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Public Infrastructure Banks: Operation and IssuesByRobert Krol8.22.16Public infrastructure banks are government institutions designed to lend funds to municipalities and private firms to finance the construction of infrastructure projects. As loans are repaid, the recycled funds are used to finance additional lending. The goal is to provide a sustainable source of funds for infrastructure investment.Politicians have been toying with the idea of a national infrastructure bank since the 1990s. Bill Clinton ran for president supporting the idea but settled for a state infrastructure bank pilot program in 1995. He later convinced Congress to enact a transportation lending program run by the Department of Transportation. Senator Christopher Dodd (D-Conn) sponsored legislation to create a national infrastructure bank in 2007. His legislation was never enacted into law.President Obama has proposed establishing a national infrastructure bank as part of his plan to improve U.S. infrastructure. Thus far, Congress has failed to act on the President’s proposal. Now, Democratic presidential candidate Hillary Clinton has promised, if elected, to establish a national infrastructure bank.This paper discusses how infrastructure banks operate, points out their limitations, and suggests some reforms. In order make the idea of an infrastructure bank more concrete, the paper reviews the experiences of state infrastructure banks.A National Infrastructure BankUnder the President Obama’s proposal, the federal government would provide $10 billion to capitalize a national infrastructure bank. The bank would make loans at Treasury bond interest rates on projects worth at least $100 million ($25 million for rural projects). The bank would finance up to fifty percent of a project. The remaining sources of funding would come from city and state governments or the private sector. These loans would help finance transportation, energy, and water infrastructure projects. Loan repayments would serve as a source of funds to finance future infrastructure projects. Thus far, Congress has not supported the President’s proposal. Hillary Clinton’s plan is similar except that it calls for an initial capitalization of $25 billion.There are a number of issues associated with establishing a national infrastructure bank. The federal government already has several lending programs. The Transportation Infrastructure Finance and Innovation Act gives the Department of Transportation the authority to provide loans, loan guarantees, and standby lines of credit that can be used to finance highway and mass transit infrastructure projects. To date, the program has provided $22.7 billion in credit assistance for 56 major projects. The 2015 transportation funding bill (FAST Act) authorized another $1,435 billion over the next five years for this program. In addition, the Railroad Rehabilitation and Improvement Financing program provides similar credit facilities to railroads.Neither the President’s nor Mrs. Clinton’s proposals provide an explanation as to why a national infrastructure bank should be established given the existence of these federal lending programs. If President Obama and Hillary Clinton think current levels of spending are too low, they could appropriate more funding in future budgets to existing lending programs rather than setting up a national infrastructure bank. Perhaps they think a new infrastructure bank would do a better job selecting projects to fund than existing federal loan programs. The President’s plan called for funding projects that provide “… clear benefits to taxpayers.” It is unclear what this means. The lending decisions are to be made by a seven member bi-partisan board of directors. Will the board focus its lending decisions based on careful cost–benefit analysis?The American Recovery and Reinvestment Act of 2009 established the Transportation Investment Generating Economic Recovery (TIGER) grant program. Cost–benefit analysis of submitted projects was to play an important role in the selection process. However, the evidence is mixed on the role cost–benefit analysis played in project selection. Research by Anthony C. Homan, Teresa M. Adams, and Alex J. Marach found project cost–benefit analysis did not play a statistically significant role in the selection process. More recent work by Homan found that the probability of net benefits was significantly higher for projects that receive a grant.Even so, the cost–benefit analysis of large infrastructure projects is notoriously misleading. Forecasting a proposed project’s construction cost and usage is difficult. On average, if analysts are objective in their estimates, we would expect forecast errors to be unbiased with unpredictable errors. Bent Flyvbjerg et. al. examined estimates of large infrastructure project costs and benefits across a large sample of projects. They found large systematic under-estimation of costs and over-estimation of benefits. Flyvbjerg et al. conclude political pressure on analysts results in a systematic bias to paint a rosy picture of costs and benefits. In other words, the errors are deliberate and result from pressure to move projects forward. Infrastructure investments impose costs on and provide benefits to the community in which they are located. So, by their very nature, infrastructure investment decisions are highly political and supported by local unions and construction companies. Politicians love to be at ribbon cutting ceremonies. There is pressure to overstate the net benefits of a project. Unlike private lenders who seek out projects that provide the highest risk-adjusted return on projects they fund, public decision makers in government, or at an infrastructure bank, are likely to be influenced by politics as much as hard economic facts. There is no reason to conclude that a national infrastructure bank would allocate funds to higher return projects than the existing programs.What appears to be a lack of sufficient transportation infrastructure is more likely a reflection of inefficient pricing. Given that most highways do not charge tolls, they can be overused and congested. Under the current arrangement, where users do not pay fees, it is impossible to determine whether more investment is needed. Pricing existing highways would reveal the value users place on these highways and provide signals where additional capacity would have the greatest value. There is evidence that maintenance has a bigger impact on the economy than new construction. Unfortunately, infrastructure banks direct funds that could be used for maintenance to new construction.Using federal funds to subsidize what is mostly a state or local function distorts decision making. Because the local community does not pay the full cost of a project, non-economic projects, where total costs exceed total benefits, are often built. Many of these questionable projects would not be built if the community had to pay the full cost, resulting in better project selection. State Infrastructure Bank ExperienceThe National Highway System Designation Act of 1995 established a pilot program that allowed states to set up infrastructure banks (SIBs). Initial capitalization used federal and state funds (at least 20 percent). The plan was for banks to make loans or provide credit enhancements, such as loan guarantees, to expand infrastructure investment in the state. Loans would be at below market interest rates and could generally be used to finance highway or mass transit construction. Because federal dollars were involved, selected projects were subject to federal regulations such as requiring contractors to pay prevailing wages. The program was extended in the 1998 transportation funding bill and made permanent in 2005. Thirty-four states plus Puerto Rico have established SIBs.Robert Puentes and Jennifer Thompson estimate state infrastructure banks made 1,134 agreements worth around $7.4 billion with municipal governments between 1995 and 2012. States spent approximately $1.4 trillion on infrastructure over the 1996 to 2010 period, so SIB lending remains relatively small, about 0.5 percent of the total. Seventy percent of the agreements supported road construction. Other major areas financed included aviation (6.5 percent), water (4.4 percent), and transit (4.1 percent). Some agreements supported social and redevelopment projects.Three quarters of the SIB agreements are in eight states, suggesting many banks are not very active. One troubling fact is that 28 percent of the loans were interest free. This limits the sustainability of the bank.SIBs can leveraged the initial public capital by borrowing in financial markets. This enables SIBs to fund more projects. However, it can create long-term financial viability problems. For SIB loans to be attractive to municipalities, the interest rate must be below the rate at which they can borrow on their own, the municipal bond rate. If these banks borrow at market interest rates and lend at below market rates, the capital of the SIB will erode over time. As a result, SIBs will require continued state government appropriations to continue to operate. Also, in order to protect bank capital, the SIB loan rates should be greater than the inflation rate. Inflation is currently low, but unexpected increases in inflation would cause serious capital adequacy problems over time.Federal funding creates incentives for states to increase spending. Can Chen estimates that each federal dollar used to capitalize an SIB leads to a $3 increase in state highway capital expenditures after three years. However, the real question is not simply how governments can spend more on infrastructure, but is it possible in the political marketplace to channel funds to high-return projects. Most SIBs are managed by the state departments of transportation. Even with a board of directors, appointed by the legislature or governor, special interests are likely to influence the project selection process. Suggested Reforms and ConclusionsIn order to improve the economic impact of infrastructure spending, the role of the federal government should be reduced. The federal government can still play a role in multijurisdictional projects, such as a seaport, but highways, roads, and urban transit should primarily be a state and local responsibility. Communities that benefit from a project most should pay the full (or most) of the cost. Since local decision making will improve the project selection process, a national infrastructure bank should not be established.Furthermore, the federal government should not provide funding to establish or support existing SIBs. In initiative states, the establishment of a SIB should be decided by voters because these types of institutions may be used as a means to avoid state borrowing limits.The attraction of a SIB is the ability to finance additional infrastructure as loans are repaid. However, taxpayers should be aware that it is tempting for SIBs to borrow in financial markets to expand lending. If the SIB loan rate is below the market interest rate, or less than the inflation rate, the bank’s capital will be at risk. Rather than being self-financing, the SIB would require continued state funding. To improve the transparency of the project selection process, estimates of project costs and benefits should be made public and compared to comparable projects already completed. Taxpayers are more likely to apply pressure to stop questionable projects in this environment. ................
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