Experts warn about leasing water authority

A University of Chicago privatization expert on Friday cautioned area people to beware of the City of Altoona’s proposed long-term lease of its sewer and water systems.

“I get incredibly nervous when I hear people take these deals as ‘This is a way of getting out of debt,'” said law Professor Julie Roin in a phone interview with the Mirror.

Deals like the one proposed by City Council two weeks ago to help Altoona get out of the Act 47 distress program are really disguised loans that usually cost more than regular loans, limit government flexibility to the disadvantage of the public, lack transparency and skew in favor of current politicians and their constituents and against future generations, according to Roin.

Altoona’s proposal is neither “radical” nor “untested,” but consistent with trends since the Great Recession, as exemplified in cities like Allentown, Harrisburg, Philadelphia, Bayonne, N.J., Detroit and “thousands of jurisdictions” in the U.S. and even in other nations, especially France, countered Leonard Gilroy, director of government reform at the Reason Foundation, also in a phone interview Friday.

The true test will be in the bidding for the proposed 50-year lease of the water and sewer systems – but “it makes sense to go explore,” Gilroy said.

Like Roin, retired Penn State Law Professor Ellen Dannin is uncomfortable with the city proposal to lease the water and sewer systems.

“Anything that important, I would want close control,” Dannin said.

When water systems are under public control, their operations are subject to the Sunshine Act and Right to Know law, Dannin said.

“Everything basically goes into a black box when you privatize,” she said.

City officials and officials of Griffin Financial Group, their consultant, have promised a “transparent” process for the leasing.

They’ve also proposed a lease agreement that protects ratepayers with a five-year cap followed by inflation plus 0.5 percent per year maximum increases, plus protections for water quality and the systems themselves, with enforcement provisions that include repossession of the assets as the ultimate penalty for non-compliance.

Those are in the typical agreements, according to Gilroy, who also recommended including provisions for “top quality” customer service. Privatization is the latest of many methods that governments have used to get around restrictions on incurring debt that have been imposed because governments abused their power to borrow, according to Roin.

From a cash-flow perspective, they’re “identical to a conventional debt transaction: cash is received up front and then repaid through higher charges levied on future residents,” she wrote in a 2011 article in the Minnesota law review she provided to the Mirror.

“The only change is in the terminology; in a debt arrangement, the funds are initially provided by the purchasers of bonds, who are then repaid with funds raised through taxes paid to the government; in the concession arrangement, the initial funds come from the concessionaires in the form of fees and are repaid when their customers pay higher prices for the goods and services those concessionaires provide,” she wrote.

Ordinary government borrowing is straightforward, with clear terms and little opportunity for mischief, Roin wrote.

“[But] privatization deals are more complex, and the privatization markets less thick [fewer buyers and sellers] and less transparent than the regular municipal bond market,” she wrote.

While a bond has only a “downside” risk, privatization has both downside and “upside” potential, with many variables that can boost or diminish revenues, many of which are unpredictable, she wrote.

Thus, it’s “harder to discern the fair market value of what parties are giving up or the adequacy of what parties are receiving in return under any particular contract,” Roin wrote.

And because deals are large, there are fewer potential buyers, leaving “opportunities for collusion or simple underpricing at the expense of the selling entity,” she wrote.

Moreover, privatization deals tend to “lock the affected jurisdiction into questionable long-term policies,” much like non-compete clauses in private business arrangements, Roin wrote.

“For example, tollway and bridge deals often limit the selling jurisdiction’s ability to build competing tollways, roads, or bridges for the term of the lease,” she wrote.

That could be closing a street for a month for repairs or for a festival, Roin said.

In Altoona’s case, a potential buyer might want protection from revenue loss if a municipality whose residents don’t like the Altoona-system rates obtains another water source, Roin suggested.

Because investors bidding on privatization deals are not “idiots,” agreements that underlie the deals invariably include provisions to protect profits, often to the detriment of the public interest, even as they take into account the taxes investors would need to pay before they can collect those profits, Roin said.

“No investor is going to give money away,” Roin said.

Privatization isn’t the equivalent of borrowing, according to city controller A.C. Stickel.

Lenders need only receive payments, while a water system lessee must run the system to the standards in an operating agreement, Stickel said.

If the city takes out a loan, it pays back the money with interest, but if it leases the water system, the responsibility for collecting rates in keeping with the agreement is all on the lessee – although the city would monitor that, Stickel said.

Straightforward borrowing, as recommended by Roin, isn’t feasible, according to Stickel.

“We’re so handcuffed by state government,” he said.

Privatizing the water system isn’t likely to impinge on the city’s freedoms to act in the public interest, as Roin suggests, according to Stickel.

“I don’t see any reason the city is going to shut down the water system for a block party,” he said.

And the rate restrictions in the agreement should ensure the ultimate payback won’t be unfavorable for area residents, Stickel argued.

Provisions designed to protect the potential profits of lessees – “adverse action” provisions – apply more often in other kinds of deals than the water system lease the city contemplates, according to Gilroy.

They tend to be common-sensical, he indicated.

They generally don’t apply to actions beyond the lessor’s control, he said.

It would be hard for the lessee to hold Altoona accountable if a neighboring municipality whose residents are customers of the city water systems finds another water source, Gilroy said.

Nor would the city be liable if the federal government adds an environmental regulation that requires a major capital investment to comply with, he said.

Still, the city and the lessee can build provisions to cover all those contingencies into the agreement, if one or both think there’s a big enough risk, he said. City officials are aware that the long list of restrictions will limit their upfront money. With the document that Altoona plans to offer, the lessee assumes all the risk, said Mike Vind of Financial Solutions, a sister company to Griffin.

If the best offer isn’t good enough, they can just back off, they have said repeatedly.

The bidding for the system will be a “vibrant, dynamic, competitive process,” according to a Griffin presentation.

“Better than an auction,” said Griffin CEO Joe Harenza.

Griffin will seek qualified bidders and play them off against one another to boost the price in what could be several bidding rounds, according to Mike Vind, of Griffin sister firm Financial Solutions and a member of Altoona’s Act 47 coordination team.

The final proposed contract should at least be available for public inspection for a reasonable amount of time before the city does the final deal, Dannin said.