Loan Guarantees Distort Free Market

April 2, 2013

A loan guarantee is a promise by one party (the guarantor) to assume the debt obligation of a borrower if that borrower defaults. Proponents of loan guarantees claim that this type of subsidy is successful when a company that otherwise would have gone out of business is kept afloat. However, loan guarantees blatantly disrupt the free market and harm Americans, says Jack Spencer, a senior research fellow at the Heritage Foundation.

  • Loan guarantees deny capital to more competitive companies that would receive a loan if a failing business was not kept afloat by a guarantee.
  • The guarantees make it more difficult for companies that are less politically favored or are riskier.
  • The guarantees also deny Americans access to technologies and services by preferring lower-risk loans to higher-risk loans, which are more likely to drive innovative technology.

The loans distort the free market system by favoring Firm A over Firm B, even if Firm B is more competitive and Firm A would fail to succeed in the free market without the loan guarantee. The government has a poor track record when choosing which businesses, ideas or innovations will succeed. Politicians often take credit for supporting a handful of companies that succeed and use these companies as justification for subsidies for companies that continue to fail, such as Solyndra.

  • The free market, which values risk appropriately, should choose the winners and losers.
  • When the government engages in the process of private investment, it removes the risk of loss by shifting the burden to the taxpayer.
  • The loan guarantee programs also encourage a dangerous relationship between government officials and private enterprises.

For companies that accept loan guarantees, they are subject to additional regulations and bureaucracy, which make them less competitive, less prone to innovate and artificially successful until the subsidy runs out.

The loan guarantees should be ended in their entirety because they do nothing to change the underlying strength of the subsidized business or the real conditions of the market. Rules should be set that allow businesses to compete in a free market.

Source: Jack Spencer, "Seven Reasons Loan Guarantees Are Bad Policy," Heritage Foundation, March 20, 2013.

 

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