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What are Israel's Loan Guarantees?

By Ed Finn
Posted Wednesday, Aug. 6, 2003, at 1:10 PM ET

The New York Times reported Tuesday that the United States may be planning to reduce Israel's loan guarantees to account for any money the country spends constructing a "security perimeter" that will divide its citizens from Palestinians. What are these loan guarantees, and how important are they to Israel?

A loan guarantee is essentially the same thing whether you're buying a car, an apartment, or housing materials for Soviet immigrants. A reliable financial entity (a bank, your parents, the United States) promises to pay off the balance of a loan if the borrower cannot. So when Congress promises Israel $9 billion in loan guarantees (as they did this year), that means the U.S. government accepts responsibility for up to $9 billion that Israel can then borrow from international creditors. And loans guaranteed by the Federal Reserve provide an additional benefit: The interest rates offered are much lower than they would be if Israel (or any small, debt-troubled nation) sought the loan without backers.

The $9 billion in loan guarantees (along with $1 billion in direct aid) comprise a special post-Gulf War II aid package, awarded to Israel on top of the $3 billion in other assistance that the United States gives annually. But with loan guarantees, it's never clear how much money is actually "given": In a perfect world, they wouldn't cost the United States a cent. Israel—or Turkey, Egypt, and Jordan, all of which snagged loan guarantees as postwar rewards—could borrow on the international markets, then pay off the loans completely, leaving the United States with no financial obligation. But Israel has already received nearly $10 billion in loan guarantees from the United States since 1992, and while it has yet to default on any of those loans, this new round of guarantees is intended in part to help Israel pay off the old debt. Which means the United States could be stuck with a bill ranging anywhere from zero to $9 billion plus interest.

When borrowing on the United States' good credit, the Israeli government can use the money for any purpose. However, Congress attached a series of stipulations to the recent package, including one that reserves the right to reduce the guarantee amount to counterbalance any money Israel spends creating new settlements in contested territory. This caveat is exactly what Bush may use now to pressure Israel to cease construction on its "security perimeter"—if the caveat is employed, Israel would find itself fully responsible for part of its loan (and thus with higher interest rates). And because Israel's annual revenues top out at $40 billion, any tweaks to a $9 billion aid package could shake up the country's economy.

Experts say it's far from clear that the Bush administration will follow through with this plan. But simply threatening to reduce the guarantees can also be effective because Israel needs the U.S.-backed loans to keep debt payments under control. In 1991, Israel was in a similarly desperate financial situation, and the United States used the threat of limiting loan guarantees to force then-Prime Minister Yitzhak Shamir to attend the Madrid peace conference and suspend settlement construction while he was there.

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Thanks to Michael Doran, assistant professor of Near Eastern Studies, Princeton University, and Max Abrahms, a Soref research fellow at the Washington Institute.

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Ed Finn is a writer in New York. You can e-mail him at .
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