Texas: Defaults, Bankruptcies, and Liquidation

Budding macroeconomists needs to pay low level attention to the situation in Texas for the next several months. 

Financial crises are often presented in the legacy media and non-economics classes as big surprises perpetrated by bad guys. Both those images are wrong.

Instead, the often percolate for a while, and get bigger through "contagion" effects. What is usually going on in these situations is that one party is insolvent and fails to pay their bills, and then the firms that were relying on that payment either become illiquid or insolvent, and the crisis spreads.

It's now clear in Texas that the grid was not requiring power producers to have backup capacity. Savings from that were passed on to retail consumers. In turn, those producers avoided adequate winterization. Instead, what they were all planning on doing was buying power from other producers (to keep their customers lights on) if they had to shut down their own production. Since the grid did not pay for backup capacity, producers all planned to buy backup capacity on the spot market. In fact, most were contracted to pay whatever they had to, and pass the cost on to retail consumers.

This is a classic case of the fallacy of composition that shows up in every discussion of the Keynesian explanation of business cycles. The fallacy is assuming that because the system will work when some producers are buying on the spot market, that it will continue to work when all producers are buying (and not many are selling).

Here's where it gets really weird ... especially for someone who has had more than a few weeks of microeconomics.

The typical spot rate for power is about $25/MW. As demand went up and supply went down, that price went through the roof. But there still was not enough power being generated. So the Public Utilities Commission instituted a price floor at $9,000/MW. The theory was that this would induce power producers to come back online for an easy killing. And that didn't happen because they'd shut down for mechanical and weather reasons.

The situation now is that consumers are seeing electrical bills in the thousands of dollars.

But it's worse at the level of the power producers, where they are often getting bills for $1,000,000,000.

The PUC has decided that they can't unwind these huge bills: everyone is depending on the firm in front of them to pay their bill first.

So here's what you need to keep an eye. The weather problem was an acute one. It's over. The resulting financial problems are just beginning. I am not predicting this will turn into a financial crisis that affects more types of firms and spreads outside of Texas. But it might.