Federal Asset Privatization, Not a Higher Debt Ceiling (SPR a good place to begin)

By Robert Murphy -- June 2, 2011

As the battle rages over the federal debt ceiling, more pundits and even some politicians are taking a serious look at a solution that any private organization would have considered from the beginning: selling off assets to satisfy creditors.

Contrary to the doomsday rhetoric of Treasury Secretary Geithner, it is simply not true that the Congress needs to raise the federal debt ceiling, lest Uncle Sam default on existing obligations. On the contrary, large (but feasible) spending cuts, coupled with aggressive privatization of federal assets, would balance the books. There is no need to raise taxes or the debt ceiling.

The bonus to privatization is also market entrepreneurship in place of bureaucratic management. So the asset transfer would be good for both taxpayers and the private sector writ large.

I’ll outline the numbers, then focus on the possible objection to privatizing the Strategic Petroleum Reserve, a topic that should be of the most interest to readers of Master Resource.

The Scope of the Problem

When analysts ran the numbers about a month ago, the federal government was projected to spend about $750 billion more in the remainder of Fiscal Year 2011 (which ends on September 30) than it would collect in revenues. Therefore, in order to avoid raising the debt ceiling without defaulting on interest payments on existing debt, the feds would need to cut spending and/or increase revenues by that amount, just over the next four months.

In a political culture where agreements shaving a few hundred million dollars are touted as radical measures, the prospect of slashing $750 billion seems inconceivable. Indeed, this is why Brad DeLong and other leftist commentators think it is obvious that the “adult” thing to do is raise the debt ceiling already, since they can see no other alternative.

There are two problems with this analysis. First, part of the reason the deficit is so high, is that federal spending has mushroomed in recent years. If the government merely went back to its 2003 spending levels, then the problem would be solved. In other words, cutting the equivalent of $1.5 trillion per year in spending sounds like draconian cuts, but only if you think the federal government was small in 2003.

Second, the shortfall doesn’t have to be filled by immediate budget cuts. By selling off assets, the federal government can buy itself time and phase in deep cuts more slowly.

Slated for the Auction Block

Here are just some of the potential items that could be privatized, with the proceeds from auction being used to cover expenses in lieu of borrowing more:

* Sell the gold in Fort Knox. The Heritage Foundation’s Ron Utt has recently proposed this, and Congressman Ron Paul endorsed the idea. The government says it holds 261.5 million ounces of gold, which would fetch about $403 billion at the current gold price of around $1,540 (as of this writing).

* Sell the oil in the Strategic Petroleum Reserve. As of late November, the SPR held 726.5 million barrels of crude. At this writing’s price of about $100 per barrel, this works out to another $73 billion in highly liquid assets held by the government. Discount the inventory by 25 percent for its in-ground status and taxpayers are still north of $50 billion.

* Sell the rights to ANWR and offshore resource extraction. According to the government’s own estimates, ANWR has some 10.4 billion barrels of recoverable crude, while the Outer Continental Shelf (OCS) has some 86 billion barrels. Although a barrel of crude in the hand is obviously worth far more than a hypothetical one buried under the sea, clearly the federal government could raise many billions of dollars if it sold the rights to develop these resources–especially if the current sale included all future royalty streams and other payments normally going to the government.

* Sell student loans and remaining TARP holdings. According to the WSJ, the federal government owns about $400 billion in student loans and $142 billion in claims on companies it rescued during the financial crisis.

We can stop at this point, as we have already documented well over $1 trillion in assets that the federal government could sell. We have not even mentioned the government’s vast holdings of real estate. Clearly there is no need to raise taxes or the debt ceiling, in order to get through the current budget crunch.

A Private SPR?

The broader point behind a sweeping privatization is that resources should be returned to the private sector, anyway. In other words, it’s not that we “have no choice” but to do something drastic like selling off student loans; what the heck is the federal government doing in the student loan business in the first place?

For readers interested in energy issues, the case of the SPR is instructive. The free market is perfectly capable of handling the functions ostensibly served by the strategic reserve.

For example, suppose tensions heat up with Iran. Speculators anticipate that in the event of war, exports from the Middle East will be interrupted, and the spot price of oil (at that future time) might jump to, say, $200 per barrel. If the prevailing price for a futures contract on oil 3 months out is only, say, $110, then as hostilities escalated speculators would buy futures contracts, thinking they were underpriced. Suppose they would continue to do so until the new futures price settles at $150, fully pricing in the likelihood of a new war in the Middle East.

It is precisely this type of behavior that President Obama and others have condemned (whether or not speculation is actually responsible for the upswing in oil prices over the last two years). But in the hypothetical scenario just described, speculators are doing what we want. That is their role in a market economy, to adjust price discrepancies and actually reduce volatility. If war breaks out and oil really does jump to $200 overnight, the jump will not be so jarring because of the prior acts of the speculators.

In particular, when the current spot price is (say) $100 while the 3-month futures price is $150, the oil market would be in severe contango. Someone could earn a relatively sure return by buying physical oil in the current spot market (at $100 per barrel), selling futures contracts for that many barrels (at $150 each), and then simply storing the oil for three months in order to deliver the product as specified. This would be a sure 50% return (over three months) less the cost of storing and insuring the oil.

Such a lucrative investment opportunity would not persist for very long. So long as speculators kept the 3-month futures price propped up at $150, investors would continue to stockpile crude in the present, in order to sell it three months later. But as more and more of current output were diverted into inventory accumulation, rather than refineries for current use, the spot price of oil would go up as well. Equilibrium would be restored when oil prices in the present had risen close enough to $150 to make it unprofitable to accumulate more physical oil inventory.

What we have just sketched (with our exaggerated numbers) is the mechanism by which speculators, who anticipate future price increases, can induce current price increases by diverting production out of current use and into inventory build-ups. Although the idea of speculators driving prices up while “withholding oil from the market” seems to be the epitome of evil in some quarters, I repeat that this is the market working properly. If the diplomatic situation deteriorates such that the chance of war in the Middle East suddenly jumps, then the “right thing to do” is for people around the world to economize on their oil consumption, while producers need to ramp up production as much as they can, in preparation for the possible catastrophe. The (nearly) $150 spot price gives the right incentives to both consumers and producers.

Finally, notice that the mechanism I’ve sketched shows that the government doesn’t need to maintain a strategic petroleum reserve. Private investors could do it far more efficiently, guided by market prices. When it looks like imports will be interrupted, the intertemporal prices in commodity markets would give the incentive to build up the private-sector “reserve.” When the danger passed, and speculators anticipated falling spot prices over time, the holders of inventory would sell down their reserves. This is exactly what the government managers of the SPR are supposed to do.

Conclusion

One caveat: In the real world, speculators and investors would not be able to earn high returns from correctly anticipating swings in oil prices, as we assumed in our example above. In reality, they would be hauled before Congress,  charged with all manner of “manipulation,” and slapped with windfall profits taxes. Therefore the market’s ability to handle a private-sector SPR would be muted. Even so, it’s worth pointing out that the fault would lie with government intervention, not with the nature of the product or industry.

Most people understand the folly of letting the federal government design personal computers or create pop music. But Uncle Sam likewise has no business lending money to college students or maintaining stockpiles of oil. All of these legitimate functions could be handled much more efficiently in the private sector, and returning them would also help solve the current budget crisis.