A bank for infrastructure

If the state doesn’t have any money for transportation improvements, maybe Wall Street can help

Illustration by Peter and Maria Hoey.

the pivot was abrupt, but it hardly sounded unfamiliar. For two straight hours, Joe Curtatone, the mayor of Somerville, had led an auditorium packed with angry residents in a rousing denunciation of the state’s Highway Department. This was a somewhat unusual scene, in that Somerville residents are normally found denouncing a different branch of the state Department of Transportation, the one that’s supposed to be extending Green Line rail service to the city. Tonight, it was state highway administrator Frank DePaola’s turn to stand in the crosshairs. The crowd scorched DePaola for wanting to spend $11 million to fix a rusting highway overpass that the state actually wants to tear down. The crowd wanted the overpass gone immediately, but DePaola couldn’t appease them. He had $11 million to keep the Somerville overpass from collapsing, but he didn’t have the hundreds of millions he would need to tear the roadway down; until DePaola had that kind of budget, all he could offer Somerville was a highway overpass that wouldn’t collapse. So after the crowd was finished punishing DePaola, Curtatone stepped in and shifted the heat off DePaola, and onto the Legislature. It wasn’t MassDOT’s fault that the agency had no money, the mayor argued; if state transportation officials wanted to demolish the overpass, build the Green Line, lay out a series of new bicycle paths, or tick any other items off their wish list, they needed to convince the Legislature to put some money into transportation.

This complaint—that the state’s transportation system is broke because the Legislature won’t fund it—is a frequent one. It’s been nearly four years since Gov. Deval Patrick proposed, and then quickly abandoned, a 19-cent increase in the state gas tax. With no new revenues to feed the system, deferred repair bills have mounted, debt costs have swelled, and legally mandated expansion projects have idled. The Somerville crowd that hectored DePaola has plenty of company: Without a massive infusion of new revenues, there will be scores of communities lobbying MassDOT for projects the agency can’t pay for. That’s why, when MassDOT Secretary Richard Davey wrapped up a contentious round of MBTA fare hike hearings in March, he issued a public appeal to the lawmakers who control the state budget: “The system we have today we cannot afford, and the system we want is well beyond reach. Unfortunately, without a new dedicated revenue source, we know we will be back in this very place next year.’’

The state’s overwhelming transportation deficit isn’t new. But it’s notable that, after years of talking about the need for new revenues, one of MassDOT’s first moves since the gas tax fiasco wasn’t to Beacon Hill, but to Wall Street.

Last March, Patrick placed a marker in a transportation bond bill that would have allowed him to establish a state infrastructure bank. The state-controlled bank would pour private funds into public infrastructure projects in two ways. The bank would receive deposits from the state and private investors, and it would make loans to commercial builders working on infrastructure projects across the state; the bank’s investors would make money by collecting interest on the bank’s loans. The infrastructure bank proposal was little noticed, since the Legislature quickly removed it from Patrick’s bond package. Nevertheless, Davey traveled to New York this summer to sell the proposed bank to deep-pocketed investors. The administration is now laying plans to roll out its infrastructure bank proposal on Beacon Hill early in next year’s new legislative session.

Davey’s MassDOT team believes the infrastructure bank, if enacted, would break new ground in American transportation finance. They don’t paint the bank as a cure-all for the state’s infrastructure woes, but they argue that it would be an important tool to have in their toolbox. In a period of limited state and federal resources, they argue, Massachusetts can’t afford to tackle its mounting transportation obligations without tapping into Wall Street. They believe a relatively modest upfront public investment could spur billions of dollars in construction spending. The bank’s critics, however, argue bank money is, by definition, not free. Loans have to be repaid, and the money to repay the loans has to come from somewhere. What’s more, the bank’s critics worry that MassDOT has its priorities upside down. The infrastructure bank is a forward-looking tool. It would fund new projects, but it wouldn’t do anything to relieve MassDOT’s current cash crunch. The critics see new transportation revenues as job one, and worry that rolling a complicated policy matter like the infrastructure bank into the revenue debate risks a legislative morass.

A different kind of bank

Infrastructure banks have had some sizzle around them over the last few years, with Sen. John Kerry leading a prolonged, and unsuccessful, effort to establish a bank at the federal level. At the state level, though, the banks are holdovers from the Clinton era. Congress and the federal Department of Transportation established the first handful of state infrastructure banks in 1995, and later opened the program to dozens more. Thirty-three states currently operate infrastructure banks. The state banks take federal appropriations as deposits, match them with state funds on an 80/20 basis, and then make loans with the combined federal-state funds. The loans only cover a portion of the project costs, so the federal funds in the banks are leveraged at least twice—once with the state match, and again when the bank loans supplement private financing. Some states issue bonds backed by the deposits in their infrastructure banks, and then use the bond proceeds to make transportation loans, a practice that cranks up the leverage on the original federal funds even more. Davey’s team believes an infrastructure bank would break new ground in American transportation finance.Even though the adoption of state infrastructure banks has been widespread, their impact has been limited. “Most of the state infrastructure banks are relatively small and essentially pass-throughs for federal funds for transportation projects,” argues Dana Levenson, MassDOT’s chief financial officer. “It’s not really a bank that leverages its capital on one side and lends money on the other. There’s nothing ‘bank’ about it.”

South Carolina’s infrastructure bank is an exception. The state issued revenue bonds backed by its infrastructure bank funds, and used the bonds to pour $3 billion into an accelerated road- and bridge-building program. But South Carolina’s bank is an outlier; the other 32 state banks barely combine to match the outlays the South Carolina bank has made. Most of the banks have focused on small-bore activity. Ohio’s bank routinely funds local road projects, issuing loans that fall short of $1 million. Pennsylvania’s bank issued 24 loans, totaling less than $28 million, last year. Florida’s bank, one of the oldest and most active among the states, has issued less than $1.2 billion in loans since 1997; that’s not an insignificant amount, but it’s also only a small portion of the state’s overall transportation spending. States have used infrastructure banks as adjuncts to, not engines of, activity.

The state infrastructure bank loans have also largely been repaid by state and local taxes and fees—the kinds of revenues that would normally backstop conventionally financed infrastructure investments. South Carolina pays back its infrastructure bank bonds with pledges on car and truck registration fees, gas tax receipts, and a tax on electricity. Pennsylvania’s loans are normally secured by municipal taxes.

Levenson says MassDOT’s proposed state infrastructure bank would take a different tack than the existing state banks’ pass-through structure. “We already have a good system for leveraging federal funds,” he argues. “There’s no reason to reinvent the wheel.” Instead, he describes the Massachusetts bank as a transportation version of MassDevelopment, the quasi-public economic development agency that floats bonds for businesses and nonprofits.

MassDOT is exploring a state infrastructure bank that would operate without any federal funds. Instead of functioning as a pass-through account for federal transportation aid, the bank would operate more like a real estate investment fund. “We want this to be a real bank,” Davey said during his pitch to private investors earlier this year, “one that’s capitalized and that serves as a vehicle to foster and invest in infrastructure throughout the Commonwealth.”

The Massachusetts bank would solicit investments from the private sector, match those investments with a one-time state appropriation, use the combined public-private fund to backstop bonds, and then loan the bond proceeds to transportation projects across the state. If the infrastructure bank borrowed $4 in bonds for every $1 in contributions from the private and public sector, it would be able to create a $600 million loan pool. Loans from the infrastructure bank would be paired with other financing sources, allowing the bank’s initial $150 million fund— $75 million from private investors, $75 million from the state—to leverage billions in construction activity.

Britain, Australia, and Canada have decades of experience channeling private funds into public infrastructure. MassDOT’s infrastructure bank would try to tap into growing activity in the sector in the US. Chicago, for example, recently raised a $1.7 billion fund to invest in municipal infrastructure upgrades; nearly all the investors came from the private sector. Levenson worked for Chicago when the city raised $2.4 billion leasing its downtown parking meters and the Chicago Skyway toll road to private investors. Wall Street investment banks, insurance companies, and pension funds—investors that got hammered during the housing downturn—are all moving money into infrastructure as they look for long-term, stable income streams. Levenson says MassDOT would solicit investments from Wall Street infrastructure funds, pension funds, insurance companies, and large construction and development firms.

Levenson and Davey both cite a hypothetical port project that would fit their proposed bank’s model: A developer would take on a capital-intensive job like dredging a channel or building a shipping warehouse with help from the state, and use the revenues from new shipping business to pay the state back.

State officals believe a relatively modest public investment could spur billions in construction
spending. Photo by J. Cappuccio.

The state bank would lend to commercial developments that include “a transportation component that serves a public need,” Levenson says. There are currently several commercial projects on the drawing board in and around Boston that pair commercial office and residential construction with significant transportation components. New Brighton Landing and Fenway Center in Boston both include improvements to the state’s commuter rail system, while the redevelopment of Assembly Square in Somerville involves the construction of a new road system and a new Orange Line station. The costs associated with moving the Green Line, and building a new Lechmere Station, helped derail the NorthPoint project in Cambridge for years. With the exception of New Balance’s New Brighton Landing, the transportation components of these commercial developments are being publicly funded; deploying infrastructure bank funds in these kinds of settings would allow scarce state funds to be spent elsewhere.

The bank’s pitch to private developers would also seem to open the door to the sort of privately financed transportation developments that are common in Canada, and are now beginning to take hold in places like Texas and Florida. In these projects, private developers take over responsibility for the construction and maintenance of public infrastructure. In Canada, outsourcing road, bridge, and rail construction has saved provincial governments significant sums of money. In Florida, the Port of Miami expects to save nearly $400 million by privatizing the construction and maintenance of a new $1 billion tunnel.

Private sector needed

When Ferdinand Alvaro has seen government infrastructure banks work, it’s been in developing countries, places where governments have to invite private capital to invest in infrastructure, because the governments don’t have the wherewithal to handle the infrastructure costs on their own. He believes Massachusetts is now approaching that same situation.

“We’re at a point in the US where we need to invest more heavily in infrastructure, despite our limited resources,” argues Alvaro, an attorney who sits on MassDOT’s board and has chaired its finance committee. “We need to find a way, whether it’s through an infrastructure bank or another way, to allow the private sector to participate. Our current system is dysfunctional. We can’t afford to maintain it with our current funding. We need an alternative. Part of the answer is finding ways to involve the private sector.”

The state’s transportation obligations far outstrip its ability to finance them. The 2007 state Transportation Finance Commission predicted a 20-year state transportation deficit of $15 billion to $19 billion. A recent estimate from the advocacy group Transportation for Massachusetts outlined an $8 billion funding shortfall in short-term road, bridge, and transit repairs. The T, for instance, has delayed billions of dollars in routine maintenance work as the cost of balancing its budget; it faces a growing $3 billion backlog of maintenance projects, including track repairs, and the replacement of decades-old subway cars. The question isn’t whether the T’s budget careens into another deficit next year, but how ugly the deficit will be. The state is also struggling to finance the $1 billion Green Line extension to Somerville and Medford (a project it originally agreed to in connection with the Big Dig), and it’s chasing a costly rail expansion project at South Station without having any means of paying for it. The highway side of the ledger isn’t any prettier: Even after investing in an 8-year, $3 billion accelerated bridge repair program, the state’s road and bridge obligations far outstrip its ability to tackle them.

A pair of laws dating from the state’s darkest financial days limit its ability to bond its way out of this hole. A December 1989 law placed a hard statutory limit on direct state debt. This cap only expands by 5 percent per year, although it excludes some debt tied to school building, the Big Dig, and the MBTA. A second law, passed in January 1990, limits annual debt service outlays in the state budget to one-tenth of annual revenues. Because these two caps contain exemptions, Patrick has imposed a new administrative cap on debt service outlays; Patrick limited all debt service to 8 percent of annual state revenues, and capped the annual growth of the state’s capital program at $125 million per year.‘Our current system is dysfunctional. We can’t maintain it with our current funding. We need an alternative.’The various checks on borrowing keep Massachusetts in the credit ratings agencies’ good graces. Despite carrying one of the nation’s highest state debt loads, Standard & Poor’s upgraded Massachusetts to a AA+ credit rating —the highest in the state’s history. The favorable ratings mean Massachusetts can go to the market and borrow at favorable rates. But they also mean that the state can’t ratchet up its borrowing without also aggressively moving to collect new revenues, since existing revenues are already spoken for.

“The state cannot keep borrowing indefinitely,” Alvaro argues. “At some point, you run out of capacity. The T can borrow at very low rates, and it has done so, but the [debt service] cost is enormous. We’ve reached the outer limit of our ability to do that.”

“We can continue to go to the market and sell paper at really good rates, but the fact that we can access the market doesn’t mean we should,” says Paul Regan, executive director of the MBTA Advisory Board, adding. “We don’t have an access to capital problem. “We have a debt problem.”

An infrastructure bank is supposed to ease this cash crunch by pumping private funds into the state’s debt-laden transportation system. It remains to be seen how many infrastructure bank customers will appear, though. Kerry’s federal infrastructure bank proposal resonated because conventional federal infrastructure loan programs were overwhelmed by demand. The US DOT’s Transportation Infrastructure Finance and Innovation Act (TIFIA) loan program has been a favored source of funds for large, complex transportation projects, including projects built by private developers for public sector customers. In privately developed projects, the federal loan program normally plays the same role that the proposed MassDOT infrastructure bank would play. Demand for the federal money far outstripped supply, so Congress expanded the program, giving US DOT the ability to issue $17 billion in loans over the next two years. By authorizing the expansion, Congress essentially set up an infrastructure bank inside US DOT without having to go through the trouble of actually incorporating a bank, as Kerry wanted.

The newly robust federal pool of funds could weigh on MassDOT’s state infrastructure bank, because loans from an enterprise that expects to generate a healthy return for its investors (the state bank) is going to have to demand higher interest rates than US transportation officials, who are playing exclusively with public money. The interest rates on the federal loans tend to run a percentage point above the price of long-term US Treasury bills, which right now are trading for next to nothing.

Joseph Aiello, a former MBTA official who now serves as a partner at the private infrastructure developer Meridiam, believes that a state infrastructure bank would likely be a fallback for projects that couldn’t tap federal debt and gap financing first. Aiello notes that the federal program has a bias toward large projects, so a state bank could fill the gap on smaller projects. A state bank could be useful for launching several projects at the same time, since federal officials like to spread money around the map. But on a one-off basis, Aiello says, a large developer’s first stop would be the US program, not a state bank.

Another tool

MassDOT’s infrastructure bank is no silver bullet for the state’s infrastructure crisis. The bank’s advocates and its critics agree on this much. But they clash over whether the bank, given its less-than-omnipresent reach, is a necessary component in the next phase of transportation reform, or a sideshow in the making.

The state infrastructure bank “will not be a solution for every project that comes down the pike,” Levenson says. “We view it as another tool in the toolbox.”

Alvaro, who is now lobbying for an infrastructure bank, asserts that, without major interventions, the state’s transportation system is heading for “a Greek-type situation,” where debt from past investments crowds out every other budget line item. “Unless we want to find ourselves in that position, we either need to find internal revenues that are acceptable to the public, or invite private capital, or a combination of the two,” he says. “That’s the ideal outcome.”

“To the extent we can leverage private dollars, we should explore it,” says Michael Widmer, president of the Massachusetts Taxpayers Foundation. “We do too little of this in Massachusetts. If it allows you to do three projects that wouldn’t get done, hey, that’s three more.” At the same time, Widmer says, it’s important to recognize that a bank would “only have a marginal impact on our infrastructure needs,” and not come at the expense of a commitment “to put more money into the system, and do more restructuring.”

The timing of the infrastructure bank pitch, which will be rolled out early in next year’s legislative session, presents opportunities and potential pitfalls. Patrick’s administration has been promising an “adult conversation” on transportation finance for years. His former transportation secretary, James Aloisi, famously derided the Legislature’s “reform before revenue” approach to transportation as “a meaningless slogan,” and Patrick lost any outside shot he had at a gas tax increase because of it. Since dropping the gas tax fight, Patrick has talked a lot about talking, but that’s been it. Aloisi’s successor, Jeffrey Mullan, publicly announced that MassDOT had “moved beyond” reform before revenue, saying, “We know it’s not enough.” That was a year and a half ago, and the most Patrick has put on the table was a $50 million stopgap bill to close the MBTA’s budget gap.

Meet the Author

Paul McMorrow

Associate Editor, CommonWealth

About Paul McMorrow

Paul McMorrow comes to CommonWealth from Banker & Tradesman, where he covered commercial real estate and development. He previously worked as a contributing editor to Boston magazine, where he covered local politics in print and online. He got his start at the Weekly Dig, where he worked as a staff writer, and later news and features editor. Paul writes a frequent column about real estate for the Boston Globe’s Op-Ed page, and is a regular contributor to BeerAdvocate magazine. His work has been recognized by the City and Regional Magazine Association, the New England Press Association, and the Association of Alternative Newsweeklies. He is a Boston University graduate and a lifelong New Englander.

About Paul McMorrow

Paul McMorrow comes to CommonWealth from Banker & Tradesman, where he covered commercial real estate and development. He previously worked as a contributing editor to Boston magazine, where he covered local politics in print and online. He got his start at the Weekly Dig, where he worked as a staff writer, and later news and features editor. Paul writes a frequent column about real estate for the Boston Globe’s Op-Ed page, and is a regular contributor to BeerAdvocate magazine. His work has been recognized by the City and Regional Magazine Association, the New England Press Association, and the Association of Alternative Newsweeklies. He is a Boston University graduate and a lifelong New Englander.

The $50 million MBTA bill invited weeks of backbiting inside the Legislature, with lawmakers breaking into regional tribes and fighting for crumbs—a saga that doesn’t bode well for any future broad-based transportation debate. Then, after passing a modified version of the MBTA budget bill, the Legislature asked Davey’s board to present it with a comprehensive transportation finance plan early next year. Even before this request, though, Patrick hinted that he intends to file an ambitious transportation bond bill next year, that the bond will contain new financing mechanisms, and that a public-private infrastructure bank will be part of the package.

Regan argues that an infrastructure bank proposal “feels kind of like a gimmick” that could muck up what’s already shaping up to be a contentious transportation debate next year. “A bank might save money going forward, no impact on the fiscal crisis today,” he says. “Can you imagine if we spend a month on this? And then say it works—we’re exactly where we were on the T, on the RTAs, on road and bridge backlog. We have plenty to worry about, without spending a lot of time on the bright, shiny object. The underlying problem is, we haven’t raised any significant revenue for transportation in 20 years, and we did the Big Dig in the middle of that. You can’t go 20 years without raising revenue and expand the system, and we did that.”