Public to private

Leasing public assets to for-profit companies poses a tantalizing proposition for cash-strapped state and local governments

June 2006

by Pat Guinane, Illinois Issues

A Dubai firm's bid to operate six major U.S. ports sparked a backlash this winter so swift and stinging that President George W. Bush warned our country might ruin its international reputation. Pundits scoffed at the notion that a spate of security-minded xenophobia might do more harm than Bush's own take-charge approach to foreign policy. But the simple truth is that America is behind the curve when it comes to private — even foreign — control of major infrastructure assets.

Chicago Mayor Richard Daley is doing his best to change that. Daley secured a landmark $1.8 billion lease of the Chicago Skyway in late 2004, and now he's considering handing control of Midway Airport over to private operators.

Likewise, state officials soon could be presented with an offer to privatize the Illinois tollway they simply can't refuse.

That's the way Republican Gov. Mitch Daniels framed his plan to lease the Indiana Toll Road to a Spanish-Australian consortium offering $3.8 billion for a 75-year deal. When the winning bid was announced in January, Daniels was asked what might happen if lawmakers rejected the idea.

"I just think it's unthinkable now," said Daniels, a former Bush budget director elected governor in 2004.

"Indiana's not going to pass up this opportunity. We're not going to tear up a $4 billion check."

Privatization poses a tantalizing yet philosophical proposition for increasingly cash-strapped state and local governments. They're promised huge financial windfalls upfront, along with a reduction in administrative burden over several decades. In return, a private firm assumes operation of the asset, be it a tollway, airport or parking garage. The private operator, in general, wins immediate and steady subsequent authority to increase tolls or other user fees. And government distances itself from consumer anger over higher costs.

Ultimately, the Republican-controlled Indiana General Assembly narrowly approved the toll road lease this spring. And, unless a pending legal challenge intervenes, the state will cede control of the 157-mile east-west route on July 1.

Emboldened by Indiana's instant cash infusion, Illinois lawmakers are exploring what likely would be an even more lucrative long-term lease of the state's 274-mile northern tollway system.

"There's clear evidence of the emerging trend for public-private partnership in infrastructure," says state Sen. Jeffrey Schoenberg. "I strongly believe that Illinois should be on the front end of that curve."

The Evanston Democrat last year sponsored a broad accountability measure designed to help the Illinois State Toll Highway Authority shed its reputation as a free-spending fiefdom. Schoenberg also serves as co-chairman of the bipartisan Commission on Government Forecasting and Accountability, which late last month planned to hire an outside consultant to determine how many billions a tollway lease might bring the state. The assessment, to be completed by the end of June, could fall to Goldman Sachs, a global financial firm that assisted in the Skyway lease and earned $19.5 million for brokering the Indiana Toll Road deal.

Chicago, meanwhile, is serious about making Midway the first major U.S airport to be put under private control. A multi-decade lease could bring in billions, which Daley would use to build infrastructure, such as schools and libraries, and to shore up four city employee pension funds that face a combined deficit of at least $5 billion.

"The mayor absolutely is on the forefront of this concept by virtue of the fact that, up until the Skyway, there had never been a privatization of a tollway in the U.S., while it's, frankly, very commonplace overseas," says Dana Levenson, Chicago's chief financial officer.

"I think, clearly, the Indiana tollway proved what we knew all along — that the Skyway was not just an isolated incident. I think you'll now start to see cities and municipalities across the country start to examine their 'portfolios' for what can be done, from a practical and political viewpoint."

Levenson says Chicago hopes to put out a request for qualifications from potential Midway operators sometime this summer. The General Assembly and the governor last month approved legislation to provide a property tax exemption should the airport on Chicago's Southwest Side come under private control. Lawmakers required that city infrastructure and pension funds receive 90 percent of the proceeds from any long-term lease.

Such transactions caught on overseas decades ago, giving foreign firms an edge in expertise that has made them the winning bidders in a small but growing number of U.S. assets now operating under private control. California, for instance, just approved a massive public works program that opens the door for private firms to operate some state roads.

Investors, especially pension funds and insurers, have found that, like public utilities, tollways and other infrastructure assets offer consistent long-term growth and steady cash flows, says Robert Poole, founder and transportation director of the Reason Foundation, a libertarian nonprofit think tank based in Los Angeles.

"They started realizing this 20 or 30 years ago in Europe, and they realized it more than a decade ago in Australia — about toll roads having those same [investment] characteristics," Poole says. "The realization has only now, in the last few years, started coming to North America."

Here in Illinois, though, there's an example of the pendulum swinging the other way. The General Assembly this spring approved legislation making it easier for municipalities to use eminent domain to reacquire local water systems. The move came after the central Illinois town of Pekin failed in 2004 to convince state regulators it could provide better service than Illinois American Water. The company is a subsidiary of RWE AG, a German investor-owned utility giant that serves customers in 29 states, including 257,000 in Illinois.

Fear of diminished service is just one of the inherent objections to handing major public assets over to the private sector, as Indiana showed this spring. Unrest over foreign control and anxiety associated with higher tolls reigned supreme as Democrats made political hay out of negative public sentiment in northern Indiana, where the Indiana Toll Road runs from Illinois to Ohio.

Already slumping in the polls, Gov. Daniels' approval rating sank to 35 percent a month after the toll road lease cleared the legislature. But Indiana will use most of the $3.8 billion in lease proceeds to build a decade's worth of new roads, giving Daniels two years of ribbon cuttings before the next election.

At the same time, it's difficult to dream up a better privatization petri dish than the Chicago Skyway. The 7.8-mile structure was awash in a sea of red most of its life, so much so that the city literally could not give the bridge away 17 years ago. Opened in 1958, the Skyway spans the Little Calumet River and Calumet Harbor, connecting the south end of the Dan Ryan Expressway with the Indiana Toll Road. Skyway use failed to meet early projections, especially with the new Interstate 80/94 providing a free alternative to the Indiana Toll Road. By the 1960s, Chicago began to fall behind on interest payments to Skyway bondholders. And in 1989, the city even tried to unload the Skyway to the Illinois State Toll Highway Authority, which rejected a $1 sale price.

The mid-1990s advent of casino gambling in northwest Indiana gave Chicagoans a reason to use the route — other than the Indiana Dunes and Notre Dame football. Still, by the time the Skyway became profitable, it was most valuable as a shortcut into the Loop. While northwest Indiana citizens possess an undeniable affinity for the Windy City, they don't get a stake in Chicago elections. And how could the city council reject a Skyway lease when Daley was offering budget relief by unloading an asset already foreign to most Chicagoans?

Chicago used roughly $860 million in lease proceeds to pay off city and Skyway debts. Levenson says about half the remaining windfall — $500 million — was placed in a perpetual reserve that kicks back about $25 million in investment income each year. Another medium-term reserve of $375 million is providing $50 million a year in budget relief until 2011. After-school programs, parolee job training and other social service providers were promised five years of funding from the final $100 million in lease proceeds.

The same Spanish-Australian partnership that won the 99-year Skyway lease in late 2004 was selected this spring to manage, maintain and upgrade the Indiana Toll Road until 2081. Cintra Concesiones de Infraestructuras de Transporte, S.A. of Madrid owns and operates airports, parking lots and tollways across the globe. Macquarie Infrastructure Group of Sidney, an investor-owned firm, ranks as one of the world's largest private owner-operators of tollways. Together, the companies manage 30 tollways on five continents. Their U.S. investments include the 14-mile Dulles Greenway in Virginia, a 10-mile South Bay Expressway set to open next year in San Diego and a series of ongoing congestion-relief projects between Dallas and San Antonio known as the Trans-Texas Corridor.

Dubbed public-private partnerships, these deals are gaining acceptance from states with major transportation needs but little start-up capital. Indiana, for instance, wants to use a mix of private and state funds to build a long-sought $2 billion extension of Interstate 69 from Indianapolis to Evansville. Conversely, the Indiana Toll Road follows the Chicago Skyway as only the second privatization involving a completed U.S. tollway. Both deals are governed by voluminous contracts covering every conceivable operating standard from plowing snow to removing roadkill. Policing the roads, for example, remains a government obligation, with Indiana setting aside $5 million a year in lease proceeds to pay state troopers.

The contracts — Indiana's spans some 400 pages — allow for predetermined toll hikes. Cintra-Macquarie immediately imposed a 50-cent hike that raised the lone Chicago Skyway toll to $2.50. The company can double the fare to $5 by 2017 and make annual inflation-based adjustments until the lease ends in 2104.

Indiana had not hiked fares on its only toll road in two decades, and the Cintra-Macquarie contract nearly doubles passenger car rates, which state officials contend would have happened even without privatization. The cost of a trip from Illinois to Ohio — now $4.65 — will increase to $8 by July. Most commercial trucks, meanwhile, will see the current rate of $14.55 hit $32 by 2010. After that, Cintra-Macquarie can hike truck and passenger tolls the greater of 2 percent or the annual increase in either the Consumer Price Index or the nominal Gross Domestic Product per capita, which has topped 5 percent the last two years. In return, Cintra-Macquarie has promised $4.4 billion in road repairs and upgrades over 75 years, including the addition of new lanes in congested northwest Indiana and the installation of electronic tolling (think I-Pass), leaving Ohio with the only major U.S. tollway without the technology.

Investing in public infrastructure has its obvious pluses for private firms seeking long-term investment alternatives to what lately has been a weak bond market. "We see this as medium-risk, medium-return investment," Macquarie CEO Stephen Allen told reporters during an Indianapolis visit just days before the toll road lease won legislative approval.

"It breaks the mold of how we traditionally looked at state-owned enterprises," says Poole of the Reason Foundation. "And I use the term enterprise deliberately because these are not like many functions of state government."

Some governments do choose to provide citizens with electricity, water, cable TV or even wireless Internet access. But Poole argues there are good reasons why such services are dominated by investor-owned entities.

"They're better able to figure out what their customers want, they're quicker to invest in new technology [and] they tend to be more efficient, in terms of the labor, because they don't get gummed up, if you will, in civil service regulation that makes it hard to be flexible when the market changes," he says. "I don't find it surprising that, likewise, investor ownership would work better in these other kinds of utilities — airports and toll roads."

Proponents argue that private firms also can pursue more aggressive financing than government and take advantage of favorable corporate tax law, which, for instance, allows them to deduct an asset's depreciation. That alone was worth at least $300 million in the Chicago Skyway deal, Poole estimates. At the same time, detractors undoubtedly question why government can't squeeze the same profits.

Nevertheless, Congress paved the way for more privatization last year when it approved a transportation spending bill that provides $15 billion in tax-exempt bonds for new construction of public-private roadways. Normally, only government entities can issue tax-free debt.

Mayor Daley's Midway privatization plan is made possible by a 1996 law allowing the Federal Aviation Administration to establish a pilot program for up to five airports, including one major hub. Only two small airports have applied for the program, with one winning approval after a more than two-year application process. Stewart International Airport in upstate New York went private in 1999, with the state signing a 99-year lease with National Express Group, a London firm specializing in air, rail and bus service.

In a 2004 report to Congress, the FAA notes that airport privatization of any size requires "a strong political commitment." It's certainly not a stretch to assume that the Midway effort might falter if Daley forgoes seeking a sixth term in next year's mayoral election. To get off the ground at all, the plan needs approval from two-thirds of Midway's passenger airlines and cargo haulers. "You need Southwest [Airlines] no matter what," says Levenson, the city's privatization point man. "You need not only Southwest, but another six or seven of the 11 carriers that are at Midway to approve this transaction prior to it taking place."

If the airlines grant clearance, the next step would be convincing aldermen. "Putting something in front of the city council that they would not approve of is something that we would not do," Levenson says. 

There's no question that Indiana's Gov. Daniels summoned every ounce of political capital to advance his toll road lease through the legislature. A Statehouse rally meant to buoy support for the lease and an accompanying "Major Moves" 10-year road construction plan proved disastrous when union workers drowned out the GOP governor with boos and shouts of "Ditch Mitch." Daniels, in turn, repeatedly implored legislators to ignore what he deemed myopic public sentiment and vote for his "jobs bill of a generation."

Still, House Democrats held fast, forcing Republicans to lean on their razor-thin 52-48 majority, a move that put several northern Indiana legislators on the election-year hot seat.

The solidly Republican Senate had no problem passing the bill, even picking up support from two Democrats. But before it was over, the legislature won major spending concessions, including a $500 million "next generation" trust fund to earn interest for future road projects and $292 million for local officials to spend on transportation and economic development initiatives in northern Indiana. Lawmakers also set aside $278 million to effectively freeze passenger vehicle tolls at or near current rates until 2016 by subsidizing any reduction in Cintra-Macquarie revenue.

Sen. Schoenberg says a similar toll freeze must be a cornerstone of any Illinois tollway lease.

"We saw how Gov. Daniels had to later scramble to include that in his proposal as a means of keeping his allies supportive," he says. "That struck me as a reactive move and in Illinois we should learn from that and be proactive in establishing that as one of the ground rules for how the proceeds would be spent."

Indiana waited until after receiving bids to ask legislative permission for a lease, but Schoenberg says he hopes to lay out the ground rules in the General Assembly's fall veto session. Gov. Rod Blagojevich, thus far, has been noncommittal, though it's hard to imagine him turning down a potential influx of billions. Like Indiana and Chicago before it, Illinois would provide job protections or comparable government positions for the tollway's roughly 1,950 employees. Schoenberg says he'd like to go a step further and offer some sort of revenue-sharing option to make the workers "greater stakeholders in the outcome."

It's still too early for anyone to say what the Illinois tollway might fetch. The system brings in close to $600 million annually, or roughly four times what the Indiana Toll Road was expected to generate after imposing higher fares. Whatever bid Illinois might receive, perhaps $2 billion would be needed to repay existing tollway debt, much of it tied to a 10-year, $5.3 billion congestion relief plan entering year three. Once commuters and bondholders are taken care of, Schoenberg says, the remaining proceeds should be used to match $3 billion in federal transportation funds available to Illinois and to help mitigate a nearly $39 billion shortfall in the state's public employee pension funds.

Schoenberg says he hopes to build bipartisan support for a tollway lease. And the Indiana experience, as well as recent state budget negotiations, suggests individual lawmakers might seek a slice of the windfall for their own pet projects.

Even with legislative approval, the plan could face other hurdles. Schoenberg will be consulting with Attorney General Lisa Madigan's office on a host of potential legal questions. And there could be public fallout over the issue of foreign control.

Poole suggests that American firms soon will join their overseas counterparts in the infrastructure game, but not in time to bid on the Illinois tollway or Midway Airport. Meanwhile, an Australian newspaper has reported that Macquarie is mulling a run at the U.S. ports deal abandoned by Dubai Ports World.

As for Chicago, Levenson predicts no uproar over the possibility of foreign Midway operators. "There seems to be no complaints that it is a Spanish-Australian consortium that owns and operates the Skyway because, frankly, the operation has gone flawlessly."

What if Daley does land an unprecedented Midway lease? "If that happens, it will be another earthquake," Poole predicts. "It'll set off just as big a shockwave as the privatization of the Skyway."

---

Pat Guinane covered the legislative debate over leasing the Indiana Toll Road as Statehouse bureau chief for the Times of Northwest Indiana. Previously, he was Statehouse bureau chief for Illinois Issues.