The Real Cost of Israeli Loan Guarantees: $3.1 to $117 Billion

By Parker L. Payson

Americans beware. The American Israel Public Affairs Committee (AIPAC) and its supporters have launched, in the words of AIPAC Executive Director Thomas Dine, "an all-out effort" to force Congress and the Bush administration to pass the first $2 billion installment of a $10 billion housing loan guarantee for Israel. According to the Forward newspaper, Israel's lobby has coordinated "a massive nationwide campaign which will bring hundreds, perhaps thousands, of supporters to Washington this September," for a lobbying battle not seen since the 1981 fight over the sale of AWACS radar-warning planes to Saudi Arabia.

President Bush, waiting at this writing for a final Israeli response to his plan for a US backed peace conference, reportedly has not decided whether to support the $10 billion loan guarantee. At Bush's request, leaders of France and Germany, who in June signed separate $5 billion loan guarantees for Israel, agreed to make their deals contingent upon the enactment of the US legislation.

Supporters of the loan guarantee legislation claim that, unlike the $5.6 billion in direct US aid given to Israel in 1991, loan guarantees are free.

"Let's clear up one thing immediately: Israel is asking for guarantees, not loans or grants or gifts, " former AIPAC political analyst Douglas Bloomfield writes. "[The US] would stand behind Israel, but would not put out any taxpayer money."

The Real Cost to US Taxpayers

This, however, is totally contrary to all previous US experience. The real cost to the US taxpayer, based upon Israel's previous housing loan guarantees, will be $3.1 to $7.1 billion if Israel repays the loans, and between $112 and $117 billion in the likely event of default.

Through the Housing Investment Guarantee (HIG) program, the US has granted loan guarantees to pay for housing poor people in more than 40 countries since 1966. HIG loan guarantees to each country are limited to $25 million per year. Since 1972, Israel has received $200 million in loan guarantees, of which $152.7 million was outstanding as of March 31, 1991.

In May 1990, Congress exempted Israel from the $25 million loan guarantee limit by offering it $400 million in housing loan guarantees. At the same time, Congress also exempted Israel from the standard HIG requirement that 90 percent be spent on housing for the poor.

In Israel's case, Congress also reduced the fee levied on all other recipient countries to cover administrative costs. According to the Agency for International Development, this waiver alone has cost US taxpayers over $58 million. On top of this, the Congressional Budget Office estimates it costs at least $75 million for "secondary placing and servicing" of the loans. Overall costs of the $400 million housing loan guarantee extended to Israel earlier this year led Senator Robert Dole (R-KS) to state last May that it would have been cheaper to give Israel $400 million in direct grants.

Preliminary estimates have placed the administrative costs of the $10 billion loan guarantee at between $40 and $140 million each year over the life of the loans. If most are 30-year loans, administrative costs alone will total between $1.2 and $5.2 billion before inflation. Add to this the additional cost of servicing and secondary placing, and the US taxpayer is out between $3.1 and $7.1 billion, even if Israel repays every cent.

Analysts caution that the additional $10 billion will increase Israel's foreign debt by more than 40 percent. Israel then will require greater US aid to make the necessary payments. "Israel is meeting its debt service obligations now, but if we add so much the question is, 'Can they keep up?"' a US official told The Christian Science Monitor. "In effect, this has to be viewed as a camouflaged grant."

This is only the tip of the iceberg. US taxpayer costs will skyrocket if, in the absence of further US grants, Israel defaults. The US would then have to pay all administrative costs and the original $10 billion, plus interest charges, which, judging from the $400 million loan guarantee, average 8.6 percent for 30-year loans. The total costs would range between $112 and $117 billion. So much for Bloomfield's assertion that there is no cost to the taxpayer.

The Likelihood of Default

The only reason that Israel has been able to service its debts is that every time it has teetered on the edge of default, Washington has thrown it an expensive economic lifeline. In 1974, to help Israel cope with burgeoning deficits, the US began waiving repayment of a portion of Israel's annual US military sales debt. Since 1985, the US has waived repayment of all of Israel's US military debt. The US stopped providing economic and military loans to Israel in favor of cash grants in 1981 and 1985 respectively.

In addition to the $1.2 billion in regular economic aid given to Israel in 1985, the US also gave $1.5 billion in emergency economic aid to help Israel restructure its economy, which was suffering from 445 percent annual inflation, a widening budget deficit and rising unemployment. The emergency aid package rode the coattails of the Cranston Amendment, which mandates annual US economic aid to Israel at least equal to Israel's annual debt repayments to the US.

Former US representative to the US-Israel Joint Economic Development Group and Undersecretary of State for Economic Affairs Richard McCormack, in a speech to the American Israel Economic Corporation in June, reported that Israel's progress on eight key goals for economic solvency—reducing the budget, lowering taxes, freeing capital, reducing subsidies and price controls, easing regulations, lifting trade restrictions, breaking government monopolies, and privatizing industry—has been "virtually none.

Rating Israel's Economy

Most financial analysts agree. The Export Import Bank, a US government agency which promotes foreign trade, gives the Israeli economy a "D" rating on a scale of A through F, while the financial magazine Institutional Investor ranks Israel just ahead of Mauritius and Papua New Guinea and just behind Algeria, Venezuela and Colombia in its credit rating. According to The Christian Science Monitor, Israel's long-term government debt that is not backed by US pledges receives a "triple B-, " the lowest rating, by Standard and Poor's investment index. "Anything below this is considered speculative, " explains Helena Hessel, a country risk analyst for Standard and Poor's.

US taxpayer costs will skyrocket if Israel defaults.

Meanwhile, Israel's short-term debt is so unsafe that, by US law, money-market funds may not invest more than five percent of their total assets in it, and Israel bonds, in which many municipal pension funds, including those of Baltimore, Boston, Chicago, Detroit, Hartford, Milwaukee, Philadelphia and Providence, have invested, are little better. "Strictly viewed as an investment, State of Israel Bonds fall short on several counts, " the financial newsletter Barron's warns. "Public employees ... are still entitled to retire, and the money must be there ... Our investment opinion: not for widows and orphans, " the newspaper concludes.

In September, Israel will ask the US government to put the assets of all American taxpayers, widows and orphans included, on the line. The legislation is, in effect, a multiyear contract, binding the US to the future well-being of the Israeli economy. Either way—whether Israel defaults or whether it maintains payments through increased US economic aid—one thing is certain. The US taxpayer will pay. Just how much could very well be a 117-billion-dollar question.

Parker Payson is the news editor of the Washington Report on Middle East Affairs.

SIDEBAR

How Loan Guarantees Work

Israelis expected to ask for $10 billion in loan guarantees in $2 billion installments over the next five years. Israel would use the guarantees to sell bonds to investors to finance a trust account. The intermediate trust allows Israel to make bonds available to foreign investors, who are prohibited by law from benefiting from US government guarantees.

Israel raises money on the promise that, over time, it will repay investors (through the trust) the original cost, plus interest (about 8.6 percent), over the life of the bond (usually 30 years). If Israel defaults, the US is responsible for paying the original bond cost and the interest.

Without the guarantees, it is unlikely that Israel would be able to secure $10 billion. Investors would expect higher interest and full repayment in a shorter time because of greater risk.

If the loan guarantees are authorized or implemented after Sept. 30, 1991, the Credit Reform Act, passed last year to reduce the federal deficit, requires that they be included in the US budget.

After congressional negotiation, the Office of Management and Budget will determine the amount that must be appropriated from the US budget to pay for the loan guarantees. This amount is based on the expected cost of administering the loans and the likelihood of default.