An excellent article by Joshua Green. Some excerpts:
But the [wind farm] industry encountered serious quality-control issues, and one reason was the nature of the government’s support. A tax credit on investment created an incentive to put up turbines quickly and plentifully and collect a check. But the tax code had nothing to say about how those turbines performed. And many of them did not. “If you look at Palm Springs,” Zaelke said, “the turbines are set one alongside the other in corn rows because you got paid by how many you installed, not by how well they produced. ...
Plotted on a graph, the history of clean-energy production in the United States resembles the blade of a saw, rising and falling each time subsidies came and went. Japan, Germany, Spain, and Denmark show smooth, upward-sloping yield curves, a reflection of consistent government policy. ...
The nut of the problem traces all the way back to Jimmy Carter’s choice of tax credits as the vehicle for subsidizing renewable energy. Direct grants would have been simpler. But Congress had recently changed the federal-budget process to keep closer track of how much money was being spent. It suddenly became easier to spend indirectly, by manipulating the tax code. Although no one realized it at the time, Carter’s decision to use tax credits lit the very long fuse on a bomb that detonated last fall and nearly took down the entire renewable-energy industry in America.
The trouble with tax credits is that in order to make use of them, you must owe taxes, and most start-ups struggling toward profitability do not. So while a company looking to build a wind or solar facility would qualify for valuable benefits, it had no means of realizing this “tax equity.” The work-around was to partner with someone who did, someone large enough to finance a $500 million facility and profitable enough to incur a large tax bill. Having witnessed two decades of busts and bankruptcies, traditional U.S. banks wanted no part of this. European banks, going by their more positive experience, were comfortable funding large renewable projects, but didn’t qualify for U.S. tax credits. The perversity of the government’s incentives demanded a big balance sheet, huge profits, and an indifference to risk. Enter Wall Street.
Investment banks and hedge funds stepped in to fill the void, engineering tax-equity vehicles with suspiciously complicated-sounding names, like “partnership flip structure” and “inverted passthrough lease,” to exploit the tax benefits. These deals amounted to financing agreements for large infrastructure projects, given in exchange for tax credits, often worth hundreds of millions of dollars, that could be applied against profits earned primarily on other investments (like mortgage-backed securities). For renewable-energy companies, tax-equity deals meant life or death: the combination of credits could offset two-thirds of the capital cost of a project. Companies like Lehman Brothers, Wachovia, and AIG became an integral part—even the integral part—of the renewables industry, because the utility-scale projects they financed produce the overwhelming majority of clean energy in the United States.
Basing the entire system of federal incentives on tax equity had two weaknesses, one that has always been clear and another that became clear only recently. Forcing renewables companies to route government support through Wall Street, thereby sacrificing a portion of it, was needless and inefficient. But it also tied the industry’s fate to that of the financial world’s most aggressive players. Just as Wall Street bankers bet that housing prices could never fall and got wiped out when proved wrong, Congress seems never to have imagined that Wall Street might someday have no profits and need no tax equity.