June 22, 2015
This week we look at look at the Megaproject Paradox as written about by Brent Flyvbjerg.
Megaproject Research has Lessons for Municipal investors
This weekend we (Mike C) caught up on our podcast listening. The highlight was an interview with Bent Flyvbjerg by Econotalk discussing his work on “megaprojects”.
Brent Flyvbjerg is a professor at Oxford University who focuses on “program management and planning”. He is the author of Megaprojects and Risk: An Anatomy of Risk and Ambition.
Several projects financed in the U.S. municipal bond market were discussed: the “Big Dig” in Boston, the Hudson Yards project in New York City, the MTA’s Second Avenue Subway, and the San Francisco-Oakland Bay Bridge operated by the Bay Area Toll Authority.
Flyvbjerg also mentioned the California High Speed Rail as an evolving megaproject (only current municipal market exposure is via the State of California).
Flyvbjerg offers valuable insights to municipal bond investors lending to megaprojects and also to smaller less grandiose projects. (Flyvbjerg defines a mega project as one that costs more than a billion dollars and effects more than a million people).
The Megaproject Paradox
Based on his research, Flyvbjerg has concluded that a high proportion (90%) of megaprojects do not meet expectations of costs or benefits, a phenomenon he describes as the “megaproject paradox”:
…it’s the paradox that we have all these megaprojects being built, more and more, and larger and larger. Spending more and more money on it as a percentage of global GDP (Gross Domestic Product). At the same time, it’s very clear that the performance of the product is dismal. That they are just not doing very well. They do not deliver the promised benefits. They cost much more than was originally estimated. They take much longer. There are many more unhappy people in the wake of projects like that than was said would be the case, and so on. So, it’s a very clear pattern. And it is a paradox.
Flyvbjerg believes that the “break-fix model” for megaproject management allows public officials to obscure megaproject mistakes:
Generally, megaproject planners and managers – and their organizations – do not know how to deliver successful megaprojects, or do not have the incentives to do so, and therefore such projects tend to “break” sooner or later, for instance when reality catches up with optimistic, or manipulated, estimates of schedule, costs, or benefits; and delays, cost overruns, etc. follow. Projects are then often paused and reorganized – sometimes also refinanced – in an attempt to “fix” problems and deliver some version of the initially planned project with a semblance of success. Typically lock-in and escalation make it impossible to drop projects altogether, which is why megaprojects have been called the “Vietnams” of policy and management: “easy to begin and difficult and expensive to stop” (White, 2012; also Cantarelli el al., 2010; Ross and Staw, 1993, Drummond, 1998). The “fix” often takes place at great and unexpected cost to those stakeholders who were not in the know of what was going on and were unable to or lacked the foresight to pull out before the break.
Right Call on Fundamentals, Not Always Best Investment Conclusion
The “break-fix model” presents a tough dilemma for muni credit analysts. Sometimes the right predictions on credit fundamentals regarding project viability are overwhelmed by politicians desire to find a “fix” for something that is “broken”. A notable example is the Pocahontas Parkway, which was a financial failure on its fundamentals but was bailed out by a private investor seeking the good graces of the Virginia Department of Transportation that held an equity-like stake.
The “Sublimes”
Flyvbjerg has proposed four factors that he believes leads public officials to consistently initiate new megaprojects that are unlikely to realize the planned cost/benefit trade-offs. Flyvbjerg refers to these factors as “sublimes”:
- Political Sublime: “politicians love to start projects…and love to cut the ribbons”
- Technology Sublime: “…there’s nothing engineers like better and technologists like better than to push the envelope, technologically speaking.”
- Economic Sublime: “…the delight that business people and trade unions get from making lots of money and jobs off megaprojects”
- Aesthetic Sublime: “…the pleasure designers and people who appreciate good design get from building, using and looking at something that is also iconically beautiful”
It’s Not Just the Public Sector
Since the financial crisis, public private partnerships have increasingly turned to the municipal bond market to replace financing options that disappeared as bank lending options dried up. A relevant aspect of Flyvbjerg’s research is that these biases are as common in the private sector as in the public sector. This conclusion is relevant to lending money to P3 ventures, but also to lending to public entities who have financed a project via a P3:
It’s not like people can relax just because it’s in the private sector. The taxpayer can relax, if the contracts are written right, because there actually is a very unfortunate tendency for things ending up with the taxpayer anyway, even if everybody thought it was private sector…There is some escape clause somewhere in the contract that said: Well, by the way, the public sector is picking up the risk if everything goes wrong. That happens too often for comfort (emphasis added).
The U.S. Municipal Market Megaprojects
While the U. S. municipal bond market is not Flyvbjerg’s focus, he did discuss several projects that should be familiar to municipal investors.
The Big Dig which was financed with a mix of Federal grants, State funds and municipal bonds experienced cost overruns, corruption, incompetence and a passenger fatality was enabled by all four of Flyvbjerg’s sublimes. The costs of diverting funds from other State (MBTA) and national priorities have not been calculated.
The Hudson Yards project was enabled by the Technology and Economic Sublimes. Bonds to finance the project are backed by several off balance sheet lendings by New York City: PILOT payments on property in the area and by “Interest Support Payments” the City.
The MTA’s Second Avenue Subway waited decades for the timing of the Political Sublime to ripen. A column by Nicole Gelinas this weekend highlights the weakness of the Political Sublime as an investment rationale. Once the ribbon has been cut, future politicians have little incentive to support projects.
The seismic retrofitting of the San Francisco-Oakland area bay bridges has largely been funded by the municipal bond market via borrowings by the Bay Area Toll Authority (BATA). BATA’s somewhat cavalier financial management demonstrates Flyvbjerg’s “break-fix model”. BATA stumbled into many of the financial engineering train wrecks of the 21st century municipal bond market: auction rate securities were refinanced into LOC-backed VRDN’s were refinanced into bank liquidity-only VRDNS. BATA’s swaps liability as of 12/14 was 4% of its debt outstanding. Despite completion of construction, the full cost of the bridges is still unknown because of apparently defective construction.
Not discussed by Flyvbjerg, but deserving mention is the Port Authority of New York and New Jersey reconstruction of the World Trade Center site. This project has been emotionally and politically charged, leading to numerous revisions of plans and haggling with stakeholders (including efforts to violate bond indentures).
The new Path Station designed by Santiago Calatrava is an extreme example of Flyvbjerg’s Esthetic Sublime and was discussed in New York Magazine in an article titled “The Glorious Boondoggle”.
Have a great week,
Michael Craft, CFA
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CLICK HERE to Subscribe to the Weekly Commentary
For more information, please contact: inquiries@lumesis.com
Learn more about Lumesis
The Megaproject Paradox
June 22, 2015
This week we look at look at the Megaproject Paradox as written about by Brent Flyvbjerg.
Megaproject Research has Lessons for Municipal investors
This weekend we (Mike C) caught up on our podcast listening. The highlight was an interview with Bent Flyvbjerg by Econotalk discussing his work on “megaprojects”.
Brent Flyvbjerg is a professor at Oxford University who focuses on “program management and planning”. He is the author of Megaprojects and Risk: An Anatomy of Risk and Ambition.
Several projects financed in the U.S. municipal bond market were discussed: the “Big Dig” in Boston, the Hudson Yards project in New York City, the MTA’s Second Avenue Subway, and the San Francisco-Oakland Bay Bridge operated by the Bay Area Toll Authority.
Flyvbjerg also mentioned the California High Speed Rail as an evolving megaproject (only current municipal market exposure is via the State of California).
Flyvbjerg offers valuable insights to municipal bond investors lending to megaprojects and also to smaller less grandiose projects. (Flyvbjerg defines a mega project as one that costs more than a billion dollars and effects more than a million people).
The Megaproject Paradox
Based on his research, Flyvbjerg has concluded that a high proportion (90%) of megaprojects do not meet expectations of costs or benefits, a phenomenon he describes as the “megaproject paradox”:
…it’s the paradox that we have all these megaprojects being built, more and more, and larger and larger. Spending more and more money on it as a percentage of global GDP (Gross Domestic Product). At the same time, it’s very clear that the performance of the product is dismal. That they are just not doing very well. They do not deliver the promised benefits. They cost much more than was originally estimated. They take much longer. There are many more unhappy people in the wake of projects like that than was said would be the case, and so on. So, it’s a very clear pattern. And it is a paradox.
Flyvbjerg believes that the “break-fix model” for megaproject management allows public officials to obscure megaproject mistakes:
Generally, megaproject planners and managers – and their organizations – do not know how to deliver successful megaprojects, or do not have the incentives to do so, and therefore such projects tend to “break” sooner or later, for instance when reality catches up with optimistic, or manipulated, estimates of schedule, costs, or benefits; and delays, cost overruns, etc. follow. Projects are then often paused and reorganized – sometimes also refinanced – in an attempt to “fix” problems and deliver some version of the initially planned project with a semblance of success. Typically lock-in and escalation make it impossible to drop projects altogether, which is why megaprojects have been called the “Vietnams” of policy and management: “easy to begin and difficult and expensive to stop” (White, 2012; also Cantarelli el al., 2010; Ross and Staw, 1993, Drummond, 1998). The “fix” often takes place at great and unexpected cost to those stakeholders who were not in the know of what was going on and were unable to or lacked the foresight to pull out before the break.
Right Call on Fundamentals, Not Always Best Investment Conclusion
The “break-fix model” presents a tough dilemma for muni credit analysts. Sometimes the right predictions on credit fundamentals regarding project viability are overwhelmed by politicians desire to find a “fix” for something that is “broken”. A notable example is the Pocahontas Parkway, which was a financial failure on its fundamentals but was bailed out by a private investor seeking the good graces of the Virginia Department of Transportation that held an equity-like stake.
The “Sublimes”
Flyvbjerg has proposed four factors that he believes leads public officials to consistently initiate new megaprojects that are unlikely to realize the planned cost/benefit trade-offs. Flyvbjerg refers to these factors as “sublimes”:
It’s Not Just the Public Sector
Since the financial crisis, public private partnerships have increasingly turned to the municipal bond market to replace financing options that disappeared as bank lending options dried up. A relevant aspect of Flyvbjerg’s research is that these biases are as common in the private sector as in the public sector. This conclusion is relevant to lending money to P3 ventures, but also to lending to public entities who have financed a project via a P3:
It’s not like people can relax just because it’s in the private sector. The taxpayer can relax, if the contracts are written right, because there actually is a very unfortunate tendency for things ending up with the taxpayer anyway, even if everybody thought it was private sector…There is some escape clause somewhere in the contract that said: Well, by the way, the public sector is picking up the risk if everything goes wrong. That happens too often for comfort (emphasis added).
The U.S. Municipal Market Megaprojects
While the U. S. municipal bond market is not Flyvbjerg’s focus, he did discuss several projects that should be familiar to municipal investors.
The Big Dig which was financed with a mix of Federal grants, State funds and municipal bonds experienced cost overruns, corruption, incompetence and a passenger fatality was enabled by all four of Flyvbjerg’s sublimes. The costs of diverting funds from other State (MBTA) and national priorities have not been calculated.
The Hudson Yards project was enabled by the Technology and Economic Sublimes. Bonds to finance the project are backed by several off balance sheet lendings by New York City: PILOT payments on property in the area and by “Interest Support Payments” the City.
The MTA’s Second Avenue Subway waited decades for the timing of the Political Sublime to ripen. A column by Nicole Gelinas this weekend highlights the weakness of the Political Sublime as an investment rationale. Once the ribbon has been cut, future politicians have little incentive to support projects.
The seismic retrofitting of the San Francisco-Oakland area bay bridges has largely been funded by the municipal bond market via borrowings by the Bay Area Toll Authority (BATA). BATA’s somewhat cavalier financial management demonstrates Flyvbjerg’s “break-fix model”. BATA stumbled into many of the financial engineering train wrecks of the 21st century municipal bond market: auction rate securities were refinanced into LOC-backed VRDN’s were refinanced into bank liquidity-only VRDNS. BATA’s swaps liability as of 12/14 was 4% of its debt outstanding. Despite completion of construction, the full cost of the bridges is still unknown because of apparently defective construction.
Not discussed by Flyvbjerg, but deserving mention is the Port Authority of New York and New Jersey reconstruction of the World Trade Center site. This project has been emotionally and politically charged, leading to numerous revisions of plans and haggling with stakeholders (including efforts to violate bond indentures).
The new Path Station designed by Santiago Calatrava is an extreme example of Flyvbjerg’s Esthetic Sublime and was discussed in New York Magazine in an article titled “The Glorious Boondoggle”.
Have a great week,
Michael Craft, CFA
For more charts and analysis, sign up for a DIVER Analytics Trial.
CLICK HERE to Subscribe to the Weekly Commentary
For more information, please contact: inquiries@lumesis.com
Learn more about Lumesis