Flying under the bridge, but ahead of the curve...

since 2005.

Craig Newmark points to a City Journal article on infrastructure financing by the private sector:

I’ve got a bridge to sell you” sounds like a sleazy salesman’s pitch. But if Indiana governor Mitch Daniels offers you one, maybe you should believe him. Daniels has already auctioned the rights to operate the Indiana Toll Road—a 157-mile road linking the Chicago Skyway in the west to the Ohio Turnpike in the east—to a private group for $3.8 billion. He’s got other state assets he’d like to sell, too, if he can just get the Indiana legislature to go along.

Meantime, Chicago mayor Richard Daley has harvested $1.8 billion auctioning the Skyway itself to a private group, and another half-billion or so turning city-owned garages over to private operators. Now he’s trying to sell Midway Airport; it could fetch $3 billion.

These deals are the leading edge of what could become the biggest injection of competition and private capital into American government in generations. Across the country, cash-strapped governors and mayors are discovering that their airports, bridges, toll roads, water systems, and other revenue-generating operations are worth far more than they thought, and are eyeing auctions that might produce windfalls similar to those in Chicago and Indiana. They’re also looking to recruit private investors to build and operate new toll roads, bridges, and other infrastructure.

If the deals can overcome resistance from anti-privatization groups and from politicians who benefit from keeping a stranglehold on government assets, they could help make up for decades of underinvestment in infrastructure—and thereby renew America’s landscape. “There’s probably $100 billion in domestic capital alone that’s being raised to invest in these transactions, and when that’s leveraged with debt, you’re probably looking at up to $400 billion in money that’s ready to go to work,” says Dana Levenson, Chicago’s former chief financial officer and now an investment banker at Royal Bank of Scotland. Add foreign investment to the mix, and the sums get even more impressive.

The trend proves the axiom that what’s old can be new again. Private investment in infrastructure, especially bridges and roads, was common in early United States history. Immediately after the Revolutionary War, for instance, investors put up $465,000 to build the Philadelphia-Lancaster Turnpike, a 66-mile toll road that proved so popular that it led to further waves of private investing in highways. During the first half of the nineteenth century, private funds provided the young republic with some 600 toll roads. And as the country spread westward during the second half of the century, infrastructure investors helped ease the way, with 100 toll roads in California alone. In fact, the private sector kept building roads until the automobile’s arrival prompted more extensive—and costly—government safety regulations, which at the time made toll roads a largely unprofitable venture. Government turned to new methods—especially municipal bonds, which investors like because they aren’t taxed—to finance infrastructure.

Privately financed infrastructure has made another appearance in post–World War II Europe. Starting with 1955 legislation, France began to tap private investors to build and operate what eventually amounted to 3,400 miles of autoroutes between cities. Margaret Thatcher’s energetic privatization drive in 1980s England sold existing government assets and spawned scores of public-private construction projects. The Soviet Union’s collapse led to extensive privatization in former Eastern bloc countries during the nineties. The U.S. Department of Transportation figures that worldwide, more than 1,100 public-private deals have taken place in the transportation field alone over the last two decades. Total value: approximately $360 billion.

USA Today on the Bandwagon

And willingly paying its tolls:

In the past decade, usage of interstates rose by more than 30%, according to the Department of Transportation, while additions of routes and added lanes increased capacity by only 4%. The problem is simple. Gasoline taxes and tolls, already unpopular, provide a fraction of the money needed to keep traffic from getting worse.

Now comes an idea to get around this problem. A number of states, most visibly Indiana, have proposed leasing major toll roads to private companies. By doing so, they can raise billions of dollars needed to make road improvements elsewhere.

....Indiana provides an example. ...Mitch Daniels .... solution is to lease the Indiana Toll Road, which stretches 157 miles across the top of the state, for 75 years. The winning bid of $3.8 billion — more than anyone expected — was accepted last week. He also wants to finance construction of a new portion of Interstate 69 south from Indianapolis by offering it for lease when finished.

Similar proposals involving new or existing highways are sprouting up from New Jersey to California. They have many selling points:

• They raise enormous amounts of money....

• They reduce congestion. The higher tolls that private companies will charge in return for their big payments inevitably will be unpopular. But unless the laws of supply and demand are applied to road capacity, drivers will pay in the form of lost productivity while waiting in traffic.

It's gotta be embarrassing when the professional economists know less economics than the editorialists at USA TODAY

We're in the money...

Indiana seals the deal, and pgl's reputation is further shredded (if possible):

By noon today state bank accounts bulged with $3.8 billion for the lease of the Indiana Toll Road to a foreign partnership.

The money flowed in a series of wire transfers and state officials signed the paperwork completing the deal.

The state, meanwhile, disclosed that the lowest bid for the toll road had been submitted by a U.S. firm, the investment bank Morgan Stanley, which was ready to pay $1.9 billion for the right to lease the Northern Indiana highway.

....The other losing bids came from an Australian consortium that offered $2.84 billion and a Spanish company that was ready to plunk down $2.5 billion.

In other words Macquarie-Cintra overpaid by about one billion dollars.

Back Home in Indiana...

[Update: Couldn't have happened to a nicer bunch of guys (from the comments section at Angry Bear before the Honda announcement):

Well, it will be interesting to see what Daniels does with his Powerball check.
Improve the economy long-term? Not likely.

[and:

... this is a short-term fix based on a long -term lease.
This is like the junkie kid selling the family heirlooms for a fix.

[and:

These new toll road transactions are and will prove to be another hollowing out of our capital base.

[and:

The goal of our Republican politicians is to reduce the level of services provided by the state to the lowest in the nation. They want a plantation economy to out Mississippi, Mississippi.

[and:

By the time this turns sour Mitch will be only a memory.

[Now back to the original post, aka speaking truth to nincompoops]

...is Governor Mitch Daniels, to welcome a new Honda factory. Likely made possible by the new roads the toll road lease financed:

11:34 AM...Gov. Mitch Daniels rushed home from a trade mission in Asia to welcome Honda to Indiana this morning.

“Honda is going to feel right at home in Indiana, and you are going to love Greensburg and this part of our state,” Daniels said.The $550 million auto assembly plant will be seen at the place where Indiana’s economic comeback began, Daniels told a press conference in Greensburg.

11:41 AM...The Honda auto plant will take 24 months to build and begin production in 2008 of a 4-cylindar car. The model wasn't revealed. The plant will pump $1.5 billion in the midwestern economy, as Honda buys auto parts and other supplies needed for the new plant.

Government will kick in at least $134 million in incentives to the project. That includes money for wastewater treatment and new or expanded roads.

Mamas don't let your babies go up to South Bend...

...for an education. That is, if Professor of English William O'Rourke is typical of the faculty (and, gee thanks, pgl for more material). O'Rourke, commenting on the impending turnover of the asset know as the Indiana Toll Road in exchange for nearly $4 billion, asserts:

... the Toll Road takeover is a triumph of ideology over economics.

Supporting his argument with such ironclad logic as:

I've always been amused by Daniels' invented campaign persona -- decked out as one of the hicks, wearing wool, plaid or flannel and some ridiculous hat, looking like some character out of a "Saturday Night Live" skit poking fun at Canadians, usually accompanied by many shots of his RV rolling through the Indiana hills. Mitch Daniels, man of the people, not....

Now that the former Eli Lilly executive has put most of the state on Eastern Standard Time's daylight-saving time (Eli Lilly time!), and Hoosier parents experience the fun of trying to put their children to bed while it's still light out ....

Yeah, we really have to wonder about people who are slaves to ideology. Especially when it gets in the way of seeing scarce resources being directed to more highly valued uses. In this case valued only by the Cintra-Macquarie consortium at anything like $3.8 billion.

Career Breaker

Max Sawicky drove the steam shovel off the Indiana Toll Road into the ditch:

The Gov could just as easily contract out operations and management, but keep the tolls for itself.

To which the FLUBA Committee on the Obvious responds; that the $3.85 billion the state will receive from Cintra-Macquarie this week, are (twice the projected net) tolls. That the lease is a contract, and, that the same consortium will operate and manage the road.

From that position, head engineer pgl has been busy excavating the position further. The latest being:

...the state could also run the toll roads more efficiently with technology. But isn’t it evident that there has been a huge efficiency gain when the private firms can offer double the state’s reservation price as established by the Crowe Chisek discounted cash flow model? ....The alleged efficiency gain would have to come from Cintra and Macquarie being able to run the toll roads not only more cheaply than the government but also more cheaply than the other bidders if this were a truly competitive auction.

The emphasis in the above not only being the FLUBA's, but also it's point--made several times in the comments sections attached to pgl's posts--and we're delighted it finally penetrated.

Not that it had any effect on the quality of his analysis. As he later explains it away as graft:

... maybe the other 10 bidders refused to pay enough to the Governor under the table as he was so happy to claim $3.8 billion was better than his reservation price - a reservation price concocted by citing a really sloppy analysis.

Which would further extend the investors' break-even point beyond the $ 8.25 billion--in addition to the $3.85 lease payment, they've committed to $4.4 billion in maintenance expenses--and make it even less likely they'll profit from this deal.

Not to mention it is a casual slander of Governor Daniels, the successful bidder, and the Goldman Sach advisers the state hired to vet this.

No mind, personal slights will be overlooked when there's money to be made. And, according to pgl, there's plenty of that left on the table:

So the Governor – aided by what appears to be a faulty Crowe Chisek analysis are selling assets that may be worth $5 billion to private investors for only $3.8 billion. ...one might wonder of the Governor asked them to lowball the reservation price. In other words, is this some form of financial fraud imposed upon the taxpayers? Why would any responsible Governor be engaged in this kind of behavior? Oh but – we are talking about George W. Bush’s first OMB director.

The FLUBA Committee on Economists Who Insist on Flying Under Low Hangers, asks (given that the Ohio Turnpike is undoubtedly next in line, unless Texas or New Jersey beats them to the punch), when will Sawicky, pgl & Assoc. be entering the lists?

I.e., if you're so smart, why don't you make yourselves rich by getting in on the deal? Thar's gold in them thar tolls, you sez.

No Free Riders

Update: [Gary Becker and Richard Posner dignify the debate]

On the Indiana Toll Road, unanimously says that state's Supreme Court:

The state Supreme Court, dealing a blow to foes of plans to lease the Indiana Toll Road to a private partnership, rejected claims the deal is unconstitutional and ordered opponents to post a $1.9 billion bond if they plan to move ahead with their challenge.

Well, there goes the Angry Bear consultancy fee. Sorry guys.

It Tolls for Thee Reputations, Fellas

The FLUBA Committee on Economists Who Can't Be Embarrassed is having to work overtime countering the fantasy lives of Mad Max and pgl, neither of whom can grasp the concept of a profit seeking business being willing to pay to lease an economic asset in the hope of making that asset more productive.

Max's singular contribution being that the state of Indiana is 'borrowing' by leasing its toll roads for 75 years to a Spanish-Australian consortium of toll road operators. Though under pointed questioning he seems to have admitted that, no, the state will not have to return the lease payment ($3.85 billion dollars) to the 'lender' at the end of the lease.

pgl, is more interesting in that he's busy trying to deny the definition of economics; the analysis of alternative uses of scarce resources, as well as the basics of arithmetic. Even when it's been spelled out for him by another professional economist:

Cintra is paying $3.85 BILLION up front for this lease. And they expect a 12.5% internal rate of return. If I can still do arithmetic, that's more than $400 MILLION per year in net income from the lease.. From a toll road currently generating only $96 MILLION in REVENUE (before any costs). And Cintra will be responsible for the operating costs, maintenance, and at least some expansion costs. The more I look at the numbers, the more I think it's a better deal for the state of Indiana than I originally thought.

Explanations of what is going on have not been in short supply, and they include a New York Times Op-ed by Indiana's governor:

In much of the world, but only recently in the United States, private capital has begun to play a role, most often in partnerships with public authorities. ....

If it were merely a matter of getting hands on money today that would otherwise come in over the years, such partnerships would make little sense. The goal for states is to capture far more value than an asset would be worth if it remained in public hands. That goal is often not difficult to achieve.

The 157-mile Indiana Toll Road had lost money five of the last seven years. A principal reason was its antique pricing; tolls had not changed since 1985 and were far below what comparable American toll ways charged.

As a private citizen, I had always been intrigued to stop at a concrete booth and fish out a dime and a nickel to pay the 15-cent toll at Gary. As governor, I asked, ''What does it cost us to collect a toll?'' This being government, no one knew, but after a few days of calculation, the answer came: ''About 34 cents, we think.'' I said, only half in jest, that we should just go to the honor system and we'd come out way ahead.

Why would a losing enterprise with an underpriced product drift on in that way? Because it was run by politicians, who are rarely businesslike and deathly afraid to annoy anyone. So the state lost money on the road, postponed repairs and expansions and failed to install the electronic technology that makes toll ways elsewhere faster, more convenient and more efficient.

Just as many business units are more valuable if separated from their conglomerate parent, an asset like a highway can be worth vastly more under different management. When we offered our road for long-term lease, we received a high bid of $3.8 billion, cash, from Macquarie-Cintra, an Australian-Spanish consortium. The highest estimate of the road's net present value in state hands was less than half that amount, and even that estimate assumed regular toll increases of the kind past governors steadfastly refused to impose. Noting the road's record of losses, one finance professor remarked, ''If they'd gotten a dollar for it, it would have been a good deal.'' Instead, Indiana will soon cash a check that closes a gap most had believed insoluble. Future toll increases will be capped at the level of inflation.