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Sunday, February 24th, 2013

Replay: The Privatization-Industrial Complex

“I think this is just the latest way for people to make money off state and local governments. This is the new way the investment banks, their lawyers, and consultants squeeze the taxpayers….They’re going around making these deals, and it’s very lucrative. It’s like a circus coming to town.” – Clint Krislov

Privatization has long been advocated by many conservatives as a good government measure. Traditionally, privatization was used a tool that subjects government monopolies to competition from the marketplace, driving down costs and improving quality of service. Privatization pioneer Steve Goldsmith, former mayor of Indianapolis and now deputy mayor of New York City, used to apply what he called the “Yellow Pages test.” If he could open the Yellow Pages and find several companies providing a service, he wondered why government should be in that business.

As Mayor, Goldsmith privatized dozens of city services in Indianapolis, saving the city an estimated $120 million the process. This ranged from contracting out services, to forming a public/private partnership to implement a $500 million infrastructure improvement plan to hiring private managers to run – but not own or lease – the airport and water utility.

Today, sadly, privatization is less about Goldsmith style operational effectiveness and more about providing jackpots for financiers who stand at the core of a growing privatization-industrial complex. Cities and states salivate over ways to sell or lease off underperforming public asset for large payouts. With local governments cash-strapped and the public unwilling to pay more in taxes, it is politically difficult to even bring user fees to a market rate. Combined with the potential billions in payoffs – Indiana received $3.9 billion for its toll road and Chicago $1.1 billion for its parking meter system – the appeal is obvious.

But these transactions differ markedly from the Goldsmith-style privatization. They are driven not by efficiencies but by an investment banker mindset focus on money and narrow parameters of the asset operations. They also provide enormous temptation to elected officials to grab the money now even at the expense of future generations. They are also rife with potential conflicts of interest and incentive problems.

One major source of conflict comes with the professional advisors that drive the deals. Since long term leases involve so much money and are so complex, they require millions of dollars of services from investment banks, lawyers, financial advisors, etc. Unlike for typical government transactions such as issuing bonds or contracting out services like printing, building maintenance, or call centers, for which cities have some experience, the vast majority of cities have little in house expertise for complex financial transactions.

Thus local officials are at the mercy of these out of town experts to give them the best advice they need to defend the public’s interest. But what advice can we expect from these firms, who have a stake on highly leveraged deals? The people in the firm may be technically competent and possess the highest levels of personal integrity, but still are prisoners of a structural conflict of interest in promoting privatization transactions.

Consider Morgan Stanley. An arm of Morgan Stanley was the winning bidder on the Chicago parking meter lease. That deal is widely seen as a disaster, giving the idea privatizing meters a black eye, and engendering such headlines as “Morgan Stanley’s $11 billion makes Chicago taxpayers cry (Bloomberg) and “Company [Morgan Stanley] Piles Up Profits from City’s Parking Meter Deal” (NY Times).

Now Morgan Stanley is back, this time advising Pittsburgh and Indianapolis on potential parking meter privatizations. Morgan Stanley has a huge structural incentive to want those deals to go through. It would restart the market for parking meter privatization, and position the firm as the preferred advisor to cities. Even where they were not the city’s advisor, a restarted parking meter market means they could potentially bid on many more assets.

If you make money on privatization transactions, then no deals means no money. So obviously these firms have every reason in the world to promote privatization and see deals go through regardless of whether any particular deal is good or not. This doesn’t mean they are crooks, it’s just the reality. These firms now form of the core of the “privatization-industrial complex” with an incentive to cheerlead for leading public assets because that’s how they make their money. They need deal flow, the more transactions the better.

This was picked up on by Harrisburg, PA. Facing bankruptcy, the state offered an $850K grant to hire Scott Balice Strategies of Chicago, one of the nation’s top privatization financial advisors. The city council turned it down. As one city councilor noted, “Their recommendation is always the same: ‘sell assets’”.

Many of these investment banks, operators, financial advisers, and law firms also have tight links with each other, and participate on deals together, often as partners, other times as opponents. The Pittsburgh Post-Gazette noted how many of these firms have ties to Chicago’s earlier round of privatization. “When Pittsburgh proposed leasing its public parking facilities, the city became a magnet for a passel of firms – many of them connected to Chicago by blood, politics or business – that pursues similar deals around the country. The firms may be partners in one city, rivals or referees in the next.” The winning bidder on the Pittsburgh parking transaction is actually Morgan Stanley’s partner in the Chicago deal, for example.

These potential conflicts make it very difficult for cities to know they are making a good deal, especially since they lack the experience necessary to independently judge it. Right now, they often are at the mercy of their advisors. And ask yourself this: when was the last time a city or state looked seriously at one of these deals and their advisors told them not to do it?

This is frequently combined with traditional clout driven contracting. Many of the Chicago parking meter firms had tight links to the Daley administration. Daley himself became a partner in the law firm that was the city’s legal advisor on the meter deal after leaving office. Similarly, in Indianapolis a city-paid chief advisor to the office of the mayor is conveniently also a registered lobbyist for the winning bidder. This combination is a recipe for disaster, resulting in very long term deals that could be very bad for the public.

Long term lease deals can still make sense – if they are done right. The Chicago Skyway and Indiana Toll Road deals were both home runs, for example. But given the enormous risks if something goes wrong, governments must put into a place a robust process for protecting the public, with a full airing and mitigation plan for the bad incentives that populate so many areas of this field.

This post originally appeared in New Geography on October 29, 2010.

6 Comments
Topics: Public Policy

6 Responses to “Replay: The Privatization-Industrial Complex”

  1. Ziggy says:

    A timely replay. An alternative label for the “privatization-industrial complex” is “corporate socialism.” The same folks you see screaming for slashing entitlements are the same ones you see angling for huge government contracts. Taxes have become the preferred method of clawing back employee wages. You won’t see this discussed on Fox or MSNBC.

    Per AR’s post from the not too distant past, beware of billionaires…

  2. Gene says:

    The ploy is to siphon public money into private hands, under the guise of ‘good stewardship’ or ‘social good':

    – Morgan Stanley is huge on this, they also did the Indianapolis water/sewer deal.

    – The Indiana Toll Road lease wasn’t a home run, rather as one academic study put it, “an intergenerational wealth transfer”. The scheme was cooked up by a foreign consortium including Macquarie. The profit is derived from passing road depreciation thru to investors; it’s a sham transaction. BTW all that money has already been spent.

    – The Indiana mass transit plan is just another financial scheme, disguised as public good. Taxes will be raised to fund (private) construction of rail transport to suburbs; large TIF districts at rail stops will funnel public money into developers’ hands. The plan is just taxpayer-funded sprawl, I mean, that is the goal. CICP etc don’t give a damn if poor people can get to work, if they did then a proper bus system inside the loop would be faster, cheaper, and more effective.

  3. Gene, I read that academic study that was very weak. In effect, all it did was argue for an extremely low discount rate – 0% in one of their scenarios. If you think 0% is a great discount rate, then I’d like to borrow $10,000 from you and pay it back to you lump sum with no interest 75 years from now.

  4. Jeff Gillenwater says:

    While that particular Indiana study may have been weak, the toll road has indeed been largely a sham, zealously oversold by the same Daniels crew who promised it would pay for Ohio River Bridges in Southern Indiana interest-free with cash. Reality? That ill-considered bridges project is now a part of the same privatization-industrial complex, with Indiana residents bearing the financial brunt of the deceit with public opinion thwarted at every planning juncture.

    Despite many of the supposedly funded transportation projects being scaled down, delayed, or cancelled, Indiana’s ten year highway funding scheme is already back in the red as it was before the toll road deal. Tolls, however, have increased substantially and built-in fee protections for locals will be removed circa 2016. Hoosiers will be paying for that very short-term cash infusion for decades to come while the company gorges on annual, pre-approved toll increases. As one writer put it, “Over the course of the coming decades, Hoosiers can expect to learn a hard lesson in compound interest, long after Gov. Daniels is gone.”

  5. Gene says:

    Aaron – I’m not sure if you support the lease then. The deal created a $1 billion profit for its extremely wealthy backers, fabricated from a sham transaction. The tax shift is quite regressive.

  6. Garth says:

    Interesting thoughts. Never really looked at it that way.

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