For all the talk about how to pay for infrastructure improvements — and there’s been a lot of it — there’s been little discussion about what potential investors need: a return on their money.
Most of the public discussion has been what the government can do to raise revenue. Hiking fuel taxes, recommended by two national commissions, is politically toxic. There’s been talk about grants, loans, debt and equity investments. Hours of congressional hearing time have been dedicated to options for financing highways, bridges, runways and railroads at a time when the economy is slow and the deficit is high.
But what about the private investors who the government will turn to for more than $500 billion for construction and rehabilitation over the next five years? What they want, of course, is a return on their investment. But what’s the best way to accomplish that?
It’s a critical question because if governments on the federal, state and local levels don’t find the political will to create the revenue streams to generate those returns, investors will look away from infrastructure and toward more rewarding, less risky endeavors.
The good news is government programs can take a number of shapes to produce that ROI, said David Seltzer, a principal in Mercator Advisors, a Philadelphia firm specializing in infrastructure financing.
“The fundamental issue in America’s infrastructure gap is not a shortage of investment capital, it’s a shortage of revenue streams to support capital investments in projects,” he said. “State and local officials are unwilling to impose taxes, fees, tolls, fares or the other things that would induce Wall Street to invest in projects.”
Robert Wolf, chairman and CEO of UBS Americas, told the Senate Banking Committee last month there is $180 billion in private equity and pension fund capital ready to invest in U.S. infrastructure. But it’s not enough that Wall Street has the money available, Seltzer said. State and local governments that account for 75 percent of infrastructure spending haven’t pledged revenue streams to assure the right return.
In the past, the bulk of private investment came through tax-exempt municipal bonds, preferred by private investors, investment trusts and institutional investors, he said. But the recession weakened that market when pension funds and other institutions that don’t pay federal taxes found better yields in taxable bonds.
Build America Bonds, which the Treasury Department began issuing in April 2009, brought a new class of investor into the infrastructure finance market, Seltzer said. “By creating this new type of taxable rate bond, it opened up new classes of investors: pension funds, insurance companies, endowments that were on the sidelines because of tax exempt bonds.”
The government sold $136.4 billion in Build America Bonds in the first nine months of the year, according to the Security Industry and Financial Markets Association. They’ve been popular because the federal government gives a 35 percent subsidy on the cost of issuing, but Seltzer said their real benefit was stabilizing the chaotic bond market of 2008 and 2009.
Investors want “a competitive risk-adjusted return,” Seltzer said. Equity investment has a higher yield with higher risk. Equity claims on revenue are subordinate to repayments to lenders and creditors. Without knowing how they will be repaid, the question to invest or not is moot.
Like politics, paying for infrastructure is local. The more people can see the results, the more they’re willing to raise taxes or approve bond issues.
“California is a trend-setter, for better or worse, for the rest of the country,” Seltzer said. “In the depth of the credit market crunch and recession in November 2008, Los Angeles County voted by a two-thirds majority to impose a new half-cent sales tax on themselves. There’s a tangible set of projects that the revenue stream is going to go for. Voters and policymakers can see the direct connection between the higher tax and the public benefit that’s funded from it.”
Compare that with the battle over the federal fuel tax. Seltzer said people don’t see the connection between paying extra tax at the pump, and the return benefits from the Highway Trust Fund. “But it’s the same mechanism,” he said. “You’re using a dedicated fee to fund specific types of improvements.”
Without the political will to find how to pay investors, governments may find themselves in competition for the money. “Capital, like water, seeks its own level,” Seltzer said. “Investment capital is looking for all sorts of options. It’s not limited to the infrastructure. It all has to make sense as a competitive risk-adjusted rate of return.”
Contact R.G. Edmonson at firstname.lastname@example.org.