The Privatization-Industrial Complex

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“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. 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.

Aaron M. Renn is an independent writer on urban affairs based in the Midwest. His writings appear at The Urbanophile.

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Random Thoughts on Privatization

Selling of capital assets in order to balance annual operating budgets is bad fiscal policy to begin with. One should only use the sale of capital assets to reduce the balance sheet (pay down debt etc.). It is like the stimulus bill plugging holes in state, county and municipal budgets, all it does is delay the inevitable for one year.

To align consultant and banker interests with the government's, one should pay them a fixed fee for consultancy rather than a commission for transaction. This same incentive conflict arises in the the private sector with any type of transaction fee and just needs to be acknowledged and managed around.

One should distinguish between privatization of operations vs. privitization of capital assets. Most of the budget disasters that state, county and muncipal governments are facing today are the result pubic sector wages and pension fund obligations for annual operations. If these operations were privatized, the goverments would not have these unfunded liabilites and the private sector would have to make it work on an operating basis or go bankrupt. In fact, I think many people might be open to paying taxes for infrastructure capital investments like public transportation if they knew that they were not going to end up with subsididized operation and growing unfunded liabilities every year.

What's All the Fuss About?

I have to admit, I am seriously struggling to figure out why everyone seems to be over-dramatizing the privatization of parking. As a resident of Chicago, I can assure you that it is not that big of a deal to anyone who actually lives here. It has no effect whatsoever on the vitality of the City, or its ability to draw "out-of-towners"; if anything it was a a short-term budget fix that worked. One way or the other, we'd have been paying more for "public services." If it wasn't the long-term lease of parking, it'd have been some other sort of revenue-generating scheme. I'd much rather have the long-term risk associated with the operating revenues and expenses of on-street parking transferred to a private investor than the City coffer, even if it means giving a little bit of a windfall to some Morgan Stanley "crooks." It's all about the time value of money....and at a time when some upfront cash was desperately needed in the City of Chicago, it will very easily turn out to be a wise deal. Besides the point, the only people who park on street meters are primarily people who don't even pay taxes to the City of Chicago anyways...they are non-residents. And if an extra $2.00 per hour to park on the street is enough to discourage them from venturing into the City...they probably weren't contributing that much to the tax base of the City to begin with.

Among other things, the

Among other things, the parking meter lease put a $20 million hole in the city's budget in perpetuity thanks to the future revenues that were consumed immediately. Also, parking is not a revenue raising mechanisms or even a traditional public service like garbage collection. Instead it is an urban planning tool that cities use to optimize the use of precious public space along our streets for the benefit of the neighborhoods.

This means pricing should be dynamic, not set in a fixed schedule for 75 years. As neighborhood business conditions change, parking policy should change to match. This contract complicates that. Also, the best use of that space in the future may not be for parking at all, but for some other activity. By levering up a huge payout up front, the city has in effect created gigantic financial penalties to repurpose public real estate from parking to other purposes. In any event, we don't know what the future will hold. The notion that we can predict the future sufficiently to sign a 75 year deal granting a de facto ground lease on our public streets is ludicrous. Think backwards. Could anyone in 1935 have possibly written a contract around parking that would still be relevant to the needs of the city today? Could anyone have written operating standards for airports? Could anyone in 1911 have written a contract for a 99 lease on a road that would be useful today?

These contracts can be dangerous simply because they benefits in the short term are so tempting. What's not to like about $1 billion? It's future generations who will pay the price.

I hear you loud and clear,

I hear you loud and clear, but I feel like you are thinking of this through a planner's "utopia" lens. I would hardly consider the 9' foot wide ROW on each side of the street as precious public space. Chicago has no shortage of world class public spaces....and street parking in the Loop or Lincoln Park certainly doesn't fall into that category. It's not like they gave away control of the entire 60-70 foot ROW for each and every street in the City.

I recognize that no one can predict what the city will be like 75 years from now. However, public decision-makers have to deal with today's realities. The ground lease of public real estate assets are structured for 65, 75 or 99-year terms all the time. Does anyone really know what the land will be worth 50 years from now when they enter into the agreement? Of course not, but there is an element of risk involved on the flip side. Who is to say that the 9x20 foot street parking spaces won't be completely useless in 30 years? If that is the case, the City may be the crooks in the deal.

Likewise, I understand that public parking is simply a utility required to serve other activities. However, the public parking in Chicago is fixed. There is no option to increase it unless you condemn private property...the only parking supply that has been added in the past decades are private garages, subsidized through TIF funds. So, not sure it is realistic to assume that parking can adapt to neighborhood change. If more parking is needed, private land owners will either wait for the tipping point at which its feasible to develop parking-inclusive projects, or the City will subsidize them.

In addition, I am struggling to understand what "alternative" public use these parking spaces could serve. If you are suggesting that some sort of mass transit expansion might require these little slivers of public land, or that they will be used for "beautification" purposes, or donated to private land owners to extend their frontage build-out (possibly to build structured or podium parking)...it just ain't gonna happen - this is Chicago. The same right-of-ways have in place in some instances for more than a century, and there is nothing to suggest that this won't be the case for another hundred years.

ANd this notion of a $20M hole in the annual budget? You may be correct, but it was going to happen one way or the other. And if you factor in the ability to pay down pension and bond debt today rather than let it escalate over time, I'll take the $20M gap rather than $30M a few years from now if it means sacrificing some useless public space.

Privatization

Overall privatization is still better then allowing government to continue mismanaging public assets. The Indiana toll road was not making money for the state of Indiana. Now it is. There is no real reason the state needs to run this toll road. In fact the toll road originally was built with private money and was nationalized when President Eisenhower signed the interstate highway bill.

However government is what it is. It still favors its cronies. So it ends up with the parking meter disaster soiling privatization in the eyes of those who have never supported it. But even after the rocky start, the private operators are making improvement that the city would have never done on its own.

So in the long run, keep cronies out of the process, get real businesses to lease public property and keep going. There is no reason to go back to government mismanagement.

For the record, I think the

For the record, I think the Indiana Toll Road lease was a grand slam home run.