ragging on privatization

posted at Knowledge Problem: Wanted: Economic Analysis of Urban Rail Transportation (five months’ belated thanks to Derek for the heads-up; a follow-on to Funding Redux‘s diss on privatization)

Privatization [of CTA] would hardly be a panacea; one of two companies hired in a privatization of the London Underground recently entered receivership, and taxpayers could be held responsible for its tremendous cost overruns. Our local “traction kings” hardly fared better: Insull made his fortune from energy, not the “L”; Yerkes profited off subterfuge and subdivisions, not the streetcars. In fact, both used securities fraud to cover the steep losses they faced on transit operations, which is why both were run out of town on the rails.

Those men faced no real competition, as their empires predated today’s heavily subsidized and regulated freeways, parking, sprawl, etc. By the end of Insull’s reign, the railroad industry had become the most regulated public utility in American history, wearing far heavier regulatory yokes than those which the cable, phone, and electric companies “toil” under these days.

This little history lesson hardly disproves that contracting out operations might reduce costs — particularly when public bureaucracies have ossified and become unresponsive to change — but do use caution before bandying about “PPP” without understanding its ramifications. One could even look back at the same Yerkes/Insull history and draw the conclusion that urban transit is a natural monopoly (thus enabling free transfers, for instance) and inherently requires local government involvement, or one might draw the conclusion that Illinois politics vis-a-vis transit have forever been poisoned by collusion and power-broking at the public’s expense.

In any case, I have it on good authority that a great many MBA-diseased minds (not least Rob Huberman, Chicago GSB ’00 and Carole Brown, Northwestern KSM ’89) are being put to work on the CTA’s problems now. This may not have quite the results that we bargained for.

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4 thoughts on “ragging on privatization

  1. Among the sources, The Age of Big Business, a 1919 book by Burton Hendrick:

    Yerkes purchased the old street railway lines, lined his pockets by making contracts for their reconstruction, issued large flotations of watered stock, heaped securities upon securities and reorganization upon reorganization and diverted their assets to business in a hundred ingenious ways… after having reduced the railway system of Chicago to financial pulp and physical dissolution, he finally unloaded the whole useless mass, at a handsome personal profit, upon his old New York friends, Whitney and Ryan, and decamped to London, where he carried through huge transit enterprises…

    He points out that Whitney & Ryan’s Metropolitan Traction Company hit $269/share shortly after its IPO in 1897, back when “par value $1 ” actually meant something; that would’ve translated to $5,367 per share in 2000 dollars. The companies lost money hand over fist, as shell companies billed fantastically overblown expenses; dividends, land leases, and bribes all came paid in shares, bonds, or loans; and the CEOs made out like bandits* because such fraud (which they invented!) wasn’t yet illegal.

    As for Insull, Graham Garfield’s Chicago-L has this to say: “Frankly, the [Chicago Rapid Transit Company] was not that much more adept at making money than the previous companies, but it sure seemed like it on paper. The new company quickly embarked on an extensive expansion and modernization program. But in fact, the company was being propped up in many ways by Insull’s large utilities empire.”

    * Whitney’s fortune at his death in 1904 would have amounted to nearly a billion dollars today.

  2. comment at Ask Carole Brown:

    No transit system in the USA operates in the black. NYC Transit makes a small operating profit (i.e., EBITDA for you accountants out there) off the subway, but loses money on buses and still relies on huge subsidies for capital.

    Many newer transit systems (notably DC Metrorail, BART, and LA Metro) have used their sizable real estate holdings (mostly park & ride lots) to pursue development projects, and several Asian systems are still run as subsidiaries of real estate groups.

    Chicago’s “L” and streetcars, like many others, was built to facilitate land development at the stations — but those properties were sold off or split from CTA long ago, so CTA’s land holdings today are pretty negligible. (Interestingly, ComEd used to own the “L,” and ComEd is still among Cook County’s largest private landowners.)

    Now the city and schools, not the CTA, profit off the considerable land value that CTA’s transit service creates. (Proximity to transit raises real estate prices.) That’s why SB 572 gives the city a chance to enact a real estate tax to fund CTA operations — it’s a chance to capture some of that value.

  3. Now I’m really straying far afield. In response to something at “Chicago Daily Observer” on the purported successes of London’s PPPs.

    Ah, the world through rose-colored lenses. In fact, Transport for London has a lower fare recovery ratio than CTA — 42% for TfL vs. 44.3% for CTA, despite cash fares as high as $8 for local trips! (The congestion charge, laughed out of Chicago’s City Hall, provides a big source of revenue for the buses.)

    Privatization has “not proven as efficient as expected in terms of service improvement,” according to Fitch Ratings’ April report on TfL; indeed, the Underground’s repair workers are right now in the midst of a series of strikes that shut down 75% of the Tube earlier this week. Why? Because Metronet, one of the two PPPs set up to handle systems renewals, went bankrupt, leaving taxpayers liable for $4 billion in cost overruns.

    And I might also remind you of the multiple deadly derailments blamed on shoddy work by Railtrack and its replacement Network Rail, both ill-fated and costly schemes to offload Britain’s railroad maintenance onto the private sector.

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