Sunday, August 22nd, 2010
Last week I taped a segment for a film project on privatization. For some reason, people keep seeking me out to be the guy that will take an anti-privatization point of view. That always puzzles me because I’m generally favorable to it. I’m a big fan of the Chicago Skyway and Indiana Toll Road leases, which were clearly grand slam home runs. Chicago pocketed over $100 million from a privatization of Midway that didn’t even go through because the winning bidder couldn’t line up financing and had to forfeit their deposit. $100 million just for running an auction has to be the all time greatest ROI in the history of privatization. The recent Indianapolis water company “privatize to yourself” transaction was a pretty good deal I thought.
The fact that I cite all these long term infrastructure lease deals as examples of privatization, and that this is what everyone typically thinks of regarding it these days, shows how much things have changed in this field in just the last couple decades. Think back about 15-20 years ago and the types of deals privatization pioneers like Stephen Goldsmith did. He’s now a deputy mayor of New York City and formerly a Harvard professor, but then he was mayor of Indianapolis. Goldsmith undertook 80+ privatization deals. His approach was rooted in a conservative vision of good government where he believed that by subjecting what was formerly a government monopoly service provider to competition from the marketplace, he could reduce costs and improve quality of service. While as a moderate Republican he had free market sympathies, he wasn’t acting out of some innate hostility to government. In fact, he allowed the government employees who were already providing the services to bid on them, letting them up to propose how they would go about doing it if freed from the previous rules that tied them down. And those employees actually won some of the deals.
In retrospect, I think you’d have to classify this as a success. Some of these deals were criticized, and anytime you do 80 of anything you’re probably going to run into problems. But because these deals were periodically rebid, vendors had to stay on their toes and if they screwed up they could be sacked or replaced at the next tender, which happened on a regular basis. The risk was manageable, the benefits clear.
This is a very different type of privatization than the infrastructure leases above. Those deals aren’t about bringing competition to bear on service provision at all. They’re about jackpots. They are about substituting one monopoly service provider for another, and splitting the resulting monopoly rents between the government and the private sector. Rather than being rooted in a vision of how to improve government services, these deals are about how to generate cash from under-performing assets. It’s an investment banker mindset, not an operator mindset.
That’s not to say they are bad, as the examples above show. But they are very different. One of the biggest differences is that unlike Goldsmith’s deals, these are extremely long term contracts, often 50-75 years. This makes them very risky undertakings. If you sign a bad deal, the consequences are much more severe. Also, these deals generate large up front payments. Because of that, particularly in an era of financial crisis for our cities, there is an enormous structural incentive for mayors who operate on a four year election cycle to grab that pot of money, even if it means signing a bad deal.
The Chicago Parking Meter Lease
Which brings us, of course, to perhaps the most controversial privatization deal of recent years, the Chicago parking meter lease, which continues to generate negative press for the city. A recent provocatively titled Bloomberg piece, “Morgan Stanley’s $11 Billion Makes Chicago Taxpayers Cry,” had this to say:
Morgan Stanley, Abu Dhabi Investment Authority and Allianz Capital Partners may earn a profit of $9.58 billion before interest, taxes and depreciation, according to documents for a $500 million private note sale by their Chicago Parking Meters LLC venture. That is equivalent to 80 cents per dollar of projected revenue. Standard Parking Corp., which runs 30,000 spaces at the city’s O’Hare and Midway airports, earned 4.84 cents on that basis last year, data compiled by Bloomberg show. The deal illustrates how Wall Street banks, recipients of more than $300 billion in taxpayer bailouts in the worst credit collapse since the Great Depression, are profiting from helping states and cities close record recession-induced deficits by selling bonds and leasing public properties.
Oddly for a financial publication, this piece ignores the time value of money. But I think it’s fair to say that it’s likely Morgan Stanley got a very good deal on these meters. They closed this deal about the same time the Midway one fell apart. The fact that financing was readily available in tight market for the parking meters while it was impossible for Midway tells you everything you need to know about the relative merits of those deals financially.
But even if Chicago didn’t extract the last penny of value out of the parking meters, so what? It’s highly unlikely you are going to win huge in every deal. In fact, the more of them you do – and Chicago has done several – the more likely you’ll encounter a loser. Chicago got massively overpaid for the Skyway and Midway, and on a portfolio basis I feel confident the city is still a net winner from privatization on a cash basis even if it theoretically could have gotten more for the meters.
The Real Problem: Policy Risk
The problem with deals like the parking meter lease is that they aren’t like buying a stock, which is an entity with a purely financial purpose, and where if you screw up the worst thing that happens is that you lose money. They’re a lot more getting married. And if you marry the wrong gal – particularly with no option of divorce for 75 years – the consequences are a lot worse than a bad stock pick.
I’ve long said that most of the critiques of the Chicago parking meter lease are overblown. They’re good fodder for gotcha journalism, but not much more. But even so, this deal, and any deal like it, contains serious fatal flaws.
The main problem with the parking meter lease is that it locks the city into a particular policy structure on parking for the next 75 years. In order to get someone to pay $1 billion up front, you have to give them certainty as to the quantity, location, hours, and rates of the meters. All of these matters are thus written into the contract. In effect, Chicago has irrevocably set public policy with regards to parking for the next 75 years.
This might not matter for something like a toll road. Firstly, unlike with parking, there’s a track record here of successful deals. Second, tolls roads by design are built to stand apart from the territory through which they pass. They are purposefully isolated. This is one reason so many urbanists hate freeways. If you get something wrong on a freeway, you affect it but not necessarily everything else to a great degree.
But with on street parking it is very, very different. Parking spots are the curb lane of your streets. Your streets are the primary public space in your city. They are intimately connected with everything that happens in the city, which is one reason parking policy is so politically controversial. On street parking – in contrast to garages, which are very different – is a fundamental and integral element of urban planning policy. In effect, these deals aren’t about just parking spots, they are assigning a property right interest in the biggest component of public space in the city to a private monopoly that doesn’t have the public’s best interests at heart. The city of Chicago has ceded a portion of its urban planning powers to a private company.
I’ll show some of the consequences of this momentarily. But first I’ll address the response that the city hasn’t given up the right to anything, but still retains all of its powers it always had. That might be legally true, but de facto these powers can’t easily be exercised. I noted earlier how all of the parameters of parking policy are specified in the contract. They can’t be changed without paying the vendor to hold it harmless. According to published reports in the Reader and elsewhere, this isn’t even based on actual loses, but on a penalty schedule in the contract that assumes nearly 24 hour meter occupancy. This means if the city wants to change policy, it has to pay dearly for the privilege. Being broke, it can’t afford to. Alderman have already been told they can’t exercise their previous prerogative power to change parking hours in their wards because of this.
The essence of a monopoly is collecting rents. Everyone thinks of the public’s quarters here when it comes to leases. But part of the monopoly is on policy, meaning that the vendor is now in a position to extract even further rents from the city to change policy. I believe this is one reason these vendors desire such long term deals. They believe there is even more future value to be extracted through penalties and inevitable re-negotiations.
I actually cited that as a benefit of the toll road leases. The city in effect bought a hedge against changes in future conditions as part of the deal. For a relatively standalone asset like a toll road, that’s a good thing. For an integral part of the city’s public space, it’s catastrophically bad. This is because management of public space is, along with public safety, schools, and taxation, one of the single most important factors contributing to the attractiveness of a city as a place to live and do business. In an innovation era, in an era of ever more rapid change, locking yourself into a fixed policy for public space for decades is a terrible mistake.
Imagine the world 75 years ago (1935) or 50 years ago (1960). Those people could never have foreseen what our cities would be like, what the challenges and opportunities of our urban spaces would be today, what the technology would be today, etc. How likely it is we’ll know what we need even 10 years from now?
Unfortunately, one doesn’t even need to hypothesize about the negative fallout from this. It’s already visible.
New York’s Pop-Up Sidewalk Cafes
It’s no secret that New York is today’s leader in urban transportation design. Under Transportation Commissioner Sadik-Khan, they’ve launched a revolution in public space management, and have brought huge innovation and positive change to New York’s streets.
Here’s a small but great example. Some of New York’s sidewalks are too narrow to permit sidewalk cafes. So what do you do? Well, the Architect’s Newspaper reports on an experimental solution using pop-up sidewalk cafes. I believe this idea may have actually been borrowed from San Francisco, but it involves re-purposing some parking spots on a seasonable basis for a temporary sidewalk cafe installation. Here’s a picture:
It’s a nice solution, and an attractive design I might add. NYC went from concept to implementation in just one month. Now, maybe they are possibly losing some meter money from space removal. But at least it is only actual loses, not Chicago’s fantasyland liquidated damages. And with tomorrow’s dynamic pricing systems (see below) it might not lose anything. Also, while tampering with parking is always a sensitive matter, they were able to move quickly because, among other things, they don’t need to coordinate with a leaseholder on the spots. Everyone knows time is the enemy of the deal, and so many innovative ideas never happen because they hit resistance and end up in the too-hard pile. New York hasn’t created a barrier to continued innovation and improvement in its streets. As Transportation Commissioner Sadik-Khan put it, “Inventions like this help make our streets into destinations and improve the quality of life for the thousands of people who live, work, and play in Lower Manhattan.”
It’s not going to be impossible for Chicago to do this, but it is going to be harder. Maybe pop-up cafes are doable. But what about large scale BRT deployment? Or the bicycle boulevard I’ve proposed on Monroe St. as a way to safely link the west side to the lakefront through the high traffic barrier of the Loop? It isn’t hard to see how the meter deal puts a major obstacle in the way of all these things, financially if nothing else.
The other tragedy is that Chicago has locked itself into a parking policy at just the moment that we’re on the cusp of a revolution in on-street parking management. Just as we understand congestion is a result of underpricing, and that we can use dynamic pricing on tollways to optimize the use of that resource, dynamic congestion pricing is coming to parking. Based on the recommendations of professor Donald Shoup, San Francisco is rolling out high tech meters like this one that will enable it to dynamically change pricing in order to maintain 80% parking occupancy at all times:
The beauty of this approach is that it not only ensures that limited parking spots are used in the most economically efficient way possible, it also depoliticizes parking rates. Rather than setting them arbitrarily, or only once and nearly forever through a lease, San Francisco is basically telling the public “you tell us what the rate ought to be.” Like eBay, the value of a spot will depend on actual consumer demand, not government fiat. Who would have thought that the greatest bastion of the free market in parking would end up being San Francisco? This is an example of what modern technology is letting us take out of the ivory tower and into the real world.
There will no doubt be kinks to work out. But that’s why it’s good SF doesn’t have to deal with a private leaseholder. And even further down the road policy might change again. What’s more, none of this actually prevents San Francisco from issuing revenue bonds against its meter proceeds (which it has done in the past), nor does it prevent contracting out management of the system, enforcement, etc.
Again, this isn’t even about money. It’s about being able to better manage one of key assets of the city – its public space on its streets.
The lesson is very clear: maintain policy flexibility, particularly when it comes to these types of services. San Francisco and New York are positioned to step on the gas here, while Chicago is going to have to figure out how to deal with the consequences of its meter lease.
Lemmings Off a Cliff
Given the paucity of successful case studies for meter privatization, and the cautionary tale out of Chicago, one would think that cities would be hesitant to follow the same path. But apparently not. Lots of cities are considering this. Indianapolis just this week signed a 50 year deal for its meters. I’m sure they would say it’s completely different than the Chicago one. And I’m sure they couldn’t have failed to learn something from the Chicago fiasco. But in its essentials, at least based on media reports, this deal has the same basic characteristics as the Chicago one. Indianapolis is selling a 50 year property right interest in its public space, including virtually all of downtown, to a private company. And they’re doing it for a comparative pittance of only a $32 million lump sum. (The revenue share component does not necessitate a 50 year deal). At least Chicago got $1 billion for their trouble. What’s that story again about Esau and a bowl of soup?
I think about Indiana’s failed FSSA privatization. Gov. Daniels took some heat for this deal, obviously. But here’s a guy that has tried to advance the ball. Occasional failure is the price of innovation. If at least a few of Daniels’ ideas didn’t work out, I’d argue he wasn’t doing nearly enough. I don’t blame him at all for trying a new idea an in fact I think he ought to be admired for the political courage he’s exhibited in making the case for the new in a conservative state like Indiana.
But guess what, when the FSSA deal didn’t work, he was able to re-evaluate and cancel it. While some people who receive services from them no doubt experienced the downsides of this, in the long term, Indiana wasn’t harmed. But imagine if the state had signed a 50 year deal in return for a large up front payment. And when the deal went sour it had already spent it all and the state was so broke it couldn’t afford to cancel the deal even if it contractually had a termination clause? Indiana would have been in for a world of pain.
Cities would be wise not to put themselves in the situation to let that happen to them. Daniels understood the difference in risk profile between the FSSA and the Toll Road, and he contracted appropriately. Parking meters are closer in risk profile to the FSSA.
What Would Goldsmith Do?
Some local political bloggers claim a cabal of Goldsmith-era people are running the Indianapolis government behind the scenes. That sort of inside politics stuff is beyond my pay grade. Given that Goldsmith was the last Republican mayor before the current one, it would make sense that Ballard hired a few of those people, just like President Obama hired many folks from the Clinton administration.
But perhaps rather than listening to what old Goldsmith hands have to say, better to just look at what Goldsmith himself does – or, more importantly, what he’s not doing, which is signing a long term lease for Gotham’s parking meters. He runs their Department of Transportation, so this is clearly in his scope of responsibilities.
Yes, I’m aware that Goldsmith defended the Chicago parking meter deal. And I agree with virtually 100% of the article he wrote. The vast majority of the complaints about Chicago’s parking meter lease are much ado about nothing, and he explains why. But he did not address the matter of policy risk that I discuss here.
I’m sure he’ll be looking at parking in New York. There’s no doubt that parking in NYC is, as it was in Chicago, grossly underpriced. Fixed pricing for parking is on the way out. As for parking garages, I’m not sure why government is in that business anyway, since it’s clear that private enterprise will spend their own money to provide that service. I have no principled objection to the involvement of private enterprise in the management of on-street parking, which is clearly long overdue for a shake-up. I think there’s plenty of scope for contracting things out, issuing revenue bonds, etc.
But I’m confident that if he looks in detail at leasing New York City’s meters, the policy risks inherent in it will become very clear. That’s doubly true in New York, where public space innovation has played a key role in moving the city forward in recent years. I’ll be very interested to see how he addresses it. If anybody can figure out a way to structure a good deal around parking, Goldsmith is the guy. If he does a major parking deal in New York, then that’s a structure I’d advise anyone to take a hard look at and consider implementing. Until then, a long term parking meter lease should be a no-go zone for cities.
Who’s Your City?
One of the things about so many of the policy fiascoes of the past is that they tended to get universally applied, thus didn’t generate competitive disadvantage. Most cities had their share of urban renewal boondoggles, for example. But what happens when a bad policy trend hits, but only some cities go for it? We might get an example of it right here.
In the future there might be two kinds of cities: those who who sold off a long term property right interest in their on street parking – which is to say, in the most important component of their city’s public space – and those who didn’t. And make no mistake about it, no matter what anyone might claim about these meter leases, the long term sale of a property right interest is what they represent.
I won’t claim this is going to be the difference between urban success and failure. But it will make things more challenging to innovate, and keep up with best practices, in public space. It’s sort of like running with ankle weights and a 25-pound weight strapped on your back. It doesn’t mean you can’t finish the race, but it does put you at a competitive disadvantage. While a place like Chicago can probably handle it, lots of other cities are still struggling mightily to attract residents and investment to their urban cores. Why create gratuitous problems for yourself? Deals like this are one reason why, despite the fact that I believe Indianapolis has higher potential, I have said that Columbus, Ohio is likely to be the better performer in coming years.
Again, it’s an era of ever more rapid change and ever tougher competition. We have no idea what the world is going to be like 5, 10, 25 years down the road, much less 50 or 75. Anything that locks cities into a particular policy framework for the long term for areas where there isn’t a strong track record of success poses a high risk. I would strongly advocate that cities avoid entering into long term on-street parking leases until successful models have been developed and have proven themselves through shorter term, successful contracts.
I haven’t examined the Chicago meter contract personally in depth and I’m not a lawyer in any case. If you’d like to, however, a copy is online here. My scan of it indicates that the city could change parking policy if it desired (it’s a “reserved power”), such as to implement dynamic pricing or some such, but only if it results in a net financial gain to the vendor. Otherwise, the city has to pay up (it’s a “compensation event”). This is what I mean when I talk about the ability of the vendor to extract even more downstream revenue through its ownership of that property right when the city needs to change policy. It’s amazing what the contract considers an adverse event. It even includes reducing the threshold for booting!