With about two-thirds of America's new transportation construction "public-private-partnerships," design-build P3s have been highly praised over the last decade. Contractors, politicians and financiers have been claiming that tiny slivers of private money bring efficiency to the formerly public process of highway building, spurring innovation and freeing taxpayer dollars for other key needs. But as Randy Salzman discovers, it's not without its problems
In the media, congress and across the political world, promoters pushing design-build public-private partnerships (P3s) are still claiming that private innovation is saving taxpayer money, creating good jobs and easing congestion.
In wanting to institute an "Infrastructure Bank" to address America's "crumbling highway infrastructure," even President Obama, using New York's Tappan Zee Bridge as a backdrop, recently encouraged P3 construction with a US$302 billion plan. The president had apparently not read Congressional Budget Office research into P3s, nor heard the Tappan Zee contractor speak at a congressional hearing.
In March, Fluor's senior vice president Richard Fierce bragged that his company was saving taxpayers US$1.7 billion on the new bridge across the Hudson until one congressman offhandedly remarked that he'd heard the Tappan Zee project would cost US$5 billion, not US$3.1 billion as the contractor had claimed.
"That may include work outside our present contract," Fluor's VP replied.
Design-build is in effect "cost plus," tailor-made for expensive change orders once construction is underway when no politician can dare pull the plug on runaway spending. P3s are even more geared for lining the pockets of financiers; hence foreign money is flooding into US highway projects today. The costs and risks, it is consistently claimed, are dumped on the privates but the reality is much more complex and, according to the Congressional Budget Office (CBO), at best delays taxpayer pain. There is little, if any, long-term savings for citizens, the CBO notes, and the tiny amounts of private equity serve primarily to get construction underway quicker.
"There's a set of financial interests who have really learned how to mine the tax code," P3 supporter Doug Koelemay, Virginia's new director of Public-Private Partnerships, frowns.
The Very Model of a Modern Major PPP?
Virginia's 1995 Public-Private Transportation Act is held up as the "model" by contractors and financiers, especially as it was implemented at break-neck speed during Governor Bob McDonnell's administration. In four years, the number of Virginia P3s skyrocketed to 22 and with the Commonwealth signing over US$6 billion in P3s during 2012 alone, Infrastructure Investor magazine named McDonnell "man of the year" and called the state's legal consultant, Allen and Overy, the world's best law firm twice. Does any magazine for investors venerate hard bargainers for taxpayers?
"A great deal of the media praising public private partnerships in transportation projects comes from sources that have a self-interest in promoting them," says Jack Trammell, now a candidate for Virginia' 7th Congressional District. "A major factor motivating me to run for office is what I think should be a national concern about this trend away from transparency and toward greater taxpayer risk in such projects."
In the past, even Virginia's Commonwealth Transportation Board (CTB) never saw P3 contracts, only being allowed up-down votes on the total taxpayer bill, which consistently put 95+ per cent of all costs on state and federal taxpayers. The privates put up tiny bits of equity, though they imply more because they borrow dollars from Uncle Sam that they likely will not pay back and they sell bonds that Uncle Sam guarantees and which will cost taxpayers when the P3 goes bankrupt – as they almost inevitably do – about 15 years down the road.
It is a "win-win-win" for private money and contractors but for unaware taxpayers it could be the biggest scheme ever in Virginia – and potentially US – history. Is getting a highway or other transportation infrastructure, which may or may not be needed, returned to we taxpayers just when it's beginning to need maintenance worth the fact that we've left virtually all construction costs, all risk, all financing costs and 10-15 years of tolls to the next generation of taxpayers?
A Clean Slate?
Secretary Layne has been shaken by what he's found in a hard look at a couple of former transportation secretary Sean Connaughton's P3 contracts. For example, although neither the Virginia Department of Transportation nor the Corp of Engineers ever indicated they could mitigate 480 acres of wetlands – and hence issue a construction permit – Virginia has paid 460 Mobility Partners almost US$300m and is on the hook for another US$900m for a highway that will likely never be built.
With that sort of issue possible in 21 other projects, Layne has ordered a "scrub" of all past P3s to find, for example, non-competitive clauses which prevent Virginia from improving nearby roads without having to pay toll operators for potential lost income. Whether the Commonwealth can get out of some of these disturbing contract stipulations is still up in the air.
We asked Secretary Layne if there was "anything criminal" in what he's learned.
His hesitant reply, "I don't think so," was echoed by Koelemay but, still, the new administration has asked two CTB members to lead an inquiry and highlight better contracting methods. Regardless, "even if some of these 'improvements' (P3 projects) are desperately needed," as Trammell puts it, "we shouldn't get them at the cost of transparency and accountability to taxpayers."
Trammell believes financiers can hide in plain sight because the terms of these contracts – often over 700 pages - are so complicated that even after studying the issue for more than a year, he can't put all of the pieces together. How, he asks, could the general public, reporters without finance degrees or part-time bureaucrats like the Commonwealth Transportation Board understand this complexity? Especially when they don't hear it.
"You did get a 'high level briefing' on the benefits of the  project," Layne explained to CTB members in March, "but you were not privy to the  contract, the contract terms, the payments schedule, the risk being taken or any terms."
CTB members were subdued with one thanking Layne for promising greater openness: "I have been very uncomfortable on a couple of projects we had (under Connaughton). I didn't have the data I needed to make a decision at the same time I was asked to vote. Don't ask me to do something without giving me the information I needed." Another was shocked that "we allocated money yet we had no authority in approving the project?"
Only Jim Rich, later fired by McDonnell and Connaughton over his staunch opposition to fiscal irrationality, stood up and questioned financing and risk management when Connaughton brought rapid-fire P3s before the CTB over the past four years.
Layne, who served as head bond salesman for the 460 "Commonwealth Connector" and still supports the project, assures there will be "competition and transparency" in future P3 contracts. As secretary of transportation today, he said his prime "fiduciary responsibility" is to taxpayers, not bond holders, as it was when he ran the bond operation for the now-suspended 55-mile "Connector."
Layne and Koelemay indicate the Commonwealth's representatives in past P3, Connaughton and Tony Kinn, the original Virginia public-private-partnership office director, were outclassed and, due to ideological considerations and trapped by promises to do "something" about congestion, couldn't just walk away from the table. They may not have realized their legal consultants were conflicted by work for private infrastructure bond sellers.
Media coverage of P3s over the past decade, furthermore, has been overwhelmingly positive, consistently following the contractor line that private innovation is offsetting significant amounts of expense, improving projects and freeing public dollars for other activities. However, the Congressional Budget Office indicates P3s provide little, if any, financial benefit to taxpayers.
"The cost of financing a highway project privately is roughly equal to the cost of financing it publicly after factoring in the costs associated with the risk of losses from the project, which taxpayers ultimately bear, and the financial transfers made by the federal government to states and localities," the CBO's Microeconomic Studies director told congress in March. "Any remaining difference between the costs of public versus private financing for a project will stem from the effects of incentives and conditions established in the contracts that govern public-private partnerships."
In that congressional hearing, Boston's Michael Capuano reminded congressmen that "people stole money" in prior equivalents of design-build P3s, and that's why the highway construction paradigm became "inefficiency intended to avoid malfeasance."
"We need to remember the potential downfalls before we go too far down the road too quickly and want to be conscious of not opening up the barn door," he cautioned.
Washington, DC shadow congresswoman Eleanor Norton was more specific: "I wonder if it's (P3) an equitable or fair deal for the public? There's a very high level of public funding and a low level of private risk. The rundown of figures amaze me and I'm trying to find out what the real advantage here is of the public-private-partnership."
Worst Case Scenario?
So, is this an ethical issue? In Virginia, at least, it should be. Having researched P3s deeply, we laid out this long-range scenario to Secretary Layne, culled heavily from the work of former Penn State law professor Ellen Dannin:
A private creates a shell company with a major finance – usually foreign - arm and an international construction contractor to bid on the P3. It sells private bonds, bonds generally backed by federal guarantee, and includes those funds as the major part of its "private" contribution. Any state's representatives at negotiations are outclassed because they have little background in finance or contract law and its legal consultants, like Allen and Overy, are conflicted. The privates' upfront financing allows the project to get underway quicker and it is implied that private efficiency is overcoming bloated public bureaucracy while heavily inflated traffic projections indicate the privates will be compensated through tolls. The construction bid comes in low with "design-build" tailor made for forcing the state to accept expensive change orders after construction is underway and the public is no longer paying financial attention. True construction costs climb as the change orders needed for functionality are accepted but no politician can dare pull the plug once dirt is turned. There are too many "good" jobs at stake and too much explaining for a public that thinks Jon Stewart provides "news."
Because P3s are exceptionally long contracts, longer than the projected lifespan of the project itself, - Elizabeth River Crossings in Norfolk, for example, is 58 years and the Capital Beltway Express in Northern Virginia is 80 years - the shell company is allowed to treat its lease as ownership for tax purposes. Hence, it enjoys a hefty depreciation allowance, like homeowners take on houses.
Once the highway is built, the shell company – and we used that word consistently with Secretary Layne – accelerates the depreciation and about 15 years later, just when the highway is actually needing much repair, often goes bankrupt. The bond holders, however, are protected because of federal financing guarantees and taxpayers find themselves facing the costs of a highway re-build when all of the toll income has gone to the shell company backers, now protected by bankruptcy laws from having to pay back loans, bonds or depreciation. When the shell goes under, furthermore, the state becomes responsible for design flaws and safety issues, regardless of how much oversight it applied during construction. Since today that oversight is also contracted by "incestuous" – Layne's word – private firms, the public has little idea of how well constructed a project was when it is returned to taxpayers.
Meanwhile, under many contracts, the state is prevented by "non-competition" clauses from improving nearby roads, bridges or adding bus-rapid transit unless it compensates the privates for potential lost tolls.
Every bankruptcy, finally, increases the return rate for the next P3 bonds. Investors, therefore, get junk bond rates due to a "risk" that is primarily accruing to taxpayers. Bondholders, again, will be compensated by taxpayers due to Uncle Sam's guarantee when the toll income fails to meet projections.
"It has happened," Secretary Layne agreed without pointing to any specific Virginia, or indeed national, project.
Something Doesn't Quite Add Up
While we can't predict the future – and can't see the contract itself – Capital Beltway Express in Northern Virginia provides a possible example. According to PW Finance, CBE bond-buyers were told to expect a "conservative" US$335,000 per day income from tolls by 2015 but, as of April 2014, there were 28,600 daily vehicles averaging US$62,357 in tolls.
Of the original US$350m in private equity from Capital Beltway Express, only US$88m was paid upfront by CBE partners, Transurban and Fluor, according to the public works journal. Virginia ponied up US$409m with Uncle Sam loaning CBE US$587m and backing bondholders to the tune of another US$587m. Capital Beltway Express indicated bond purchasers could expect a 13-per cent return on investment - or over five times the return on Treasury Bills - because PW Finance reports the contract allows CBE to pay zero interest for 10 years on the loan and not begin paying a penny on the principal for 25 years.
Long before the federal re-payment schedule kicks in, however, Capital Beltway Express will likely go bankrupt, as the experience of other American P3s illustrates. Generating today only one-fifth of its projected toll income, Transurban's shell company indeed announced a "restructuring" of some US$280m in remaining private equity in February just months after Transurban's other Virginia P3, the Pocahontas Parkway, went belly up again.
In the midst of the Beltway and Parkway debacles, unless Transurban totally misunderstood its own financial situation and couldn't read its own CBE traffic and income counts - or understood something taxpayers don't - it would never have sought and won the 95 Express Lanes project. If Transurban was losing that many real dollars, why would the Australian multi-national throw good money after bad on another P3, the I-95 toll lanes?
Like the Pocahontas Parkway, Virginia's first P3, the stage is set for Capital Beltway Express bankruptcy once the accelerated depreciation schedule is over. CBE and Transurban can easily walk away – and Fluor already has – because the money they actually did provide has been reimbursed by actual tolls and design-build change orders, leaving the next generation of taxpayers not only compensating bond holders but also now responsible for maintaining a highway which is beginning to show wear and tear. Uncle Sam will likely not collect Capital Beltway Express' US$587m loan and, instead, will pay off bond-holders at a rate multiple times what they'd have received through T-Bills or state securities.
Yet the consistent media story is that privates paid three-quarters of the US$2 billion Capital Beltway project, never pointing out that the actual upfront cash that privates provided is covered in only four years of actual tolls. This lack of insightful mainstream media coverage - even around Washington, DC, the center of American news media – leaves ill-informed citizens and policy makers.
Unconnected coverage of each individual P3 makes it difficult for citizens and policy makers to comprehend the hoopla and recognize that private money dots every 'i' and crosses every 't' to ensure profitability. To the reporter who is assured private industry is more efficient than public bureaucracies, and is rarely versed in finance or tax law, each project sounds reasonable when inflated traffic projections implying tolls will cover all debt are handed out in press releases. However, we cannot find an operating American P3 project that is making the toll income it projected prior to construction.
There are well-reported positives in individual P3 projects, but this guaranteed bonds-depreciation-bankruptcy-pay off scenario; this "mining of the tax code" is happening behind the scenes and over decades in a bumper-sticker culture obsessed with fashion, sports and trivia.
Mainstream media, meanwhile, forget that private industry rarely leaves a dollar on the table. It does not participate unless it has strong assurances it will profit in the long haul. Virginia's program, remember, is called "the model" by financiers and contractors. Not by taxpayers.