The U.S. subprime crisis was something everyone could see but few predicted. Lending practices were notoriously lax. Banks were dangerously over-levered. Interest rates could not stay low forever. All of those toxic conditions came to a head when housing prices stopped rising in 2006, causing a dangerously over-levered banking system to raise standards/slow lending and thereby set off a race to the bottom. That race to the bottom led to many mortgage originator bankruptcies and nearly destroyed the American financial system.
Some of solar's detractors say that solar's retained value is the new subprime asset-backed security. They point to the similarities: In their complex subprime asset backed security models, banks assumed that housing prices would never fall significantly because they never fell significantly before. Similarly, in their retained value calculations, solar companies assume that electricity prices will always rise because they have always risen. The detractors also point out that solar companies such as SolarCity (NASDAQ:SCTY) and SunEdison (NASDAQOTH:SUNEQ) (much like the subprime mortgage companies) assume too low of a default rate. Finally the detractors draw the analogy between the current unsustainable solar tax credits today and the low interest rates before 2006.
While history does sometimes rhyme, here are three reasons why solar isn't the new subprime.
Why solar is different
First, electricity prices are unlikely to go down because most nonrenewable energy sources will cost more money to produce going forward. Coal, for example, will only become more expensive as the government ratchets up environmental regulations. Natural gas prices will likely rise as the U.S. begins to export it or as other sources of demand begins to consume it. The only plausible scenario where electricity prices fall significantly is if solar (or some other renewable) grabs the lion's share of the electricity market. But if solar were to grab the lion's share of the electricity market, that would clearly be good news for solar companies.
Second, the current leasing standards are not lax. Most solar companies only lease to customers with good credit ratings and most people with good credit ratings won't intentionally try to get out of a lease because it could hurt their credit. The default numbers will not be as bad as the detractors say they will be.
Third, while it is true that solar depends on unsustainable tax credits subsidies, the industry won't have to depend on subsidies for very long. Currently, the solar industry depends on the Investment Tax Credit (ITC) for much of its boom. The detractors point out that ITC will be reduced from 30% today to 10% by the end of 2016.
But what the detractors don't point out is that the total cost of solar energy is falling every year as installers become more efficient at installing and solar panel producers become more proficient at producing. According to GTM Research, residential solar will still have close to grid prices in at least 14 states once ITC is stepped down to 10%. So while the reduction of ITC will hurt, it will not hurt as much as the detractors expect.
The bottom line
Those things being said, the solar industry could eventually grow to a point where leasing standards do become lax. The actual default rate could be significantly higher than what is currently assumed. Solar companies could experience another valley like they did in 2011. But given the current conditions, this doesn't seem likely.
Jay Yao has no position in any stocks mentioned. The Motley Fool recommends SolarCity. The Motley Fool owns shares of SolarCity. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.