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The Case For Selling Off the City

You’ve read plenty in these pages about the hazards of turning over roads, airports, and parking meters to private companies. But when privatization is done right, argues advocate John Schmidt, it can be an ideal partnership.



In the last few years Chicago has become the epicenter of a national debate about the merits of turning over public assets to private corporations. It started in 2005, when city officials made a deal to lease the Skyway for 99 years to a pair of overseas firms for about $1.8 billion plus a guarantee they'd maintain it. It was the first privatization of a major highway in the United States, and it paved the way for others—including the Indiana Toll Road, leased for 75 years in 2006 for $3.8 billion. Supporters of these deals argued that they brought cash and infrastructure investment to strapped governments; skeptics worried that the public would pay higher tolls while losing future revenue and control of the assets.

After the Skyway deal, Chicago continued to blaze this trail, closing a deal to lease downtown parking garages and negotiating one to lease Midway airport (it was aborted when financing fell through). These agreements inspired other governments to look into their own privatization possibilities, but none generated the interest—or the fury—that followed the 75-year, $1.2 billion deal Chicago made in late 2008 to lease its parking meters. This deal has enraged drivers: rates have soared, free parking hours and days have been reduced or eliminated, and the meters and new pay boxes have broken down repeatedly.

It's also caused a political headache for Mayor Daley and the City Council, who've had to defend it in the face of evidence presented by the Reader and others that the public got hosed. As revealed in our previous stories, the idea was hatched behind closed doors by private firms that reaped millions by executing it, the city may have collected less than half the meters' value, and most aldermen signed off on the deal before they'd even reviewed the terms of it. Most recently the mayor and aldermen decided to spend most of the meter proceeds—including a pot of cash previously designated as a "rainy day fund"—to close the 2010 budget gap, robbing future generations of promised interest on that money.

As details of the meter deal spread nationwide, mayors in Los Angeles, Pittsburgh, and Indianapolis started wondering what kind of money they could squeeze out of their own parking systems. Privatization critics had harsh words for it. "It may not fit the myth, but that's the real Chicago way," Thomas Frank, author of What's the Matter With Kansas? and founder of the recently revived Chicago cultural-criticism journal the Baffler, wrote in the Wall Street Journal. "Sell off public property without public scrutiny. Prohibit public input on an essential public service. Rationalize the whole thing, as Mr. Daley's administration has done, by insisting that government can't run such things as well as the private sector can."

Yet Daley continues to argue that all of the lease agreements have been good for the city. He's even said that he's open to privatizing other assets, including Chicago's water system and waste-sorting centers. And last week Republican gubernatorial hopeful Jim Ryan jumped on the bandwagon, floating the idea that privatizing the state tollway system could finance much-needed infrastructure improvements.

Attorney John Schmidt thinks these pols have it right. Schmidt, a partner with Mayer Brown, has served as Daley's chief of staff, associate attorney general in the Clinton administration, and chairman of Project Vote, the nonprofit voter-advocacy group. But in recent years he's spent much of his time doing the legal work behind privatization deals in Chicago and beyond. His efforts on the Skyway, parking garages, and Midway netted his firm more than $4.5 million total, and as other cities and states have sought to follow Chicago's lead, his services have been in great demand. He brokered the privatization of the Indiana Toll Road, advised Pennsylvania on a proposal to do the same with its turnpike, and conferred with New Orleans officials preparing to lease out Louis Armstrong International Airport.

But Schmidt wants be sure everybody knows what deal he didn't work on: Chicago's parking meter lease. "I feel like I should be walking around with a sign that says, 'I didn't do that one,'" he says with a laugh.

Still, he agrees with the mayor that it was a great deal for taxpayers—and maintains that even though there were serious problems with the way meter privatization was carried out, the city should look into other leases for cash, operating efficiencies, and investment. In his view, the private sector is better equipped to manage and maintain public infrastructure than government, and if safeguards are in place—a big if—the public will benefit. He recently sat down with me, an admitted skeptic, to try and make his case.

In the last year the economy has changed, and it looks like the money isn't as readily available to enter into lease agreements like the Skyway and parking meters. But will we see more of them coming down the road?

Yeah, I think we will, because there are situations where you have private operators who can do a better job of managing certain types of operations, and where it's in the financial interest of public entities to turn the operations over, realize the value, and use it to meet some other needs. So on the one hand the current economic condition has clearly made it harder to do some deals—I mean, Midway is an example of that. On the other hand, it has re-emphasized the fact that public entities are often without resources to do things they really need to do. So the desirability of doing good deals, if they can be done right, is not reduced.

What are your guidelines for when a government should consider these sorts of deals?

First of all, you have to have qualified private operators around, and I think they ought to be able to do it better than a public entity before you really think seriously about privatization. I think that was true in the case of the Skyway, I think it'll be true when we get Midway done, and I actually think it's true with street parking, although no one can deny that the initial transition was totally fouled up.

And I think it has to be a transaction that makes sense for the public entity. I've never had a particular ideological point of view on it, that per se privatization is a good thing or a bad thing. Years ago, when I was at the Justice Department, the Gore people had their "reinventing government" program, and they were always suggesting that we privatize federal prisons because it was a way that we could instantly reduce the number of federal employees. That never seemed to me a very good idea, in part because of the kind of power the prison guards exercise—you know, they shoot people. I don't think you want to put that kind of power into the hands of private operators.

But there's no question that airports could be better run by experienced private operators than they're run by any public entity in the world. You know, you go to Vancouver, [whose airport authority] was going to be the operator at Midway, and you feel you're at a high-quality regional shopping mall compared with a typical airport. They have three spas, they have a four-star restaurant—the whole feel is different.

I once said to someone, what would Old Orchard be like if it were run by the village of Skokie? The answer is that I think it would be all right, but I don't think it would be the quality that it is. There are areas like that where you have people who have learned how to do it and do it well, and not to take advantage of that, if you can do it on financially attractive terms, seems to me to be a mistake.

But some of the controversy over privatization agreements is over exactly this question—can this asset be better managed or run by the private sector? And for what price? Even when you leased the Skyway in 2005, there wasn't a lot of precedent in this country for a private company running a major toll road.

Yes, but almost all of the major European toll roads are privately operated, and if you drive on one of them you think you're driving on a new road because the quality of the maintenance is so much higher than what's typical on U.S. roads.

Same thing with airports. Midway was the first major U.S. airport privatized but a large share of European airports are privatized, the Sydney airport is privatized, and Rio just announced that its airport will be privatized in advance of the 2016 Olympics. So in that sense, while the transactions are novel in this country and tend to involve more political controversy, from a financial standpoint they're not novel, and you can get some comfort from looking around the world and seeing what's been done successfully.

I do think it's a question of: are these core functions that the government is capable of doing, and where the particular qualities of government are important? Law enforcement generally seems to me to fall into that category. Running revenue-generating operations seem to generally fall into the other category—in part, I think, because the nature of political bodies means they're just not good at running revenue-generating operations. They have a visceral resistance to ever raising prices.

When we did the underground garage privatization here, one of the striking things to me was realizing that those garages really were underpriced in comparison to private garages. And for no good reason—I mean, nobody thinks it's a good thing to subsidize people who want to drive downtown instead of taking public transportation. It was because to raise parking rates in the underground garages you have to go, in that case, to a combination of the City Council and the Chicago Park District. Both have a political, visceral resistance.

Yet I heard critics of the parking meter deal say, this is Chicagoyou mean to tell me the mayor and the City Council don't have the moxie to raise parking rates on their own?

Well, they didn't, and I don't think they're unique. I don't think there's any city that has consistently been able to price its street parking at a market level, which is a point that environmentalists have made for years, advocating not only higher parking rates but higher parking taxes. I think it's the phenomenon where the incremental benefit of raising parking meter rates in any single year is going to be relatively slight but the political reaction to it is going to be significant. It's not necessarily that everyone's going to complain, but enough will that a politician is going to resist it.

You know, on the Skyway 75 percent of the drivers did not live in the city of Chicago. I would be surprised if more than 5 percent of the people of Chicago drive the Skyway typically, and most of them are people who drive back and forth on weekends because they've got houses [in Indiana or Michigan]. The city nevertheless had not raised tolls on the Skyway for 13 years. It's that 5 percent that ends up driving the political process, and I think that is true around the country with parking rates.

You weren't involved in the meter deal, but it sounds like you don't think it was a bad idea.

No, I don't think it was inherently a bad idea. I think it was obviously fouled up in the transition—I mean, the mayor has said that, and "fouled up" is probably a polite way to put it. I think financially it's clearly a very good deal for the city.


Yes. The system had been generating $20 million a year. To get $1.157 billion for it—I mean, if the city had wanted to it could put that into a bank account and get a nice rate of return on it.

But isn't that the rub? I read an interview you did with the Wall Street Journal where you said that's one of the dangers of these agreementsif you don't put the money away and plan to use it appropriately you can sell off your future revenues for short-term gain. I know times are tough, but that's exactly what the mayor's planning to do here.

Well, he's said that he's borrowing it. If you think this is just an ordinary operating deficit then you shouldn't be using it as a one-shot revenue source. But do we really think this is an ordinary deficit? Clearly the falloff in city revenue has been stunning, way beyond anything we've ever experienced before, and you have to believe, and the mayor does believe, that those revenues will come back. So using some of it isn't necessarily wrong. But you should replace those revenues.

You mentioned Midway. Is the city looking to lease it again?

Certainly we want to. Of course, Midway is different in some respects. The city doesn't get anything financially out of Midway—zero. [Under federal law] no public entity is allowed to take any revenues out of an airport, with the single exception of a privatization transaction approved by 65 percent of the airlines [operating out of the airport]. And even then the law currently only allows five airports [nationwide] to be privatized, and only one of them can be a hub airport the size of Midway. So the city has a very unique opportunity to gain revenues.

Another difference is that under state law the city is obligated to use at least 90 percent of Midway [privatization] proceeds for infrastructure in the city or a contribution to pension funds. So the issue of possibly using the proceeds for something that people don't think is appropriate is barred by a matter of law.

It's also different from an operating standpoint. I think one of the problems with street parking is that everyone thought it was easy and so no one thought too much about it. In the case of the airport there's been just enormous attention to how it's going to be operated. Part of our agreement with the airlines was that we wouldn't even allow into the process anyone they hadn't approved as a qualified operator. And we have a whole new operating agreement to govern the airport that the airlines have participated actively in. We also hired independent engineering consultants to work on developing operating standards to govern operations at the airport. On top of all that you've also got the FAA, which goes through its own independent process and conducts a public hearing, and you have incredibly elaborate plans for the transition.

Exactly when it could happen —well, it would be better for the city if it happened sooner rather than later.

Even in this market? One of the questions raised about the meter deal was, even if there are takers and their offers fall within the city's expectations, is this really the best time to go into a transaction? Shouldn't you hold onto this asset until the economy improves and see the value go up?

Well that's obviously a judgment you have to make. I think that the strength, though, of Midway is that it's the only airport [of its size] in the U.S. that's been [given approval to be] privatized and [under current federal law] it's the only one that can be privatized. So it's really unique.

The other element is that Midway is doing really well. So when you look at what you're likely to get in relation to other airports, having an airport that is doing extremely well at a time when most other airports aren't is not a bad thing.

A public finance newsletter has reported that city officials started looking into privatizing parts or all of our water system earlier this year, and when asked about it Mayor Daley wouldn't rule out leasing any of the city's assets. Isn't providing water and sewer service part of the city's core function? And are there really precedents elsewhere?

I've heard discussion about it, but as far as I know there's no current, active work being done on that possibility.

But one argument for privatizing water systems here in Chicago and elsewhere is that major city water systems, almost without exception, require enormous ongoing capital investment. They're old and they have to be very substantially rebuilt.

One of the advantages of private operations in general is that private operators can carry out major capital expenditures at anywhere from 25 percent to 50 percent less than public operators. That's been generally the experience, for example, with toll roads. Part of it, I think, is because of their experience. They're [also] able to hire people of quality that are very difficult to get for public entities that don't pay comparable sorts of salaries. It's also partly because they can create a structure where they can effectively motivate people, with bonuses and such, and they can fire people more easily also. Part of it is being free of the public procurement process, which is a real constraining factor in construction, if you always have to go through prescribed bidding processes which we put into place because we don't trust public officials. That isn't the way a major construction company does business—it controls its people through other means. As a result, they have much greater flexibility and can often move much faster.

One of the arguments when we started talking to the airlines about privatization of airports that they all immediately agreed with was that a private operator would be able to do major construction much more efficiently. They're aware of this because they fight with public entities around the country to get control of major construction projects.

So you apply that to water, and you look forward, and you say, well, there's a massive capital expenditure required, it may be that a privatized structure would result in the ability to do that at a greatly reduced cost. The result of that may not be in upfront proceeds to the city; the result may be simply to avoid very substantial increases in water rates.

I know Indianapolis is looking at privatization of its water system at the moment. They have particular capital expenditure requirements because they're under a decree with the EPA for environmental purposes and I think they see it as a potential way to carry out those capital expenditures. And there are a lot of private water companies. There are even cities in Illinois that have their water provided by private companies.

The other element with water is to say that it's sensitive is putting it mildly. You clearly would not do it unless you were very confident you were going to maintain or enhance the quality of the water. Our water's awful good here in Chicago, so I don't know that you'd do it to improve the quality, but you certainly wouldn't want to do it if you threatened it in any way. You could also privatize the sewer system without privatizing the water system. I think the reality is that there'd probably be less sensitivity about what's going out than what's coming in.

One of the things that's come up with the meter lease, and I'm guessing it will be an issue with any future lease, is the length of time75 years. I know there's a trade-off, because obviously the amount of money you get up front is far greater when you extend the lease. But then you also risk losing control of that asset over time.

Some of that discussion, in my mind, is off base. If you don't have operating standards and controls that give you confidence in the quality, then you shouldn't do it for even 10 years or 20 years. If in fact you do have in place those kinds of quality controls and standards, then it seems to me you're left with a judgment of what is the best term for maximizing the financial benefit for the city.

And one of the strengths of investments of this kind for private investors is long-term predictability and stability. The private investors are overwhelmingly pension funds from around the world that are looking for places to put a lot of money for a lot of time. A lot of the value there is in that long-term element. From that perspective the financial aspects argue in favor of the longer term.

One of the criticisms of the meter deal was that we gave away too much control—that it's going to cost a lot to move or change the hours of even a few meters, and it would be way too expensive to get out of the deal if the city ever needed to. So what is the standard?

The deals we've done have been structured so that the city retains the ability to make changes. You may have to compensate the private operator if you're reducing the tolls, for instance, but if you maintained operation of the toll road yourself and you made changes that reduced the tolls, you'd be paying that cost. You can't have it both ways. You can't say, in the case of Indiana, we're going to get $3.8 billion for use of the toll road and then decide next year that you're going to eliminate six interchanges and reduce the tolls without compensating the private operator. But having the ability to do literally anything—if you're willing to compensate the operator—has been retained under all of these agreements.

But the compensation seems to be greater than if the city retained control itself. The meter situation appears to be that we'd have to pay far more in compensation than the meters were bringing in.

I've seen reference to that but I've never read the agreement. With the Skyway it is literally whatever the actual cost is to the private operator, and if you can't agree with that then you go to an arbitration process to fight it out.

Are you concerned that the way these deals have been done has undermined the overall point of them? The ideas for each of them were presented to the city by private companies who then worked on the deals and ended up profiting from them. Even if there was nothing untoward about the way things went down, it still has the look of it.

I don't think that's true. The person I think who really deserves the credit for the Skyway deal is Walter Knorr, the city's comptroller [at the time]. He was aware particularly of the transaction that had been done in Ontario [in 1999], where the province had leased Highway 407 for $3 billion Canadian. If there was any real precedent for the Skyway, it was that.

With the case of Midway it was very much a process where, after the Skyway transaction, those of us who were the city's advisers and the people at the city, the financial people, started looking around and wondering, are there other possibilities that are good for the city? And there are always investment bankers around who are advocating all kinds of things, but I don't think it's true that these transactions have been driven, really, by the advisers.

William Blair & Associates says it came up with the idea of leasing the garages and meters—and then the city hired the firm, without a bidding process, as its financial adviser on those deals, paying it about $6.5 million.

And I've heard from you and from others that even though Mr. Knorr was the person who said we should privatize the Skyway, Goldman Sachs, which had done a bunch of bond deals for the Skyway, also had that idea—and they ended up getting paid $8.4 million to work on it. Maybe they were the best people for the job, but the city didn't have a bidding process.

There are cities that go through RFQ processes before hiring investment bankers—Pittsburgh is doing it right now. On the other hand, by nature, hiring an investment banker isn't a competitive bidding situation—in fact, you wouldn't want an investment banker who charged you the least. It would be like hiring a doctor on that basis.

Still, on Midway the city did conduct an informal process with multiple possibilities and is now advised by Credit Suisse, which I don't think had anything to do with suggesting that was a good idea for the city. William Blair may take credit for it but the idea for privatizing both the downtown garages and the parking meters was around the city in the aftermath of the Skyway. They were very much on the list.

Why didn't you work on the parking meter agreement? Were you not invited?

I didn't refuse. But I think the explanation in part is that we were very engaged in Midway, and the timing of it was such that, you know, Midway was going on all of last year, and then the street parking deal came along and didn't require anything like the lead time—we'd been working on Midway for three years. So I think the city decided to use another law firm.

I want to switch gears just a little bit. You've been chief of staff to the mayor. He's taken some hits over the last year, and his approval ratings are the lowest ever recorded. What does he need to do?

I thought that poll was almost certainly exaggerated, but I really felt it was attributable to the street-parking situation. They were so angry about it that their response was really directed at that. In terms of an overall sense of whether he's been a good mayor for the city, and do people think anybody could do a better job, I think his basic strength is still there.

Do you expect him to run again?

Yes. I've never heard him say anything to suggest he wasn't going to.

Now, he's never said it to me, but I said it to him that not getting the Olympics, while a disappointment, was also a relief. And I think the relief is not so much that we don't have to do the Olympics, which I think we could have done a fabulous job of, but that we don't have to devote so much of our civic energy to that single objective, and instead we can focus on all kinds of other things. I sort of sense that reaction in the city, and I don't know if he would want to say that himself, but he didn't disagree with me when I said it.

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