There, But For the Grace of God and Goldman Sachs, Goes New Jersey

April 30, 2007

The idea of using asset monetization — i.e., leasing public fixtures like the New Jersey Turnpike to private investors in exchange for upfront cash — to plug New Jersey’s budget hole seems to have lost a lot of steam, but bad ideas and bad pennies have a way of coming back. So this Business Week survey of the national fad for privatizing public assets is important reading.

State and municipal authorities across the country have embraced monetization, beguiled by the peopsect of quick money laid out for them by investment banks such as Goldman Sachs. The technique is rapidly developing into a separate asset class with its own investor base.

The biggest immediate worry about asset privatization is that the new owners — probably consortia of overseas investors, such as the Macquarie Group-Cintra partnerships that bought long-term leases to the Chicago Skyway and the Indiana Toll Road — will immediately begin aggressive toll hikes to increase their returns.

Asset privatization is still developing a track record in the U.S., but let’s say the experience has not been uniformly encouraging:

The certainty of future toll hikes doesn’t jibe with the uncertainty of service quality. Assets sold now could change hands many times over the next 50 years, with each new buyer feeling increasing pressure to make the deal work financially. It’s hardly a stretch to imagine service suffering in such a scenario; already, the record in the U.S. has been spotty. In 2003 the city of Atlanta ended a lease of its water system after receiving complaints about everything from billing disputes to water-main breaks. The city wrestled with the owner, United Water Inc., over basics like the percentage of water meters it should monitor. Both parties acknowledge that the contract lacked specifics. In the end, “we didn’t believe we were getting performance,” says Robert Hunter, commissioner for Atlanta’s Dept. of Watershed Management. “I don’t believe the city will ever look at privatizing essential services again.” United Water says the contract wasn’t financially feasible because Atlanta’s water system was in worse shape than the city had represented.

I have two words for United Water: due diligence. If the company did it properly, the weaknesses of the water system were already known. If due diligence got short shrift, the company has only itself to blame. The problem is that, either way, the process of discovery came at the expense of the ratepayers.

State lotteries, another popular target for monetization, may seem like a sure-fire bet, but privatization carries a hidden social cost. Privatization means ending the constraints on advertising that are meant to discourage people from getting in over their heads. Considering that New Jersey already does plenty of expensive favors for the Atlantic City casinos (where college savings accounts and mortgage payments go to die) I really don’t think we need any more avenues for exploiting pathological behavior.

When I hear about how privatization will open the way for such “innovations” as peak pricing, which imposes higher tolls on drivers during rush-hour peaks, I can’t help remembering the “diamond lane” fiasco of the 1990s, in which California and New Jersey tried to remold driving habits by creating designated lanes for multi- passenger cars.

This abusive experiment in market-driven social engineering, which was supposed to encourage carpooling, instead generated more traffic congestion and fueled road rage incident as resentful drivers, stuck in miles-long traffic jams, refused to make way for lucky duckies in the “diamond lane” trying to reach their exits. With worksites scattered across scores of miles of highway, carpooling was a pipe dream.

Similarly, “peak pricing” is based on the notion that higher rush hour tolls will reduce demand during peak hours. But there’s a reason for rush hour: that’s the time when the greatest number of people have to get to their jobs. Letting a private investor jack up tolls between 7 a.m. and 9 a.m. won’t change the times that employers expect their people to be at their desks. It will simply create an under-the-table tax on productivity, with the proceeds going to a private company instead of the coffers of a public authority.

But the most ridiculous “diamond lane” scheme was abandoned by New Jersey in response to political pressure, helped along considerably by the late great Star-Ledger columnist John McLaughlin, who waged a one-man crusade against the program. Under a privatization regime, such political responsiveness would be a thing of the past.

At the end of the day, the argument for privatization undercuts itself because there is nothing to prevent the state from realizing the same cost benefits available to private investors.

Timothy J. Carson, vice chairman of the Pennsylvania state turnpike commission, recognizes this:

Carson isn’t dissuaded by arguments that investors are better qualified to run turnpikes profitably. “There’s no magic here,” he says. “These [deals] are largely driven by one factor: the permitted toll increases.” Carson says the state doesn’t need to hand over the turnpike to private owners. Historically, he says, the state wanted the turnpike to collect only enough money to break even. But it could just as easily adopt its own toll-hike schedule. The state could also charge tolls on more roads. In other words, the public could remain in control simply by changing the turnpike’s mission. That would ensure that the benefits of the toll hikes were spread throughout the populace, says Carson.

Privatization is like a pickpocket who gives you back your money as a low-interest loan. There are no benefits to be realized that the state could not realize on its own, at lower cost, while retaining control over assets vital to the public good. Privatization simply puts those benefits into the coffers of investment firms.

That line about pickpockets, incidentally, is borrowed from Sam Harris, who used it in a debate about the nature of religious faith. It seemed doubly appropriate because not only is it a good line, but it also reflects the near-religious faith privatization advocates hold in the magic of the marketplace.

Trouble is, there are no wizards outside of Harry Potter novels. There are, however, plenty of suckers in state and municipal governments ready to buy some of this snake oil, and it behooves us to keep an eye on them.

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One Response to “There, But For the Grace of God and Goldman Sachs, Goes New Jersey”

  1. Ron Says:

    Privatizing a public asset makes no sense unless there is significant competition (competing toll roads? don’t exist), otherwise you’re essentially selling a franchise to the highest bidder. Cable companies running our public roads? That sounds like a nightmare. Roads are like the commons, and traffic jams are its tragedy.


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