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Changing the tenor of the conversation

If long-term leases of infrastructure assets are to have a future in the US, investors have to take a more nuanced approach to how they pitch such deals to the public sector.

It is time to change the tenor of the conversation surrounding the leases of infrastructure assets in the U.S. – both figuratively and literally.

The figurative element, of course, refers to the misperception that if a city leases an asset to a private investor for, say, 50 years, then all it can do is plug one year’s worth of operating deficit with 50 years’ worth of revenues from the asset. Hence, many politicians look dimly upon such deals.

The literal element is the practical impact of this attitude on potential asset leases: city council members considering such deals keep insisting on shorter tenors for lease lengths – down from 50 years to 25, 15 and even 10 years.

Cezary Podkul

Local politicians who insist on shorter tenors can avoid the oft-cited discomfort of binding the city to a deal that might go on even after they leave office or die. But, as a result, the deal also becomes much less attractive to long-term investors willing to pay top dollar. The city council gets a low valuation, balks and the deal dies.

That, in a nutshell, is the status quo of the public-private dialogue surrounding many of these deals today. Here’s how to change it.

Begin with a more nuanced understanding of a city’s finances. Sure, it’s easy to seize on a large budget deficit figure, discount some cash flows for a city-owned asset and show up with a glossy pitchbook promising relief. But if you do that, you’ll just end up in the same spot. So try a different approach.

Cities need to finance not just short-term operating needs but also longer-term needs such as building infrastructure and funding pension obligations. And right now, ballooning pension costs are squeezing cities’ long-term budgets more than ever before.

Take Chicago, for instance. The city splits its finances into two main accounts – the property tax levy account, which funds long-term obligations, and the corporate account, which funds shorter-term operating expenses. And right now, things don’t look good for the property tax account: of the city’s proposed $797 million property tax levy in 2011, about 43 percent will go toward pension obligations, another 47 percent toward debt service. The remaining 10 percent goes to the library, leaving the city with no room for additional bonding capacity, or the ability to issue new debt for long-term projects. How, then, is the city to finance its infrastructure?

Finance the infrastructure of the future using the infrastructure of the past

 

Chicago isn’t alone. Cities all over the US are finding themselves in a similar position. Because pension obligations are exploding as a relative percentage of cities’ property tax income, bonding capacity is quickly becoming scarce. It may well be the latest victim of the 2008 financial crisis, which continues to reverberate throughout municipal, state and federal finances.

So what’s a city to do? The need to build and improve infrastructure is still there, but the old way of doing it – issuing general obligation bonds with a 30- to 40-year maturity – is no longer an option.

This is where the idea of a long-term lease comes in: finance the infrastructure of the future using the infrastructure of the past. That is, enter into a 50-year contract on a city-owned asset, take the proceeds and use them to build the new infrastructure your city needs today. After all, if that’s what you’re using the proceeds for, then you’re not doing anything that much different than entering into a 30- to 40-year contract with bond investors to finance the same purpose. Either contract may exist well after a city council member leaves office or passes away, so neither should carry the distaste and political vulnerability of using long-term assets as a short-term budget fix.

But local politicians clearly don’t yet see things this way. In Hartford, Connecticut, where a proposed 50-year lease of the city’s parking system would have funded a long list of “transformative” infrastructure projects, the city council still tabled the deal due to discomfort over the length of the lease. “I have trouble moving forward with something that could be affecting the city 25 years after I’m dead,” City Council President rJo Winch told Infrastructure Investor after the council’s vote in March.

A deal in Hartford, or similar transactions in any other city facing the same long-term pension pressures as Chicago, may still make sense. But it will have to start with changing the tenor of the conversation.