Here’s a quick sketch of a ‘Convertible PAB’ in context of TCJA bill, the Move America bills and political reality:

• Keep or even reduce current PAB volume allocations – not expansion like Move America. So price tag is $39bn or less – even $10bn starts a market. Maybe expand scope of qualifying projects – but I don’t care about outcome here.
• Include the Move America 4:1 conversion option for QIFs and the other MAIFC mechanics, more or less.
• Cut out the Move America project-specific conversion credits altogether – using straight PAB is the only P3 option.
• Add a feature that monetizes tax credits through withholding taxes – but for ‘qualified retirement funds’ only, and only those that are public or large-scale (e.g. labor) US pensions. So the whole credit conversion option is strictly public QIF-to-public-ish pensions. No Wall Street involvement needed.

Chances? This depends on how hard the PAB fight turns out to be. If GOP is determined to repeal altogether, then there’s no chance. Or if GOP just caves on PAB repeal without modifications, then again no chance.

But a fight in the middle is possible – GOP willing to keep (some) PAB volume as long as a level-playing field option for public infrastructure is included – then there’s a shot. Worth thinking about anyway – if only for setting-up infrastructure bill concepts re QIF loan program support.

This post was recycled from an email exchange where someone suggested that the case for at least not repealing (and ideally, expanding) PABs should look like this: “PABs promote private investment in traditionally public infrastructure by lowering the debt costs for projects with private equity investment.” Although not explicit, the source and context makes it (somewhat) clear that what’s being contemplated are private-equity based P3s. As readers here will know, I’m not much of a fan. My response:

“Your case relies on the assumption that “private investment in traditionally public infrastructure” is such an obviously good thing that the federal government should subsidize debt costs for private equity. That might be heavier lift than complexity per se in current environment.

I don’t think anyone is arguing that private-equity P3s are always a bad thing – if the numbers actually work, and if the social value is really there, why shut the door on an option? But there’s apparently a lot of skepticism even in GOP about P3s now – Trump’s pivot not the cause but an effect – and if there’s widespread doubt about the effectiveness or social benefit of P3s, then the PAB case seems to boil down to subsidizing private equity to “give them a chance” to show how in fact good P3s really are. Tough sell.

That’s why I thought the Move America bill was especially interesting and subtle [this bill was part of the broader discussion – summary here]. Sure, it starts with usual case of expanding PAB volume (so P3 supporters and muni market are happy) but then pivots to converting the tax cost of the PABs into 2 types of tax credits. One is a project credit for private investment – again the usual P3 pitch. But the other is directed towards distinctly local public-sector Qualified Investment Funds like SRFs and SIBs (which do have a good track record and seem to enjoy widespread support even among the swamp-drainers). That’s the real new idea – and I think it’s there for a reason.

In effect, what the Move America bill is saying “yeah, we don’t know if P3s are always a good thing, but shouldn’t shut the door on them – let the states decide on individual cases. But if P3s don’t work, states then can use the tax cost to expand SRFs and SIBs for basic public infrastructure – and everybody likes that”

So I think the Move America bill conversion options (complex as they appear to be) are actually making a good and politically practical case for PABs – keep PABs around as a P3-oriented option (and avoid a fight w/ muni bond folks) but show how the tax cost of keeping them can be (and likely will be) used for something other than private equity – e.g. for ever-popular SRFs. That approach covers a lot of stakeholders and defuses a lot of objections, I think.

Worth noting that Move America lead sponsor is Republican Rep. Walorski from Indiana – a state which has big & successful SRF and SIB programs, and knows P3s, good and bad. More specifically, she’s on Ways & Means and her website is currently singing the praises of TCJA bill – at the same time her own bill is calling for PAB expansion. She definitely knows the full picture. I think there’s some subtle stuff going on here – so I wouldn’t be too quick to dismiss the Move America conversion approach, especially in the context of defending PABs.”

I’ll add an afterthought – private-equity is not a sector that gets (or needs, frankly) much sympathy. I think the real-world defenders of PABs definitely are not advocating “lowering [private equity’s] debt costs” for a reason. Far from it: what I see in the muni trade press is an endless litany about all the hospitals, low-income housing and campus facilities that have used PABs in the past, followed by a subtle conflation to PAB’s usefulness for ever-popular ‘infrastructure’ in general. This is clearly a tactic. All the more-or-less benign current uses of PABs rely on small-scale, relatively competitive and low-roller private equity specialist markets. But the potential real action is in much less benign large-scale, revenue-generating economic-core public infrastructure assets – that’s what the private-equity P3 high-rollers are looking for.

And why might these high-rollers care about something as pedestrian as PABs? I’m guessing it has less to do with “lowering debt costs” and more about getting their hands on juicy assets.
They’ve found it tough so far to make a compelling case for their product. States & locals under short-term fiscal pressure are naturally tempted – but there’s lots of internal dissension (quite apart from public resistance). In these political battles, I think anti-P3 officials use the public-sector’s more/less exclusive use of tax-exempt financing as a ‘shield’ – a simple soundbite excuse to dismiss private-equity owned P3s.

But if PAB volume and eligibility are expanded (and of course, avoiding repeal is a sine qua non of that process), this shield collapses. Which means a few extra basis points of yield for P3 owners courtesy of federal taxpayers, but I think the real point is that it allows private-equity – with a federal imprimatur – to get closer to ‘persuadable’ state & local officials. So I think it’ll be a serious fight.

Tax reform legislation, if and how passed, probably won’t have much in it about US infrastructure renewal per se. But I think the process will still be extremely enlightening about how Congress and the Administration look at economic and financial issues (with all their political and social ramifications) in the context of actually trying to pass an infrastructure bill in 2018. So well worth paying attention to it, and I’ll focus a number of coming blog posts on it.

To start, I read the House’s TCJA 80-page summary and went through the JCT numbers. There’s definitely a ‘drain the swamp’ theme against using federal tax code to support private investment even when that doesn’t count much as pay-for. PAB repeal rationale: “The Federal government should not subsidize the borrowing costs of private businesses” – sounds like an ideological ex cathedra statement. At least PAB cut gets about $39bn in revenue, but whacking tax credit bonds just gets chump change $0.5bn Cutting rehab and new market tax credits together don’t add up to much either – about $11bn. Also, it seems the PAB repeal in effect cuts about half of LIHTC credits.

Presumably Senate version will be much more moderate, but won’t they have to fight for the big stuff first (SALT, home mortgage, deficit itself etc.)? If GOP really is serious about passing partisan bill quickly (and it seems they have a lot of existential-type motivation for that), I could see an outcome where a lot of small-scale stuff stays on the chopping block.

Especially this outcome re infrastructure – wouldn’t one response to negative impact of TCJA PAB and tax credit repeals on infrastructure be: “we can always put infrastructure-specific PABs and tax credits back in the infrastructure bill if they’re all that important?” If so, then Delaney’s flashing billboard might end up as the real problem, apart from any further energizing of the drain the swamp animus if TCJA passes i.e. bait & switch.

Re chances of passing partisan bill, many folks know far better than I do about this stuff, but after reading the summary it struck me that this is very different than Obamacare attempt. In that mess, there was visceral consensus on ‘repeal’ but no unity or even coherence on the ‘replace’ part. In TCJA, there seems to be a clear unifying theme on the ‘repeal’ cuts (even apart from the need to raise revenue) –actually somewhat populist (look at cuts to executive compensation) – but more importantly, the ‘replace’ proposal is crystal clear: broad rate reductions and simplification. There’s a much better story to build & enforce consensus, even in the face of extreme Democrat and media (and lobbyist?) opposition. And 2018 mid-terms will definitely concentrate minds.

The Wall Street Journal just ran an interesting article, mainly about the Trump Administration’s latest infrastructure proposal but including what appears to be an emerging set of guiding principles for infrastructure policy. The latter aspect is worth an extended look – specific proposals come and go, but principles reveal a continuing mindset about how the Administration views the problem and what they think the nature of a solution might be.

Raising a WTF Question

One idea pervades the article even though it’s explicitly highlighted in only a few places: the belief that states and cities themselves actually have pretty much all of the resources needed to meet the infrastructure challenge.

Of course that’s true. Individual US states have total GDPs that are comparable to those of whole countries elsewhere, some near the top of the list. On a per capita basis, the lowest ranked US state, Mississippi, still beats Italy, an OECD European country. Some US cities individually have world-class, country-sized economies. Places like Puerto Rico and Detroit are glaring exceptions that prove the rule – and provide fuel for the usual media misconceptions. The simple reality is that at some level of sub-federal jurisdiction, all of the resources necessary to make America’s infrastructure great again exist, along with the institutional and political machinery to access them.

Everybody involved knows this. What’s really important and interesting is the Administration’s willingness to actually say it and – more surprising – explicitly use it as a guiding principle for infrastructure policy. Why? Because it inevitably raises a rather pointed question from state and local officials: “Okay then, if we basically pay for it ourselves, WTF is the purpose of your federal infrastructure policy?”

Say what you will about the Trump Administration, they’ve proving to be effective at surfacing uncomfortable questions. What indeed is Washington’s role in making America’s infrastructure great again, given that almost all basic public infrastructure (the nuts-and-bolts stuff that really needs improvement) is already funded and managed at the state and local level? The standard Beltway answer: massive inter-regional transfer payments financed with federal deficits. An ARRA for infrastructure, in effect. That doubtless would have been Hillary’s plan and in some form is likely to be the Democrats’ approach. But if you take massive deficit-financed transfers off the table at the outset, as the Trump Administration seems to be suggesting, then what’s left?

Searching for An Answer

Obviously, the Administration can’t simply answer “not much really” or dodge the question, given the centrality of the infrastructure promise in their campaign and current legislative plan. But it is in fact a tough question, so it’s not surprising – nor discreditable, to be fair – that it’s taking them so long to provide the answer in the form a specific plan.

We’re seeing two Trump approaches to the question of Washington’s role so far. The first is actually a “reduced-role role” – cutting red tape and streamlining infrastructure approvals. I think that will prove to be effective, as far as it can go. But regardless of success, it’s hard to claim credit for a trillion dollars of infrastructure investment if all that you did was get out of the way.

The second approach, where the real action is, involves looking for something that (1) is a small but critical missing ingredient in the otherwise good-to-go mix of state and local infrastructure funding and financing options, and (2) can be uniquely provided by the federal government with an equally small cost but a big impact on infrastructure spending.

In effect, the Administration is looking for a catalyst.

Their search to date shows a learning curve and a steady evolution, I think. First up was Navarro & Ross’ tax credit for P3 private-equity investors – quietly dropped when it became clear that this P3 playbook solution applies to very few infrastructure projects, and not at all to non-revenue producing infrastructure. Politically somewhat toxic, too.

Next, we see Australian asset recycling, wherein a small incentive is meant to trigger sales of revenue-producing public infrastructure assets, the proceeds of which can then be used for the non-revenue producing sort. Very popular with US and foreign investors looking for brownfield assets. But my guess is that the idea is running into opposition because anything that looks like ‘privatization’ is distinctly unpopular everywhere else in the US, especially among Trump’s base. So I’d predict asset recycling will fade to a small part of the eventual package, or (as was the fate of its Australian predecessor) not survive at all. The WSJ article, filled with quotes from unnamed White House officials, did not mention asset recycling once. The trial balloon-like nature of the article is in any case an indication that the search continues.

This brings us to the current state-of-play – the ‘20% solution’. The approach is the most explicit one so far (perhaps consciously so) with respect to the objective of a ‘universal infrastructure catalyst’. Right up front, WH officials say in the article that localities are expected to find their own funding for their own chosen projects in whatever way they want to do it, implicitly including P3s, asset sales and user fees but not excluding traditional paths. So all the difficult politics stay local, with state and local governments setting up the basic almost-good-to-go mix without federal involvement. Only then, if there’s not quite enough funding juice in the mix, the current proposal would have Washington pitch in the rest, apparently up to about 20% of project cost. The rationale is that a cash-grant will be the catalyst that was needed to make the project happen — and so credit can be duly claimed.

To get the most bang for these federal bucks, the prioritization is very simple – those who ask the least will be served first, auction-style. This is meant to also change the dynamics of the federal role — no more pounding on the table, self-serving economic studies or lobbyists.  Of course, if the local officials are raising at least 80% of the cost themselves, they’ll need all those things to deal with local stakeholders — but that’s their day job after all, and they’re better at it (or at least more accountable) than out-of-towner feds.

Hope(ish) and Change, Actually

There’s a lot to like in this, I think. First, the evolutionary story as a whole shows that the Administration is taking the fundamental question of Washington’s role in infrastructure renewal seriously. They’re searching for something new in accordance with a principle, not just politics, and they’re showing flexibility and a willingness to learn. I don’t know how much of the principle is derived from ‘drain the swamp’ ideology, but the catalyst role happens to be the right one with respect to the federal government’s relative strengths and weaknesses in infrastructure finance.

Second, the Administration is acknowledging that American basic infrastructure, not big glamorous (and rare) projects, is really the focus of renewal. It’s an obvious point, but I think it does take some discipline to ignore political eye candy and stay focused on distinctly boring stuff.

The third positive point flows from the first two – the search for a catalyst to unlock resources for basic infrastructure leads inevitably to territory where state and local governments make the decisions and find the funding. This path changes the fundamental nature of a federal catalyst to something that isn’t really related to the infrastructure itself. Instead, finding the missing ingredient is all about what’s constraining localities from using their own resources (which they indeed have) on spending for basic local infrastructure (which they know very well how to do). We see this directly in the current 20% solution – the constraint is assumed to be that state and local governments can’t quite get to 100% funding, presumably after they’ve considered or included all the infrastructure-specific ways to achieve cost-efficiencies (e.g. P3 design-build). So the missing 20% really reflects – what? It could be a lot of things — local budget politics, state constitutional debt limits, rating agency pressure, anti-tax activism, etc. But not anything to do with the infrastructure itself. In effect, the 20% solution is not an infrastructure proposal as much as it is simply state and local fiscal support that’s related to their infrastructure spending. And that, I believe, is what’s really needed.

Overall, this is in fact a new direction that has the potential to “upend the way US public works are financed” – or at least Washington’s role in it.

Not There Yet

Still, we’re not there yet. Although the overall direction is transformative, I don’t think the 20% solution itself will accomplish the upending. My pessimism is based on some practical aspects of the idea:

•   A minor shortfall in the funding plan might not be the binding constraint in many situations. A cash grant of 20% of project capital cost translates to a reduction of about 1.60% in terms of the 30-year financing rate – so from 2.75% (AAA tax-exempt 30 year) to about 1.15%. That’s significant, no doubt, but will it unlock infrastructure spending? In one sense, this approach has been tried before on a macroeconomic basis – the Federal Reserve’s QE since 2008 and the subsequent (and significant) fall in long-term rates. The rate on the 30-year Treasury has fallen by 1.6% since May 2011. This prompted some volume in muni-bond advance refundings – but not much new issuance for infrastructure investment, which remains at historic lows. Why would a 1.6% reduction now be different?

•   Additionality will be an intrinsic problem. If a state or local government can do the heavy-lifting for stakeholder consensus and get 80-90% of the funding for a project in place, they often will be able, by hook or crook, to land the balance from their own resources. But if there’s a program in place that might award it from federal taxpayers instead – well, everybody likes free money, no? In effect, it will be difficult to ensure that the 20% grant is actually working as a catalyst as opposed to a windfall. And possible rule-oriented protections will likely lead back to the table pounding, self-serving economic studies and lobbyists that the Administration is seeking to avoid. It’s made even worse by the least-ask, first-served plan for prioritization coupled with an effort to streamline the process. I’d expect a flood of ‘last 5%’ requests in the lottery-ticket spirit of ‘hey, you never know’. That result will be glaring enough as to erode the credibility of Administration claims that the program was catalytic – even the mainstream can figure that one out.

•   More generally, the 20% solution is just a more tactical version of the standard Beltway inter-regional transfer approach, despite very different intentions. A cash grant is a comparative federal strength only in the sense that taxes or debt can be spread across a bigger base than any region has. For some insurance-type purposes that’s enough (e.g. FEMA), but for state and local constraints on infrastructure investment, I think the federal government may have other unique strengths that can be brought to bear, especially with respect to flexible long-term financing capacity. The direction is transformative, but the 20% proposal is not.  Why not keep searching?

What’s Next?

There’s enough in the story so far to make a few tentative predictions, based on a combination of apparent principles, search trajectory and (perhaps most importantly) state and local facts on the ground:

First, it’s hard to see how the Administration has any choice but to stick with the principle that the role of a federal infrastructure program is to provide a catalyst, not a massive transfer. This view doesn’t require the assumption of doctrinaire adherence. Instead, it’s simply the result of promising a trillion dollars of spending based on $200bn of appropriations. Any other path will break one leg of the promise, and it’s obvious that little forgiveness from any side will be forthcoming at this point. Finding a workable catalyst is the only way out.

Second, I’d expect another one or two iterations of trial-balloon concepts (as in the WSJ article) before specific plans are presented. This might be motivated by a sense that continuing their search could lead to something better than the 20% solution, but practically it’s simply because they have more time (the rest of this year is jam-packed with other issues) and they’re on a steep learning curve where further feedback can alter views. I’m sure the Administration always hears a lot from state and local officials. But since the latest plan specifically involves their fiscal situation, feedback in the next four or five months may be qualitatively different – more narrowly focused on what they actually need in terms of a catalyst. That kind of data will lead to a further evolution of the catalyst before the plan gets finalized, probably in early 2018.

Third – and going further out on a limb – my guess is that the next-generation catalyst plan will involve, not cash grants, but some sort of financing support to mitigate state and local short-term fiscal constraints. Prompted to look by a little feedback, these constraints are actually hard to miss. There’s been a veritable tsunami of local and national media articles and think tank papers about state and local public-sector travails since 2008 – revenue volatility, budget crises, ratings downgrades, emerging pension liabilities, etc. None of these problems seem to be getting better, and as state and local governments struggle to manage today’s mess, it’s not surprising that they’re reluctant to pull the trigger on infrastructure commitments, regardless of long-term resources. P3 tax credits, asset recycling incentives or a 20% grant won’t do much except chip around the edges in this context.

But infrastructure financing that is specifically designed to avoid getting caught in the web of constraints in the first place might in fact have a transformative effect. Which leads to up-sized federal loan programs.  As a patient, flexible and (if necessary) somewhat forgiving lender, the federal government really does have some unique strengths to offer that financing – all (like a true catalyst) without doing any damage to federal taxpayers. So I think this what the Administration is looking for. It’ll be interesting to see if they find it.

I’ve frequently mentioned in this blog and presentations that federal loan programs can — and should — play a central role in helping state and local governments overcome short-term fiscal constraints on long-term infrastructure financing.  Easy to say as theory — but what’s a practical form?

Here’s an approach that I think plays to the strengths (and subtly avoids the weaknesses) of the institutions and agencies involved (PDF download here):