It was previously suggested that the Trump administration’s $1 trillion infrastructure plan would mostly rely on leveraging private investment. But Bloomberg reports that they are now backing off that plan, saying that public private partnerships don’t work.
I don’t want to pooh-pooh privatization too much. It can work well when done right, and for many assets like airports, toll bridges, etc, with high quality revenues steams, some form of private deal can make a lot of sense.
But maintaining existing roads isn’t really an applicable area for this. Ultimately, private finance is a niche when it comes to much of our highway and transit infrastructure.
It’s good to see the administration come to the same conclusion that I laid out in my American Affairs essay on transportation earlier this year.
President Trump has pledged to undertake a $1 trillion plan to rebuild America’s infrastructure. While nothing specific has been proposed, early reports suggested that it would lean heavily on private capital.
Many have argued that pension and similar funds could potentially be large-scale investors in infrastructure projects. These funds are chasing stable, quality returns in an era of low interest rates, and infrastructure seems to fit the bill. Infrastructure projects where there are high-quality revenue streams attached are good potential candidates for private equity investment. Toll roads, bridges, and airports around the world are owned or operated by private entities.
But private capital is not free money. Investors expect to both make their capital back and earn a profit. This will ultimately come from users of the facility. From an economic point of view, this makes a lot of sense. The problem comes in when the facilities are in economically struggling communities.
A private firm might buy Flint’s water utility and replace all the lines, but ultimately that cost would have to be born by the residents of Flint through higher water bills. One reason why so many of these communities have accumulated such a huge backlog of infrastructure needs is because their citizens cannot afford to pay for them, or can’t afford to competitively disadvantage their communities by raising taxes or utility rates. That is not to excuse their frequently poor political leadership, but the problem of fiscal capacity is real. For example, the Saint Louis area’s plan to retrofit its sewer system to comply with federal mandates will double or triple the bills of people in troubled Ferguson.
Moreover, much of the infrastructure deficit we face as a country arises from costs such as environmental remediation, for which there is a public purpose but not enough of a revenue stream to satisfy a private investor. Another large chunk is not amenable to private investment because it is in localities where the citizens and business community have limited ability to pay. America’s infrastructure problems cannot be solved with private investment only. More tax dollars will be required.
In addition, even in cases theoretically conducive to private investment, actual experience in the United States suggests it will be harder to pull off successfully than many might think. Consider the case of Chicago’s Midway Airport. That city received special federal permission and tried twice to privatize Midway Airport by leasing it to investors, failing both times. In 2008, former mayor Richard M. Daley announced a deal for $2.52 billion to lease the airport for 99 years to a consortium led by Citibank. But that deal fell apart after the consortium failed to obtain financing. Mayor Rahm Emanuel tried a second time but likewise failed: the deal attracted only two bidders, but one backed out, forcing the city to scrap the tender. The fact that a highly motivated Chicago failed twice to close a deal for this high-profile and well-patronized airport suggests that airport privatization in the United States is not as simple a matter as supporters might suggest.
It’s the same story with private investment in highway and bridge projects. Many of these transactions have not gone well. A number of the operators of privately run toll roads and bridges have gone bankrupt. Even in rapidly growing Texas, the concessionaire operating the SH 130 toll road near Austin went bankrupt. The company operating the Foley Beach Express toll bridge in Alabama went bankrupt. The operator of the South Bay Expressway in San Diego went bankrupt. Some of these bankruptcies have spawned litigation, with accusations that the deals were done using fraudulent traffic projections. A private consortium that leased the pre-existing Indiana Toll Road from that state for $3.9 billion also went bankrupt.
In one sense, these bankruptcies might be good news for taxpayers. They revealed that the companies had overpaid. In places like Indiana, this created a windfall gain for the public. But these bankruptcies led private firms to shift strategies, away from skin-in-the-game equity deals toward the so-called availability payments model.
In an availability payments contract, a private consortium builds, maintains, and operates a toll facility over a period of time. In return, the government entity promises a fixed stream of payments to the consortium for making the roadway or bridge “available.” The new East End Bridge near Louisville and the Goethals Bridge replacement by the Port Authority of New York and New Jersey are using the availability payments approach.
There is nothing wrong with availability payments per se, but these contracts hardly constitute what has usually been meant by private investment. Because the vendors are entitled to their payments regardless of the revenue stream, they have shifted the revenue risk—the biggest risk, and the one that bankrupted all those toll roads—back onto the government. In effect, this is just a fancied-up form of traditional debt financing.
Chicago looms large as a cautionary tale about the limits of private investment and what can go wrong with privatization. Beyond the Midway privatization failures, in 2006, the city leased its downtown parking garages for $563 million for 99 years. This appeared to be a great deal until it later came out that the city had included an onerous no-compete clause in the contract. Not only did the city itself agree not to build any competing garages, it also promised not to allow any private companies to build competing facilities. This was a highly dubious use of government power. Even worse, the city actually did allow a competitor to open, which exposed them to damage claims. The city ended up paying $62 million in compensation to the vendor they had privatized city garages to
No-compete clauses are common in privatization contracts and examples of “submarine” clauses that can unexpectedly surface and torpedo a government at some future date. Having used no-compete clauses to his own advantage, such as in the deal to open the Grand Hyatt in New York, President Trump must surely understand how easy it would be for sharks to take advantage of cities and states the same way.
More recently, Mayor Emanuel tried another way to use private capital for financing infrastructure improvements in his city. He devised his so-called Chicago Infrastructure Trust (CIT), announced to great fanfare at a ceremony that included former president Bill Clinton. He hoped to raise as much as $1 billion in private capital to finance projects such as $200 million in energy efficiency retrofits of public buildings. The CIT struggled to execute and has completed only one project to date, a vastly downscaled energy retrofit program that ended up being less than a tenth of the size originally envisioned. A report by the nonprofit watchdog group Project Six found significant problems with that transaction, too: the deal included what was in effect $2.2 million in loans to replace light bulbs and install weather stripping, repairs that should never have been debt-financed. It also gave Bank of America, the financier on the project, a lien on all the equipment installed in city buildings as collateral. Furthermore, there appears to be no compelling reason why the city needed to use complex, non-traditional financing for the project.
Chicago’s use of privatization and private capital for its infrastructure has arguably been a net negative for the city. If a sophisticated financial center like Chicago cannot get it right, this bodes ill for other, less experienced states and cities.