A Bridge to Nowhere...

Oops, sorry about that. Something about Infrastructure brings out bad metaphors (or is it an analogy?). BusinessWeek's article, "Roads to Riches" (see what I mean?) by Emily Thornton on the rise of infrastructure in the US as an asset class for institutional investors provides some interesting tidbits about how not to think about investments. Infrastructure can be thought of as essentially a high yield bond. Since I am not a big fan of high yield bonds and don't see a place for them in a policy portfolio (lots of risk, not lots of upside), not surprisingly I'm not a big fan of infrastructure. Bridges and toll roads are 'purchased' (50 year operating leases) with enormous leverage (80%ish) while cash flows are the difference between operating costs and user fees. Investment bankers have done a good job of selling pension plan CIOs on the idea that these assets have amazing stability. Well, could be. Problem is, we have almost no history. Other problem is, these assets are used to provide public services and even though municipal governments have 'sold' them, they still have a responsibility to ensure that their 'clients' (i.e., voters) are happy with what their getting. And there's the rub. The Goldman Sachs bankers may think its a slam dunk that tolls will rise at 3% per year forever ("see, it's in the contract!") but if the voters decide they don't like it - really don't like it - and start chucking politicians out of office, those contracts will be renegotiated.

Some choice bits from the article:

"There's a lot of value trapped in these assets," says Mark Florian, head of North American infrastructure banking at Goldman, Sachs & Co (GS ).

Translation: my bonus is trapped in these assets and I'm going to get it out!

Ms. Thornton, the author of the piece, writes that although its true cities are getting big piles of cash, but

...are investors getting an even better deal? It's a question with major policy implications as governments relinquish control of major public assets for years to come. The aggressive toll hikes embedded in deals all but guarantee pain for lower-income citizens—and enormous profits for the buyers. For example, the investors in the $3.8 billion deal for the Indiana Toll Road, struck in 2006, could break even in year 15 of the 75-year lease, on the way to reaping as much as $21 billion in profits, estimates Merrill Lynch & Co. (MER ) What's more, some public interest groups complain that the revenue from the higher tolls inflicted on all citizens will benefit only a handful of private investors, not the commonweal (see BusinessWeek.com, 4/27/07, "A Golden Gate for Investors").

Oh my, another investment that is "socially irresponsible". After divesting from Sudan, all the pension funds were feeling pretty good about themselves (as well they should). But then they'll wake up one morning and read on the front page how they're oppressing poor Americans by their rapacious toll hikes.

"We're using [infrastructure] as a fixed-income proxy," says William R. Atwood, executive director of the Illinois State Board of Investment, who plans to invest $600 million to $650 million, or 5% of its portfolio, in infrastructure funds over the next three years. "We're hoping to get 11% to 12% returns and lower risk."

Those Goldman marketers are good, aren't they. Let's see, a 6% spread over treasuries with lower risk. Can you say, "free lunch"?

Infrastructure "delivers similar yield expectations to high-yield bonds and real estate, with less risk," says Cynthia F. Steer, chief research strategist at pension consulting firm Rogerscasey.

We know it has less risk. We calculated it. It's right there in the spreadsheet. Spreadsheets don't lie. Remind me never to hire RogersCasey.

Indiana legislators became so alarmed by promised hikes that they changed the terms before the toll road lease was completed. The state set aside $60 million to pay the difference in tolls for up to two years or until the buyers install electronic tolling equipment. After that, the fee for cars with electronic toll cards will rise to $4.80 over the full 157 miles, while the fee for cars without the cards will soar to $8. After 2010, both rates will rise each year by 2%, the pace of inflation, or the rate of economic growth, whichever is highest.

Wait, let me see if I understand this. You mean legislators are responsive to voters? You mean they care even more about staying in office than they do about the contracts they signed with Goldman Sachs? Incredible!

Chicago's former chief financial officer, Dana R. Levenson, sums up the situation: "There is money to be had, and cities need money."

Who is this dude, Dana Levenson?

Former CFO Levenson has been one of the movement's biggest champions. He was an architect of the Skyway deal, which kicked off the market. Then he sold control of parking garages to Morgan Stanley for $563 million. Next, he started shopping around a lease for Midway Airport that could fetch as much as $3 billion. And soon the city hopes to auction off rights to operate some recycling plants. Levenson dismisses critics who argue that he has dumped prized assets. "This is not like where a person goes in and buys a loaf of bread from a store and walks out with that loaf of bread," he says. "Some entity, we expect, will make an offer to lease the Midway Airport for 75 to 99 years, and the following day I'm pretty sure it will still be there."

Great loaf of bread analogy Dana. What are you up to now?

Wearing a crisp suit and stylish eyeglasses, Levenson looks like the Wall Streeter he once was, working for Bank One Corp. and Bank of America Corp. (BAC ) before taking the Chicago city job in 2004. In April he returned to banking: As a managing director at the Royal Bank of Scotland Group (RBS ), he now beats the bushes for infrastructure deals.

Smart career move Dana. After doing infrastructure deals for a few years, then you can move over to RBS's newly formed infrastructure workout/restructuring group. You will be just the man for that job.

Juan Rodriguez used to patrol the freeway for Chicago city. Today, he cruises the road for private owners. He discovers some potholes have grown unacceptably large because of salt that was spread the previous night. There's some tire debris that must be removed, and a disabled vehicle holding up traffic. In the past, Rodriguez says, he had to write out a ticket for each problem, which would be added to a long list of chores. Addressing problems often took days, Rodriguez recalls. But by 10:25 a.m., all of this morning's issues on the Skyway's 7.8-mile stretch of pavement are resolved. "The new owners are taking the Skyway to a whole new level," he says.

He "cruises the road for private owners"? I thought this was a business magazine. Seriously, at least Juan is digging this whole infrastructure thing. Imagine the boost to American productivity as we fill our potholes a hundred times faster! Who says we can't compete with India!

Levenson doesn't understand how local governments can afford not to put public works up for sale. Thanks to the 99-year lease for the Skyway, Chicago has paid off its debt and handed over $100 million to social programs like Meals on Wheels. Plus, says Levenson, it's earning as much in annual interest on the $500 million it has banked from the transaction as it used to earn from running the Skyway ($25 million).

Wait, Dana, you mean, I can't afford not to do this? Well, if you put it that way, where do I sign?

Meanwhile, the higher tolls will take a big bite out of lower-income people's wallets. "You have to ask yourself if you want roads that used to be considered a public service to be rationed by income class," says Princeton University economics professor Uwe E. Reinhardt.

Damn, just when you're beginning to enjoy your lower risk, up pops this guy Uwe with his class warfare stuff. C'mon Uwe, I dumped all my French oil stocks with Sudan projects. You mean by investing in these low risk but higher returning investments I'm taking a bite (a big one!) out of lower-income people's wallets? It's enough to make me (you guessed it) jump off a bridge!