Sunday, April 22nd, 2012
Infrastructure banks are back in the news thanks to Chicago Mayor Rahm Emanuel’s plan for his billion plus dollar Chicago Infrastructure Trust. This trust would leverage private funds to finance infrastructure improvements in his city. I’m not taking a position on whether or not it is a good idea or a bad one. Partially that’s because I can’t figure out exactly what it is or what its actual value delivered is. This has nothing to do with Rahm’s proposal per se. I was equally confused back when President Obama proposed his National Infrastructure Bank.
The concept, as I understand it, is that an infrastructure bank is some type of investment fund. It collects money from private and in some cases (e.g. Obama’s proposal) public sources. These funds are then invested via some criteria into infrastructure projects that generate some type of financial return such that the original investment can be repaid over time.
So far so good I guess. The question I have though is what does this actually do for us that we can’t already do? Let’s examine some potential sources of value and what infrastructure banks might deliver on them:
1. They might raise funds in a debt constrained environment. In the Chicago proposal, we hear that the city is staggering under a huge debt load such that it can’t borrow any more money without negatively affecting its credit rating. Ok. So explain me this, if private investors put money into a project and expect to be paid back by some revenue stream over time, how is that not debt? This strikes me as very similar to some privatization transactions, which should be basically seen as a type of off balance sheet borrowing. For example, in the case of the Chicago parking meter lease, the city really just borrowed $1.1 billion from Morgan Stanley and is paying it back to them over 75 years in the form of quarters.
I’m not saying these types of financing activities are all bad. But we’ve seen enough of what happens when companies load up with special purpose vehicles and off balance sheet transactions to know that it dramatically reduces transparency. This will make it difficult to assess just how much debt the city has taken on. If the ratings agencies haven’t caught on to this, you can believe they will at some point if more cities shift to these types of financing structures.
Unfortunately, infrastructure banks are often presented as if they are “free money” to the public. I believe this greatly misrepresents the reality. Any money invested by the bank has to be paid back. An infrastructure bank seems to be just another fancy name for borrowing money. We should probably evaluate it just like we do debt.
2. They might be a vehicle for pools of private funds to be invested in infrastructure. There are two items here: private funds and pooling. We already have many ways in which private funds can be invested in infrastructure. The first is called the bond market, which is a well established mechanism. The second is through more traditional public-private partnerships such as privatization transactions, development projects, etc. It’s hard to see how an infrastructure bank uniquely contributes here. There are already ample means for private funds to be channeled to infrastructure.
An infrastructure bank also pools funds from various investors, which has value. But so to bank banks. And so do various purely private infrastructure funds of the type that already invest in toll roads, water systems, etc. It’s hard for me to see any unique value infrastructure banks bring here.
3. They might limit public risk. Potentially the repayment of the investors could be ring fenced to only the revenue streams of the project. For example, any tolls collected on a new toll road. This would be unlike general obligation bonds, which are backed by all the taxpayers of the city.
There’s clearly value here, but there are also other traditional vehicles like revenue bonds that accomplish the same purpose. Revenue bonds may not be the easiest mechanism however, since they typically require a separate contracting entity like a utility or special purpose authority, and investors want to know that there are stable revenue streams to repay them, like sewer fees.
An infrastructure bank might be good where some of these are not available. For example, the project Chicago has highlighted as an example of where to use its infrastructure bank is to retrofit buildings to make them more energy efficient. There may not be an easy way to use revenue bonds for this. Also, the exact energy savings might not be predictable.
In these cases, the investment might look more like equity than debt, since the ability to get repaid is uncertain. I’ve often seen privatizing contracts in this light. They include a hedge against future risk. For example, when Indiana privatized the toll road, they hedged their risk against traffic declines, which in fact happened during the Great Recession.
Of course, to get someone to take on your risk, you are going to have to compensate them. Thus the rates on this type of financing should be higher.
This raises two fundamental risks. The first is whether or not the city overpays a private entity to take on that project risk. The second is that the city might write a terrible contract such that it really doesn’t outsource much risk at all.
I used to crow about how privatization transferred risk to investors. After reading some of these contracts and seeing how they operate in practice, I’m much more skeptical. In practice, most of these contracts ensure that the public retains almost all of the risk associated with the deal. For example, pretty much the only risk the parking meter lessee took on in Chicago was whether or not people continued to put quarters in the slot. Anything else – like hosting a NATO summit that requires meter closures – is the city’s responsibility.
As I noted in my piece “The Privatization Industrial Complex,” cities are pretty much at the mercy of sophisticated investors who do transactions like this day in and day out for a living. Even in a sophisticated financial town like Chicago, multiple contracts have blown up in the city’s face. The idea that somehow governments will do a better job of negotiating deals with an infrastructure bank than they’ve done with other private investors seems dubious.
However, if you can develop a good framework for this, it does show what I think is one clear advantage of an infrastructure bank construct: it sets up a replicable structure through which these types of investments can be made such that you don’t have to make it up from scratch every time.
4. They might promote rational prioritization of investments. This was something Obama touted for his infrastructure bank. The idea is to somehow depoliticize investment decisions and channel money to the highest priority projects. I would agree this might be a valuable thing at the federal level. And we’ve seen some examples of how it can work, such as the BRAC process for military base closures. But Republicans clearly saw the risk that this would become in effect a slush fund for the President to use to reward supporters. The TIGER process I thought showed that there could be a pretty fair allocation of transport funds on a discretionary basis however, though clearly its decisions favored the President’s view of transport priorities.
In any case, given the lack of a clear and easy to understand rationale for why, if these projects will generate funds to repay the initial investment, any government involvement is need to lure in private funds, it’s easy to see why this wasn’t going anywhere, particularly when there is a fundamental disagreement on the vision for transport infrastructure in America (e.g., high speed rail) and on infrastructure spending and the federal role in it generally.
At the local level this seems less valuable. For example, Rahm can already pretty much channel investment anywhere he wants. If we wants a rational allocation of funding to high priority projects, there’s nothing stopping him from soliciting input on what those projects are from various advisors, then making it happen.
5. They might circumvent costly public contracting rules. Privatizing advocates sometimes suggest that for items with large capital expenditures such as highway or airports, private companies can implement these much more cost effectively because they aren’t subject to burdensome public contracting rules. Unlike public officials, who have an incentive to award contracts to their pals, these private companies have an incentive to make money, so they don’t need the legal framework around public procurement.
From an infrastructure bank perspective, I’m not sure how this would work. Is this just a financing activity that otherwise channels money through the normal bidding process? Or is it an entire separate contracting structure. Given that in Chicago the mayor has promised to abide by minority set-aside requirements and such, it seems like the latter.
It’s hard to see how this would be anything new compared to traditional privatization. Also, the public is likely to want many of its key policy goals such as supplier diversity or open records to be followed in any case. And for major construction, I think people are delusional if they think non-union labor is going to be used.
Again, I’m not saying an infrastructure bank is bad, but I’ve yet to see any clear and compelling explanation of the value proposition. It strikes me as just yet another alternative borrowing structure. I’m happy to be shown wrong on this. But if I’m confused, it’s easy to see why lots of other people are too and why there is so much skepticism around the concept. Feedback welcome.