Private Investors Have Higher Costs of Capital

Private companies have higher long-term borrowing costs than public entities. Ac-cording to analysis by Dennis Enright at the investment bank, NW Financial Group, in 2007 public sector costs for raising capital through debt were a full 35 percent less than the lowest cost a private entity could hope to obtain.72 Other academic studies confirm these higher private capital costs.73

Today, due to the tighter private credit market, the disparity in financing costs is wider than it was. A recent report by PricewaterhouseCoopers found that in countries with good credit ratings, the spread between the cost of public and private capital - once in the range of 0.6 to 0.8 percentage points - had increased to 1 to 1.5 percentage points by late 2008. "Funding for large brownfield monetizations (like the Pennsylvania Turnpike at $12 billion+) are finding credit margins are well above 200 basis points [2 percent-age points]," the report states.74 Deloitte, a major consultant on privatization projects, advises that, "with the maturing of the private finance market in the United Kingdom, the financing costs difference between the private cost of capital and public borrowing is now in the range of only 1-3 percentage points."75 The public-private spread is nothing new. For example, back in 1997, Karen Hedlund of the law firm Nossaman, Gunther, Knox & Elliott similarly reported in Toll Roads News that the public sector enjoyed a 200 basis point advantage over investors when borrowing long-term in the capital markets.76

Due to these higher costs, Robert Poole, director of transportation studies at the Reason Foundation and a strong proponent of road privatization, predicts that states will receive lower bids for their roadways as investors attempt to cover their costs.77

The financial crisis has already doomed at least one privatization project. In 2008, Missouri officials announced an ambitious plan to repair or replace 802 bridges by 2014. The initial proposal envisioned using private financing to pay for construction, with the state reimbursing the investors over a fixed period of time. However, when the credit market began to worsen in September 2008, private financing became infeasible. The Missouri DOT quickly scrapped the private-financing scheme and now intends to fund the entire project through the sale of government bonds. In explaining the decision to forego private funds, Bob Brendel, the transportation department outreach coordinator, noted that it had become clear that the public sector could borrow money more easily than private citizens.78

Because government officials can issue tax-free bonds and bond traders are willing to accept lower interest rates on public bonds, deals based on private capital are inherently more expensive than public financing. In light of the turmoil in the credit market, it will probably become even more difficult for the state to get a bargain through private financing. Moreover, approximately 20 percent of the financing for a private deal is typically done through issuance of stocks or other private equity. As even aggressive privatization advocates concede, equity is typically more expensive than debt.79 When investors purchase private infrastructure stocks, they take on greater risk than if they purchase private infrastructure bonds; therefore, they expect higher rates of return. Thus, regard-less of whether private companies raise capital through debt or equity, their costs will be higher than public financing.

The higher private cost of capital means that privatization deals will create significantly higher costs that get passed onto taxpayers and drivers. Even when multiple private companies bid for a public toll road, their higher long-term borrowing costs will be passed on to the public in the form of lower upfront payments than the government could generate by borrowing against the same future toll hikes without using a private road operator as an intermediary. In other words, privatization requires greater toll hikes to generate the same up-front payment that could be generated without privatization. According to the NW Financial Group study, published before the recent financial crisis, "doing such a deal with non-public ownership will result in tolls 20 to 30 percent higher than a public deal of equal size."80

Privatization requires greater toll hikes to generate the same

up-front payment that could be generated without privatization.

The previously mentioned study of public and private options for the Pennsylvania Turnpike similarly found that, "[f]or a given upfront sum to be raised, tolls levied in a Full Public Monetization may require only 71.5% of the tolls charged under a Corporate Lease."81

There is no debate about whether public borrowing costs are lower than the private sector's. Defenders of road privatization may argue that private-sector efficiencies will offset the private sector's higher borrowing costs, but there is little evidence that those efficiencies, where they exist, can make up for the higher cost of capital.