Selling the Commons

by Thomas Brom

In early October the state Legislature finally passed a budget that featured no new taxes, deep cutbacks in social services - and a dubious form of inventory shrinkage. To help meet expenditures, the State of California sold 24 office buildings - including the Department of Justice Building in Sacramento, the entire Civic Center complex in San Francisco, the Elihu M. Harris Building in Oakland, and the Ronald Reagan State Building in Los Angeles - for $2.33 billion. The new owners include Hines, a Houston-based developer, and Irvine-based Antarctica Capital Real Estate.

Last year the Legislature and Gov. Arnold Schwarzenegger authorized the 20-year sale-leaseback, which was the subject of conflicting economic reports. The Department of General Services forecast that it would bring more than $1.2 billion in net revenue, a claim challenged by both the Legislative Analyst's Office and Beacon Economics, a consulting group. Beacon's Christopher Thornberg, principal author of a report titled "A Bad Deal," concluded that if the state used standard accrual accounting - rather than cash accounting as permitted in the public sector - "this transaction would actually end up expanding the budget gap substantially, rather than reducing it."

Thornberg argues that the sale of buildings violates the spirit of Proposition 58 - the 2004 balanced-budget initiative - by "using long-run debt to fund current state spending." In an interview, he adds, "We have rules: You can't use long-term debt for short-term obligations."

But whether the deal pencils out takes a back seat to the policy decisions hidden within it. The Beacon report was funded by SEIU 1000, the largest public employee union in the state and a longtime foe of privatization schemes. The report claims that the sale-leaseback is "based on the idea that buildings managed by the private sector will be cheaper to maintain because of lower employment costs. Notably, this new policy is a direct repudiation of a tradition enacted over 30 years ago to lower the state's cost for courts, employees, and agencies by developing state-owned office buildings."

Privatization is new to California, but not to many other states or to the European Union. Indiana recently sold and leased back its toll road, using the proceeds primarily to build other infrastructure. Chicago has privatized its Skyway Toll Bridge and an underground parking garage, and currently it's negotiating the sale of Midway airport. "Toll roads and bridges in the U.S. are the last ones in public hands," says John R. Schmidt, a partner in the Chicago office of Mayer Brown who represents the City of Chicago in these deals. "In Canada, Australia, France, and Spain, the toll roads and bridges have all been privatized." Mayer Brown, Fulbright & Jaworski, White & Case, as well as the U.K.'s Magic Circle firms, have a thriving practice in infrastructure financing.

Schmidt says there's a well-established market for sale-leasebacks, primarily infrastructure funds created by private equity firms. Spain-based Cintra, along with the Macquarie Group, an Australian investment bank, own both the Skyway Bridge and the Indiana toll road. Morgan Stanley owns the Chicago parking garage and half of the city's privatized parking meters, sharing them with the Abu Dhabi sovereign wealth fund and Allianz insurance of Germany.

"Infrastructure is a state-by-state process," Schmidt says. "Even if a project has some federal funding, there are 50 different capital markets for infrastructure. But in places where the population is growing - Texas, Florida, Georgia, and California - those states are seeing that this is a better way to do things. Public entities have no other resources."

Twenty years ago California was a pioneer in so-called public-private partnership (P3) agreements, a hybrid ownership form. In 1989 the Legislature added section 143 to the Streets and Highways Code, resulting in construction of two public-private toll roads in Southern California. But the Professional Engineers in California Government (PECG), the union representing CalTrans white-collar employees, opposed alternatives to the design-bid-build formula, and the authorizing statute lapsed.

"P3 contracts are very different from privatization," says Fredric Kessler, a partner in the Los Angeles office of Nossaman who has represented state entities in P3 projects in Texas, Washington, and Alaska, among others. "They are used for new construction financed through a combination of tax-advantaged bonds and private equity funds. The project is owned by the public and subject to regulatory control through contract provisions to assure that the parties comply with their obligations."

Faced with a pressing need to build infrastructure but a limited ability to issue bonds, the Legislature passed the Infrastructure Financing Act of 1996 (Cal. Gov't Code §§ 5956-5956.10), which authorized P3 agreements for fee-producing projects. In 2007 the Legislature authorized such financing for the Long Beach Court Building, to be constructed by a consortium led by Paris-based Meridiam Infrastructure, a private equity fund. Schwarzenegger then pushed lawmakers in 2008 and 2009 to amend the Streets and Highways Code to permit CalTrans and regional transit authorities to use P3 financing for the Presidio Parkway, which will replace the roadway at the south end of the Golden Gate Bridge in San Francisco.

Of course, whether it's a good idea to partner with private investors to build, manage, sell, or lease back public property is a matter of opinion. Leonard C. Gilroy, director of government reform for the libertarian Reason Foundation in Los Angeles, insists "privatization is not partisan and not ideological." He says P3 contracts should be "performance-based," permitting public entities to mitigate risk in financing, construction, and maintenance.

Gilroy is principal editor of the foundation's Annual Privatization Report, which chronicles privatized roads, bridges, buildings, airports, water and sewage systems, schools, prisons, and social services. "There's a big cloud of private capital hovering, waiting for an opportunity to invest," Gilroy says.

But the skeptics aren't buying it. Reacting to last year's expanded P3 authority in the state budget, PECG warned that strict oversight would be needed "to prevent foreign, multinational companies and Wall Street investment houses from taking huge profits out of our transportation system, preventing the improvement of public roads, and inflicting outrageous tolls on motorists."

There are no guarantees for investors, either. Earlier this year, the Macquarie Group's toll road in San Diego County declared bankruptcy. The ten-mile roadway took almost 17 years to build, but its owners took less than three years to default on debt payments. The parties are now in litigation.

There have been other recent privatization failures. In 2006 a superior court judge voided Stockton's 20-year contract for a privatized wastewater system after citizens complained of a sewage spill. In 2007 Petaluma declined to renew a water treatment contract with Paris-based Veolia Environnement after city officials decided public operation would be cheaper.

More than a century ago the U.S. Supreme Court held that the Illinois legislature was not free to sell the entire Chicago harbor to a railroad, upholding a pubic trust in the state's navigable waters and the commerce over them. But in the teeth of the recession, advocates of a broader public commons are finding it hard to attract a quorum.

"Public agencies in California are facing difficulties they have never faced before," says Steven Meyers, a principal at Meyers Nave in Oakland who recently established a P3 infrastructure group. "Property tax revenue is not coming back-so the public agencies must change."

Faced with a Macquarie Toll Road, an Antarctica Capital Civic Center, and a Meridiam Court Building, we're left with the words of 17th-century protesters to the English enclosure acts:

The law locks up the man or woman
Who steals the goose from off the common,
But leaves the greater villain loose
Who steals the common from under the goose.

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