The New Privatization
By Darwin Bond-Graham
In 1923, the California Legislature passed the Golden Gate Bridge and Highway District Act, establishing the public agency that would build, own, and operate California’s most iconic piece of transportation infrastructure. After seven years of debate between bridge boosters–mostly North Bay businessmen and farmers–and the powerful Southern Pacific Railroad, which wanted to keep the region dependent on rail transportation, the public approved millions in bridge bonds and construction was begun. The Golden Gate Bridge opened to traffic another seven years later; together with a flurry of similar public infrastructure projects, it prompted a lasting economic boom for the region.
Engineering, environmental, and aesthetic factors all impacted the bridge’s construction, but its most politically significant component was its method of financing, predicated on the belief that the public should fund and own its transportation infrastructure. Like most publicly financed projects in the state’s past, the arrangement relied on private lenders to provide up-front capital for construction. The government was committed to repaying these loans, allowing ownership and control of the project to remain in the hands of the public. This arrangement involves a moral argument: wealth created by a specific community is best retained by and reinvested in that same community in as broad and equitable a way as possible, and this is best achieved through the public sector.
This philosophy gained traction in the 1930s, when the New Deal prompted enormous investments in infrastructure across the United States. One of these pieces of infrastructure was Doyle Drive, the elevated roadway that would become the Golden Gate Bridge’s main approach from San Francisco. Although heavily overshadowed by the bridge itself, Doyle Drive was an equally complicated and costly engineering feat, without which the Golden Gate project could not have been completed.
The federal government took the notion of public ownership a step further with Doyle Drive, paying for its construction through the New Deal’s massive deficit spending. Rather than borrowing capital from private lenders via bonds, the federal government literally printed extra money, extending credit to local communities to invest in schools, court houses, and roadways. Again, the public maintained ownership of and control over the product.
Earlier this year, a battalion of hydraulic excavators equipped with pulverizers and shear claws razed Doyle Drive, and the rubble was cleared for a dramatic new roadway that will widen and straighten lanes while tucking traffic into two tunnels running toward and away from the bridge. Portions of the project are already in use, and the entire roadway is expected to be finished in 2015. Once again, more than the sophisticated engineering, complex environmental issues, and aesthetic concerns, the most significant aspect of the replacement project is how it’s being financed. This time around, it’s largely a private affair, marking what could be a historic shift in public policy.
Ditching the name Doyle (as in Alfred P. Doyle, a Santa Rosa banker who lobbied heavily for the Golden Gate Bridge’s construction), the new road, called Presidio Parkway, is to be financed and built by a French bank, a German construction corporation, an American engineering company, and three global investment banks. Staking their own private equity in the project, these corporations will eventually lease the roadway back to the state for a profit. The legal and economic details of the new arrangement are complex, but its most important consequence is the shift of control over a crucial span of California transportation infrastructure to the hands of private companies. This is a radical departure from the philosophy that guided construction of Doyle Drive and the Golden Gate Bridge. Despite a mixed track record, this new philosophy–which can be summed up as privatization of the public sector under the rationale of neoliberalism–is now on the rise in California.
The Case of Presidio Parkway
In 2009, halfway through its construction, work on the Presidio Parkway was halted after the California Legislature passed a bill dramatically altering the way transportation projects could be built in the state. A priority of the Schwarzenegger administration, Senate Bill 4 (SB4) revived a lapsed statute allowing for the privatization of public roads and bridges. The new law granted the California Department of Transportation (CalTrans) and the state’s regional transportation agencies the ability to enter into so-called “public private partnerships,” or “P3” agreements, with corporations able to design, build, finance, maintain, and operate public transportation infrastructure.
Dispensing with traditional public funding methods, project officials instead invited proposals from private firms to complete the Presidio Parkway. Under a P3 financing model, California and San Francisco County would be required to put only a fraction of the money up for construction. Much as a credit card provides a consumer more purchasing power, this would free up public dollars for other projects. California’s budget woes had recently reduced available funds and the state’s borrowing capacity, making any short-term financial savings appealing. A P3 agreement promised to stretch declining state capital immediately, even if it meant higher costs down the road.
The consortium ultimately selected to build Presidio Parkway was Golden Link Concessionaire, LLC. This conglomerate
Golden Link Concessionaire’s Presidio Parkway contract is the first of what supporters of the new privatization hope will be many public-private mega-infrastructure projects throughout California. These projects would recapitalize public infrastructure with private dollars, and would use tolls, user fees, or lease arrangements to pay back the private investors. Jose Luis Moscovich, executive director of San Francisco County’s Transportation Authority and a leading advocate of the P3 model, told Transport Finance Intelligence that his agency is already considering other privatized projects in San Francisco. “I think that this project is a harbinger of what could come,” he said.
In addition to freeing up state transportation funds for immediate use, P3 backers argue that the partnerships increase savings by reducing public sector risk, a benefit referred to as “value for risk.” Matti Siemiatycki, a professor of urban planning at the University of Toronto who studies the financial structure of P3 deals, explains that by bringing in a private company to design, build, operate, or maintain public infrastructure, a government is able to offload various cost-overrun or delay risks (receiving shoddy, unusable materials from a supplier, for example). By transferring these risks onto the shoulders of a private partner, government obtains a value. “PPPs have higher base construction, financing, and transaction costs than traditionally delivered projects,” explains Professor Siemiatycki. This is primarily because P3s must often secure financing for construction in private markets where debt is not tax-exempt, as it is with government bonds. “It is only after the risk of major cost escalations that would be borne by the government are considered that the PPP delivers better value,” says Siemiatycki.
Whether this value for risk actually materializes and provides savings for the public is anyone’s guess. Professor Siemiatycki says a P3’s merits must be determined on a case-by-case basis. “It depends on the allocation of responsibilities and risks between the partners; it depends on how the contract is structured and written; and it depends on the extent to which the incentives between the partners are aligned to ensure that what is written in the contract is actually achieved in practice.”
Even more importantly, the success of a P3 seems to depend on a rather subjective judgment of the amount of risk involved: what are the chances that delays, accidents, unforeseen events, inflation, economic slumps, and other factors beyond anyone’s control will actually occur?
The Roots of P3 in California
Private corporations built and directly owned the majority of California’s highways, ports, and infrastructure for much of the state’s early history. By 1902, private investors had built fourteen private toll roads in San Francisco alone. This laissez-faire period–also a time of severe inequality–was drastically altered during the Great Depression, which sparked a previously unthinkable level of public investment in infrastructure, as well as a larger scale of government. The state’s consequent funding of countless infrastructure projects, including roads, dams, and colleges, continued for decades and helped lay the foundation for California’s prosperity through much of the twentieth century. However, by the 1970s and ’80s a taxpayer-led backlash had begun, and think tanks like the libertarian Reason Foundation sprang up to push privatization of government roles on a variety of fronts.
In the late 1980s, Reason’s co-founder, Robert Poole, published a policy paper entitled “Private Tollways: Resolving Gridlock in Southern California,” advocating a model of toll highways used in Europe. A number of influential parties apparently read Poole’s paper, as a powerful legislative-industrial alliance quickly began to coalesce around his proposal. Pro-business Republicans, global construction corporations, investment companies, and a handful of powerful Bay Area and Los Angeles law firms began to draft new laws and regulations and to lobby for their passage.
A year after the publication of Poole’s paper, Republicans in the Assembly and Senate managed to block a transportation measure that was to allocate billions for highway construction and maintenance. Advocates for Poole’s privatization scheme struck a deal with the Democrats–in exchange for Republican votes on a gas tax which would have financed these improvements, Democrats had to approve legislation allowing the privatization of infrastructure. The ploy worked, and the legislation, AB 680, was signed into law soon after. A steering committee was quickly organized to identify potential projects, ultimately leading to the development of two highways–one in San Diego and another in Orange County–with P3 ownership arrangements.
Both of these privatized highways experienced major financial and political problems. The SR-91 Express Lanes project in Orange County is perhaps the most financially successful P3 highway project in the United States to date, but its success came only after an extended legal fight that exploded into a political controversy. The SR-91 contract had been written with a non-compete clause, effectively preventing state and local agencies from funding improvements to nearby public highways because this would cut into SR-91’s private profits. As congestion increased in Orange County, state and local leaders sought to expand nearby freeways, unaware of the crucial clause restricting their doing so.2 A mini-scandal erupted in Sacramento when the corporate beneficiaries of SR-91 successfully blocked the planned public-highway expansions–legislators’ taste for P3s soured, and P3 infrastructure quickly became synonymous with old-fashioned highway robbery in the minds of the public. This controversy led to SR-91’s sale to the Orange County Transportation Authority for $208 million in 2003–it’s estimated the road cost only $135 million to build.
Even Poole, the biggest booster of P3s in California, admitted in recent testimony before the California State Assembly that SR-91 had failed to ease congestion. Poole also discussed serious problems with the San Diego South Bay Expressway, another P3. Planning for the project was based on projections of rapid home construction along its corridor, but when this suburban growth failed to materialize–due to what Poole called the “burst of the real estate bubble”–the project was thrown into disarray. As a result of the shortfall in expected toll revenues, the South Bay Expressway lost an enormous amount of state and federal money. Its corporate owners took the freeway’s holding company into bankruptcy in 2010, seeking to cut their debt obligations, and a federal bankruptcy judge cooperated by imposing a 42 percent loss on the project’s bondholders–American taxpayers.
The Congressional Budget Office, a nonpartisan government watchdog funded by taxpayer dollars, concluded from these two highways along with several in Texas, Florida, and Virginia, that with the exception of SR-91, “private equity investors’ expectations of profitability for the projects have been unfulfilled. The outcome may partially explain why, since 2002, no major highway projects in the United States have been financed exclusively through private sources.” In 2004, frustrated lawmakers repealed AB 680, and California ended its experiment with privatized highways–for the time being.
Despite these failures, interest in privatized infrastructure resurfaced just a few years later. Governor Arnold Schwarzenegger, a strong advocate for P3s, appointed lawyer Dale Bonner to head up the state’s Business, Transportation and Housing Agency in 2007 to further the cause. “In 2006 there was this strategic growth plan that catalogued massive infrastructure needs in California,” said Bonner. “But when you crunch the numbers and look at how much public revenue would be available versus what our needs were, they were saying they’d need $500 billion minimum to invest in infrastructure. A quick back-of-the-envelope calculation showed there was a funding gap, though, and the idea was to find ways to leverage the private sector.”
The state’s altered political climate since the days of AB 680 also bolstered the resurgence of P3s–rank and file Democrats had shifted to the right in key respects, most importantly regarding taxation. Due to the need for a two-thirds majority in the legislature to pass new taxes, along with a perceived hatred of any new taxation amongst voters, many Democrats had seemingly given up on securing new sources of revenue. With the economy in shambles and the state’s budget perpetually in the red, some on the left argued that the state lacked enough public revenue to finance infrastructure improvements. The private sector, they believed, was the state’s only choice.
Republican legislator Dave Cogdill authored SB4 in 2009, and the bill began its path towards approval. Multiple firms–most considered global players in the infrastructure investment industry–comprised a strong lobbying effort, and the bill passed quickly. Once it was signed into law, however, it faced immediate opposition.
P3 Today
Soon after Presidio Parkway’s project leaders began the hunt for private firms, the Professional Engineers in California Government (PECG), a union representing public-sector employees in California, made their opposition known. Calling public private partnerships “proven failures,” the union stated that “the Presidio Parkway replacement . . . is shaping up as California’s next P3 disaster through a no-bid contract that will waste one billion taxpayer dollars.”
PECG filed suit to block Presidio Parkway from being taken over by Golden Link Concessionaire, and waged a simultaneous campaign in the Bay Area and statewide media against the public officials and industry representatives who advocated privatization. Because the state’s lawmakers had just passed SB4 and had thus officially committed California to privatization, PECG was forced to take a highly technical tack against the Presidio Parkway P3. The union essentially claimed that SB4 authorized only the privatization of roadways that could be paid for by tolls. Presidio Parkway had no tollbooths–it relied instead on a thirty-year lease-back arrangement between the state and Golden Link–which PECG argued was against the letter of the new law.
Important agencies of state government also opposed the Presidio Parkway P3. In March 2010, the State Legislative Analysts Office (LAO) released a report on the state transportation budget, which included a requested allocation of $3.5 billion to finance unnamed P3 projects. It was generally known that these funds were intended to help push Presidio Parkway forward. Using an interpretation similar to the PECG union’s, the LAO argued that the arrangement relied too heavily on a lease-back agreement instead of toll or user fees. “[T]his type of deal does not appear to be allowed” under the law, the report stated. The LAO went on to cast doubt on the entire concept that P3 arrangements could save the state money. “While we are still in the process of reviewing the data, it is unclear how the P3 procurement would achieve certain cost savings that it assumes would save the state money over the life of the project.”
The California Transportation Commission (CTC), California’s highest authority on transportation policy, joined the opposition to the project. Similar to the LAO’s concerns, the CTC worried about the lack of toll or user fees to generate funds to pay off private investors, stating that “approval of this project by the Commission would effectively establish and endorse a means of committing state transportation funds to capital projects that bypasses state programming procedures designed to ensure statewide funding accountability and equity.”
Buoyed by the criticism from state agencies, the union lawsuit succeeded in temporarily stalling Presidio Parkway’s conversion to P3 through a temporary restraining order granted in December of 2010. Yet by early January, the court lifted the order, stating that SB4 did allow for the use of yearly payments to finance P3 projects. The contract was signed and the project continued to move forward.
Some believed Governor Jerry Brown would work to scuttle SB4 and the Presidio Parkway’s P3 conversion, but according to former transportation secretary Bonner, Brown has mostly kept his hands off the project and the new law. “He certainly had chances to kill the project if he wanted,” said Bonner. “He could have ordered CalTrans not to defend the PECG lawsuit, for example.” Bonner, still a strong advocate of P3 projects despite their pitfalls, claims that the implementation of P3 in California is threatened less by active opposition than by the indifference of those in power, as well as the inertia of the simpler, traditional means of financing infrastructure. “The administration isn’t fighting the program, but they aren’t trying to push it forward either, and as local agencies look at their infrastructure, if they look at P3 projects they know they’ll need the governor’s support,” said Bonner. As other projects get moving, he says, “it’ll be necessary for the governor to be clear if he’s for the program or not.”
Kome Ajise, the program manager for Public Private Partnerships at CalTrans, says there are possibly four infrastructure projects in the Los Angeles region being prepared for bid as P3s. These include major highway extensions and expansions involving the 710 and 210 freeways, a “High Desert Corridor” highway through San Bernardino County, and a “highway goods movement package” that would include multiple, large-scale road projects around the Los Angeles metro region. Together, these highway improvements will cost billions. “The big P3 market players come out to check and see on the progress of these from time to time,” said Ajise. “Some have put together teams in anticipation that these projects will be put to procurement.” Presidio Parkway’s success or failure, however, will weigh heavily on whether these and other possible P3 projects are carried out.
The Future of P3
Whatever stance Governor Brown ultimately takes, indifference seems like an unlikely response to the possibility of privatizing the state’s infrastructure. Brown’s father, former governor Pat Brown, was responsible for a slew of major, publicly funded infrastructure projects throughout the state (the State Water Project, for example, which funnels water from the far northern regions of the state to Southern California). California was built largely by enormous public investments in highways, schools and universities, aqueducts, bridges, and ports, which makes the relative lack of opposition to the privatization of Presidio Parkway surprising. This is especially true in San Francisco, a city famous for its liberal politics and storied battles over land use and development; many non-profits headquartered in the city are active campaigners against privatization across the globe.
It’s possible that the lack of numerous public interest groups, crusading lawyers, and grassroots coalitions opposing SB4 and the arrival of global infrastructure investors is due to a public resigned to a broken tax system that leaves state government constantly scrambling for funds. Californians know they need infrastructure, but they also know the state doesn’t have the funds–if the government can get money from the private sector, they should take it, regardless of the cost.
A more likely factor is the complexity of the new privatization. Byzantine contracts and lease agreements bridge multiple levels of government, deals span decades, and giant, unfamiliar global corporations abound. Most Californians are likely unaware of the renewed push toward privatization–a push that is now very much underway.
Notes:
- The group consists of German construction company Hochtief, a private equity fund called Meridiam Infrastructure Partners (which itself is owned by the French Credit Agricole Bank), and core lenders including Barclays Capital, Merrill Lynch, and Scotia Capital.
- Ironically, one of the justifications for allowing a private company to build and operate the SR-91 Express Lanes was that it would ease traffic problems, but the privatized road, while profitable to the investors (a consortium that included the French toll road company Cofiroute S.A., Level 3 Communications, and Granite Construction, Inc.), did not deliver on this promise, and traffic continued to worsen.