U.S. Markets closed

How taxpayers fleeced well-heeled investors, for once

Rick Newman
Senior Columnist
How taxpayers fleeced well-heeled investors, for once

Everybody’s used to hearing how crony capitalists use the public purse for their personal enrichment. This is a rare turnabout tale in which taxpayers ended up winning at the expense of moneyed interests.

An important highway known as the Indiana Toll Road — running for 157 miles in the northern part of the state — declared bankruptcy this week. The toll road, which includes portions of I-80 and I-90, is the sort of public-private partnership many analysts feel will be the most effective and maybe only way to fund big infrastructure projects in the future, since governments are generally short on cash. So the toll road’s bankruptcy — not something you hear about every day — seems to raise troubling questions about funding methods for roads and bridges that even President Obama has endorsed.

Those questions, however, involve unsound decisions by investors that left taxpayers with a surprisingly sweet deal. The Indiana Toll Road was built in the 1950s and by 2006 was a neglected stretch of the federal interstate system, with tolls that hadn’t been raised in 21 years. Indiana Gov. Mitch Daniels oversaw a deal in which the state offered to lease the highway to the highest bidder. The winning firm was ITR Concession Company, backed by institutional investors in Spain and Australia. It paid the state $3.8 billion upfront to run the road for 75 years and earn revenue from tolls.

A controversial deal

To make sure ITR didn’t exploit motorists, the deal required the new toll-road operator to make needed upgrades. Annual toll increases were capped close to the rate of inflation. ITS did raise tolls, while also spending at least $300 million on improvements and installing the electronic EZ-Pass system to simplify toll collection. The deal was controversial in 2006, when it narrowly passed the state legislature, but by 2010, when Daniels was running for reelection, it barely registered among voters. “Indiana taxpayers got a better road with millions of dollars of improvements and protection from outrageous toll increases,” says Robert Poole, director of transportation policy for the libertarian Reason Foundation.

Indiana used the $3.8 billion to pay off debt, fund other projects and set up an interest-bearing fund that would generate revenue for future infrastructure investments. Not everybody felt this was the best possible deal for the state. One study, for instance, argued that leasing the toll road was a good deal for current Indiana taxpayers but would short-change future generations, because the $3.8 billion would run out well before the 75-year lease was over, yet all toll revenues would continue to go to the lessee, not the state. But that study assumed tolls would continue to rise by enough to cover the cost of maintaining the road, when reality showed politicians were unwilling to raise tolls in the pre-lease days, even when the road suffered.

ITR got into trouble because its traffic projections were overoptimistic. The 2007-09 recession cut into truck traffic at the same time overall driving miles fell. Revenue from tolls came up far short of forecasts, and with much of the deal financed by debt, ITR fell into arrears. It missed a debt payment in June and declared bankruptcy this month.

The toll road, however, continues to function normally, with no disruptions expected because the lease requiring routine maintenance of the road remains in effect. The lease is now an asset that will go to the highest bidder — who will be obligated to abide by its terms — as ITR works through bankruptcy. The biggest losers will be ITR’s debt and equity holders.

One firm that might bid on the lease is Abertis, a Spanish toll-road operator that manages a similar project in Puerto Rico. Hedge funds holding some of the distressed debt could end up as owners. It’s also possible the state could end up running the toll road itself again, which would mean it took a nonrefundable $3.8 billion payment from investors in exchange for 75 years’ worth of toll revenue that only ended up being eight years’ worth. Investors, meanwhile, bore all the risk if the lease didn’t work out. That’s like private investors putting money in taxpayers’ pockets. It’s hard to imagine better public financing than that.

Two other toll roads  —one near Greenville, S.C. and another near San Diego — declared bankruptcy in 2010, also because traffic came in below projections. In both cases, there was no taxpayer bailout and the road stayed open as usual. Many other public-private partnerships have been successful. In Indiana’s case, there seem to have been three basic problems: flawed traffic projections, excessive use of debt to finance the deal, and plain old bad timing, given that the recession came right on the heels of the lease.

Public-private infrastructure deals these days incorporate lessons learned from recent failures. “Indiana hasn’t really proven to be a model,” says Sean Slone, program manager for transportation policy at the Council of State Governments. “The huge upfront payments from the private sector like Indiana got don’t really happen much anymore.” That’s too bad for taxpayers, because many states are interested in luring private investors to help fund badly needed improvements to roads and bridges. The smart money, apparently, has learned to protect itself from the little guy.

Rick Newman’s latest book is Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.