CTA For "Sale"?

The price tag on the Brooklyn Bridge too high? Florida swamp land not your cup of tea? How would you like to buy a money losing urban transit system? If a recent article in Pensions & Investments magazine is to believed, some lucky investor may soon get that opportunity.

The article discusses how various classes of publicly-owned and run infrastructure in the United States, including state lotteries and toll highways, are being viewed by private investors around the world as attractive assets. The article cites Governor Blagojevich's proposed sale of the Illinois Lottery and the City of Chicago's long-term lease of the Skyway.

The article also includes this interesting tidbit:

In Chicago, Mayor Richard M. Daley is behind a move to privatize Midway Airport. This month, Mr. Daley also proposed selling parts of the Chicago Transit Authority, the city’s mass transit system, to provide the cash needed to fund the CTA’s pension fund, which is 33% funded.

At first blush the notion that a savvy investor would buy some or all of the CTA system seems daft. Why would any sane investor want to buy a money-losing transit operation plagued by dysfunctional labor relations and saddled with large unfunded pension obligations? Here's how and why.

First, the how. Let's assume that the CTA and/or the RTA pledge a steady and growing stream of operating subsidies to the investor. The CTA retains its pension obligations and uses the upfront payment from the investor to fund these obligations. The investor agrees to keep on all existing employees with their wages and benefits intact. However, with respect to new employees the investor is allowed much more flexibility in setting wages, benefits and work rules. Given the turnover in the CTA workforce, this will yield significant potential savings in a matter of a few years.

The investor is also allowed to set fares within certain economic parameters such as the rate of increase in the Consumer Price Index. At some point, the potential financial return from the combination of guaranteed subsidies, escape from under the weight of the CTA's pension obligations, reduced long-term labor costs, and the ability to set fares in a captive market will make such a deal attractive to investors.

Second, the why. There are a variety of reasons why privatizing the CTA through a Skyway-like transaction makes sense. First and foremost, the current institutional arrangements that have resulted in the current CTA "crisis," indicate that reforms and good intentions plus lots of new money are unlikely to result in significant, sustained improvements in the CTA system. It will take a fundamental shock to the system--akin to the formation of the CTA from the wreckage of several private transit companies in the middle of last century--to yield such improvements. (A risky proposition I admit.) Second, the CTA might realize a higher rate of return if it is the first transit system to market. As the P&I article mentions, returns tend to be higher for early deals in a new market. Third, the RTA and the service boards may be unable to extract sufficient money from the General Assembly and the Governor through traditional political means.

There are three key obstacles to such a transaction. First, there is high political risk to the investor inherent in a long-term pledge of RTA operating subsidies to the CTA when it is under private control. What if the General Assembly suddenly repeals the RTA's power to tax. There may be some ways to mitigate this risk, such as a pledge by the City, Cook County and/or the State to pay these subsidies if the RTA spigot runs dry. The adverse impact of such a pledges on the credit agency ratings of these public entities, however, makes such pledges unlikely.

The second risk is labor costs. Labor costs are a relatively insignificant portion of the cost of running tolled assets such as highways and bridges. Labor costs are a much higher proportion of total costs in the case of public transit agencies. High labor costs and difficult labor relations makes any transaction much riskier for a private investor than a plain vanilla tool toll bridge acquisition, for example.

The third risk--or reality--is that some of the CTA's assets already have been conveyed to third parties. Before the IRS crackdown (and here) on leveraged leases the CTA conveyed at least one of its rail lines to private parties under a long-term lease arrangement. (Metra did the same with some of its rolling stock.) (Article here.)

These risks and the larger structural deficit associated with public transit agencies make privatization of the CTA an unlikely proposition. Never underestimate, however, the creativity and persistence of investment bankers in putting together complicated and fee intensive deals!

It is possible that the Mayor's remarks were limited to the CTA's proposed Airport Express to Midway and O'Hare Airports. The CTA has been exploring ways to interest the private sector in taking on this project. If news reports are to be believed, the immediate prospects for a true Airport Express are not that great. However, with time, and long-term investors have all the time in the world, even an Airport Express venture might make some real money.

A final note about the P&I article. The article mentions that the Illinois State Board of Investment has put together an infrastructure investment fund. Wouldn't it be interesting if the State finds itself investing in the very infrastructure projects that involve sales or long-term leases of Illinois public assets. I guess that is one way to mitigate risk. If the CTA, for example, gets skunked in a privatization deal the State of Illinois will get some of that upside. If the CTA gets a great deal at the expense of the investors, at least some of the State of Illinois' loss will be spent in Illinois on CTA projects. What goes around comes around.