarter as the borrowers have grown. In Washington, the electric co-ops are represented by the National Rural Electric Cooperative Association (the NRECA); four different lobbies fight for the cooperative, investor-owned, and private companies that can get telephone loans. Many of the top staff in the lobbies are former REA or congressional officials (Bob Bergland, the executive vice president and general manager of the NRECA, is a former congressman and secretary of agriculture). Those who have battled these groups are particularly in awe of the NRECA. “It is probably one of the most polished lobbying groups–aside from Social Security–in this town,” says a former REA official. “The REA has, I think, one legislative person, and the NRECA has nine registered lobbyists. So it’s nine to one. That’s tough.” The REA wasn’t the only agency doing that kind of math. At OMB, says Randy Davis, “One time we figured out that the NRECA’s congressional staff was larger than my OMB staff–let alone the people I had working on the REA. And their existence is based on the continuation of these federal programs.”

The NRECA’s political clout on the Hill, and to a lesser extent that of the telephone lobbies, comes from the co-ops. “They have that sort of motherhood flavor,” says Frederick Khedouri, the associate OMB director who preceded Davis. “They’re local people–they’re good guys.” Each of the co-ops, which are liberally scattered through congressional districts across the country, has a board composed of some of the most prominent citizens in the community. And the lobbies can reach all beneficiaries of the REA by dropping inserts in with their bills each month. What rural congressman could deny such a constituency? Khedouri described trying in the early eighties to write regulations that would prevent electric companies from borrowing directly from the Federal Financing Bank; instead, they would have to take their federal guarantee and apply it to a private loan. That new rule got nowhere. “The Congress immediately legislated it right out of existence. It passed the House by something like 417 to 3. So that was the framework in which we were operating.c The mystery, of course, is why so many urban congressmen played along. Fortunately, for the REA borrowers, it turns out that the traditional combination of obfuscation, cajoling, intimidation, and inertia has always been more than enough to sway them.

Obfuscation. The loan programs are extremely complicated, and few congressmen other than the ones who are out to preserve them are willing to invest the time to figure them out. “The best example of hiding behind complexity is when Rep. English changed the formula for interest rates” for the Rural Telephone Bank, says an administration official who has fought the REA for years and gotten a little frustrated in the process. “It was so fucking complex that no one could figure it out.” As a result, no one really challenged it. No one seems to have noticed that the bill the House passed this spring would make some radical changes in the loan program. “I really can’t think of anyone who’s delved into it,” says an aide to a congressman known for his antipathy to subsidies. Even the National Taxpayers’ Union (NTU), which has fought the REA lending programs for years, didn’t notice. “You can write that you got this lobbyist’s butt off the dime,” said Sheila Macdonald of the NTU when I asked her about the legislation. “I’m going to get hopping on it.”

Cajoling. Each time a piece of legislation affecting the REA comes up, the NRECA brings literally thousands of co-op directors to town and sics them on their congressmen. But what about the city representatives? “They’ve got one of those ‘Adopt-an-Urban-Congressman’ programs,” says an administration official. Delegations are dispatched to the offices of city congressmen to plead their case.

Intimidation. You can imagine the campaign commercial: “He tried to cut the energy lifelines to America’s farms … ” The telephone lobbies also have an effective line: “The minute that you say you don’t want to have subsidized loans, they say ‘Oh, they want to take away the phones from rural America, they’re going to make the phones go dead,”‘ says Macdonald. The NRECA spent almost $ 450,000 on candidates in 1988 and $ 270,000 so far in 1990. Senator Paula Hawkins was one of the last members of Congress to take on the lobbies. As chair of the Senate subcommittee with oversight of rural electrification, she held hearings into REA lending practices. During her 1986 campaign, the NRECA gave $ 10,000 to her opponent–more than it gave to any other congressional candidate that year. Hawkins lost. “Obiously, they did her some damage,” her campaign manager told The Wall Street Journal.

Inertia. This is partly a function of the three previous forces. It means that once a program is authorized, it’s almost impossible to eliminate. Americans may want to see the budget cut, but it’s hard to translate that political will into surgical reductions. The problem isn’t just that everyone can agree only that somebody else’s benefits should be cut, it’s that they don’t particularly care who that somebody else is. The farmer is less sensitive to (in fact, is probably oblivious to) the $ 5 he sacrifices each year to support the Small Business Administration than he is to the benefit he is accustomed to getting from the Rural Electrification Administration–mostly because his electricity and telephone companies constantly remind him of it. So the national call to cut programs is general and vague, but the district-by-district call to preserve them is itemized and intense. Congressmen respond to the latter, which means the executive branch–to which has its own pet programs it wants to save–can’t get a whole lot of mileage out of the former.

As a result of all this, who was willing to bear the administration’s standard on the Hill for REA cut-backs? “Basically, no one,” says Randy Davis. “Jesse Helms was willing to support us,” another Reagan administration official says, “but he’s sort of the kiss of death.” So the administration essentially accepted the program’s survival as inevitable. “It was never a major emphasis on our side to reform that program, because there was never much prospect of Congress going along,” says Davis. “Where we really drew the line, though, was on losing ground.” Now can you see where this $ 160 billion deficit came from?

This year, each house passed a version of a “rural development” act. The Senate bill calls for expanding the REA’s mission into development projects besides electricity and communications–which means freeing up more money for REA borrowers. For example, it authorizes a new $ 40 million program for the REA to make loans to electric and telephone companies to set up water and sewage facilities. The NRECA has been pushing for these sorts of changes for several years. “It’s a duplication of things that are already being done by the Department of Agriculture,” says Harold Hunter, who resisted this expansion of the REAhs role while he was head of the agency. So why are they doing it? “Because development is a very vital activity to give them a reason for existence. . . . They see it as a way to keep the REA going.” At OMB, they used to describe REA supporters’ efforts to expand the agency’s mission this way: “The sun is setting, so they’re trying to stop the earth from spinning.”

The theme of the House bill is “flexibility.” It also broadens the REA’s mission, but it calls for no new appropriations for the new programs. In addition, it contains a section (“Title VII”) that would make some fairly startling changes to benefit the telephone borrowers–naturally enough, since they were the ones who wrote them. “Title VII,” says Tom Walker of the National Telephone Cooperative Association, “is a set of concepts and ideas and whatever that we helped get goether and passed on to the appropriate people in the House.” Those “appropriate people,” he says, were English and E. Thomas Coleman, a Republican from Missouri and the ranking minority member of the subcommittee on rural development that English chairs. Title VII basically shoots down, one by one, several efforts by the administration and the REA to restrict lending. For example:

* Congress always sets a minimum and maximum amount that the RTB can loan out in a given year. For the past few years, OMB has refused to let them lend above the minimum. If enacted, Title VII would not only make that move illegal, it would force the RTB to lend out, at 5 percent, the difference between the minimum and the maximum ever since OMB started using the trick. “All of that money is suddenly available,” says an administration official–$ 544 million worth.

* The REA announced about a year ago that the revolving fund and the RTB would make loans to finance only the improvement, construction, or acquisition of telephone lines or facilities. Except in hardship cases, it wouldn’t back buying vehicles, furnitures, office equipment, and office buildings. Title VII would force the REA to finance all such investments.

* In the past, almost all REA loans were paid back over 35 years. But the REA found that equipment could become obsolete in as short a period as 12 years, at which time the borrower reappeared, hat in hand, for more money for an upgrade. So as part of last year’s new regulations, the REA announced that from now on, it would peg the amortization period of its loans to the expected useful life of the equipment the loan would buy. This reasonable proposal was too much for the lobbies–and evidently for Congress, too. Title VII puts the borrowers in charge of deciding how long they want to take to pay back each loan. That rule exists in no other federal lending program.

* Title VII forbids the REA to demand that borrowers raise their rates or otherwise improve their ratio of cash flow to debt in order to qualify for a loan. In other words, if Donald Trump were an REA borrower, he’d be able to get financing for a fourth money-losing casino in Atlantic City. One effect of this provision would be to allow more companies to qualify as hardship cases, eligible for loans at 2 percent–less than a quarter of what the government pays to borrow.

* “The Administrator and the Governor of the telephone bank shall not . . . deny or reduce any loan or loan advance under this Act based on a borrower’s level of general funds.” Get it? The REA can’t deny a cut-rate loan to a borrower, no matter how much money the borrower has. Does that sound like common sense to you? Well, here’s the kicker: That same rule, attached annually to appropriations bills by Jamie Whitten, the Mississippi Democrat who chairs the House Appropriations Committee, has been in force for at least the past seven years. Getting it into the Rural Development Act would simply save Whitten from having to go through that annual ritual. It seems astonishing that in floor debate on the bill this year, not a single representative objected to this or any of the other provisions listed above.

According to House and Senate staff members and lobbyists, it’s too early to predict what the Rural Development Act will look like when it emerges from conference. The NRECA is happier with the Senate bill, the telephone lobbies with the House version. But the two bills don’t conflict, so the conferees may just decide to please everyone and stick the two together. After all, as Tom Walker, the lobbyist for the NTCA, says of the Senate legislation, “As long as it doesn’t hurt the program, it’s OK.”

The problem, of course, is that the program hurts all of us. Maybe the conferees will catch on to that fact. Maybe they will realize that it doesn’t make much sense for the government to pay for the privilege of lending money to millionaires. And–who knows?–maybe they will actually wake up to the fact that, even though the REA isn’t a big ticket item, if you cut a hundred million here and a hundred million there, pretty soon you’re talking about real leadership.