City as banker and venture capitalist
As we are growing the endowment that is our city, improving its overall wealth and prosperity, most of our investments need to be riskless, but a small fraction need to be high risk, high reward. This contrasts with the current approach used by nearly all cities, one where there is relatively high risk (higher than most people realize) and only a very limited capacity for return. We need to be savvier with our limited resources.
This week is our big Strong Towns on Tap event at the HUGE Theater in Minneapolis. For all of those that can make it, we're having six different speakers using a rapid-fire format not to be named and then I am going to give a totally new talk on a completely new topic. I've suggested the title: A New Economy approach to Public Participation (aka: how to stop soothing the conscience of the privileged and powerful and start actually learning from the public.) Not a short title, but descriptive. Hope you can make it -- bring a friend, it is going to be a great evening.
The last three weeks we have delved deeply into the different mindsets for local governments to approach capital improvement projects. For a country that reflexively believes that investments in infrastructure are a catalyst for growth (build it and they will come), this is a very important conversation. Is there a way to invest limited dollars so that, over time, the pie expands and our capacities grow?
Should public officials be penny-pinching misers or gamblers? How about both? (Click photo for Creative Commons attribution.)Our current approach is ad hoc, at best, where experts and their theories on what makes a good investment advise public officials on the best ways to throw around millions of dollars, a growing amount of which is borrowed. It takes money to make money. Will it work? Who knows. While this approach is comforting to those that want action, acquiescing to the human impulse for easy gain, we reject it wholesale. Local governments should not be in the businesses of risk.
This led me to define three core understandings for how risk and return are measured for local governments. While a radical departure from our current thinking, there is simple logic to the suppositions that:
- Local government investments need to generate a REAL rate of return, one where the government actually gets money back for the money it invests.
- That the revenue a local government receives in an investment be capturable in amounts sufficient to actually fund the project.
- The revenue stream from a project is capable of sustaining the improvement over multiple life cycles?
Finally, for a local government to get out of the risk game and actually be prudent stewards with a long term vision for the public purse -- as if their city itself were an endowment -- then a new strategy is needed. A Strong Towns approach combines the risk adverse mentality of a banker or accountant on nearly all of the city's "portfolio" with a venture capital swagger on the tiny sliver that remains.
As I indicated last week, today I'm going to elaborate on what a guaranteed return (banker) project and an experimental (venture capital) project looks like. I apologize in advance to those of you that don't like math but, if you can wade through it, I've kept it fairly simple (overly simple, especially if people really want to quibble with the numbers).
Guaranteed Return / Low Risk
For each of these three examples, I will assume (for the sake of round numbers) that 25% of the city's budget is used for infrastructure maintenance, with the remaining amount going to the other functions of local government (police, fire, parks, elections, etc...) I'll also assume (for the sake of simplicity) that the city's revenue, outside of one time grants and fees for service, is from property tax.
Example #1: A developer is putting in a new housing subdivision and is requesting that the city take over the maintenance of the infrastructure. The long term cost (calculated through a full life cycle and replacement) for the infrastructure is $100,000 per year. The new development will generate $400,000 per year in new taxes when it is fully built out. The city signs an agreement to take over the maintenance of the infrastructure once the development is built out and the value reaches the target amount. Until that time, the infrastructure is privately owned by the developer and/or a housing association.
Examples #2: A street in a city is in disrepair and a maintenance project is planned. In evaluating the project, it is discovered that new growth and a rise in property values along the street has doubled the revenue the city is getting from within the project area to $400,000 per year. An enhancement that would widen sidewalks, installed decorative lighting and make other improvements would add $50,000 per year to the long term costs of the project, bringing the total annual cost to $100,000 per year. The city goes ahead with the project with the knowledge that the tax base has grown a sufficient amount to cover the long term costs.
Example #3: A STROAD runs through the city, bisecting two neighborhoods in a way that artificially separates them. Development along the STROAD is not very productive, providing an annual revenue stream of only $400,000. The cost to maintain the STROAD alone is $600,000 per year, which does not include costs for policing, responding to accidents and other normal city costs. The city secures a grant from the federal and state governments to put the STROAD on a road diet, narrowing the overall surface, connecting the adjacent neighborhoods and improving the overall prospects for the corridor. As a result of the project, the annual cost to maintain the STROAD (now a street) decreases to $300,000, an amount now covered by the corridor's revenue stream. The growth in value expected along the corridor -- if it materializes -- will only enhance the city's already marginally-positive position.
Experimental Approach / High Risk
Example #4: The north end of a block has viable businesses along both sides while the south end of the same block has vacant storefronts. On each side of the street, there is surface parking that creates a gap for people to walk past. The city takes $2,000 and erects a six foot high fence in an effort to close these gaps and improve the viability of the southern end of the block. The following year, $500 is given to the local school for student artists to paint a temporary mural along the fence. Will it work? Who knows, but if it doesn't the city is only out $2,500. If it does, it could be huge.
Example #5: A Safe Routes to School study indicates that a neighborhood surrounding an existing school is not safe for walking. Engineers recommend $800,000 to build sidewalks, the construction of which requires removal of many mature trees. It is noted by locals that the streets are excessively wide, the traffic moves too fast and the neighborhood is very poor. Since there currently isn't a walking/biking culture within the neighborhood, resistance to the improvements is fierce. The city opts to spend $7,000 to stripe the streets in the neighborhood to define narrow driving lanes and create parking lanes an adequate distance from the curb so as to maintain a protected walking corridor on the edge of the street. The modest experiment does not meet every need, but addresses most of the problem at a fraction of the cost and, in doing so, provides space for walking/biking to become an accepted part of the neighborhood before more costly and dramatic improvements are undertaken. Will it work? Who knows, but if it doesn't the city is only out $7,000. If it does, it could be huge.
Example #6: An intersection has a high accident rate and the businesses near there, except for the attorney's office, are struggling. The city decides to run a month long experiment narrowing the lanes, adding more pedestrian space and making the intersection a shared space environment. The city rents traffic cones at $500 for the week for four weeks. The only other costs involve staff time for setting the project up, doing public outreach through the media and then installing some burlap sacks to cover the existing signals and signage. Will it work? Who knows, but if it doesn't the city is only out $2,000. If it does, it could be huge.
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The first three examples rely on the banker mentality. There is a saying among bankers that goes, "You can only borrow money when you don't really need it." What that captures is the notion that bankers want their money to be safe and secure. If they loan you $10,000, they want $10,000+ in collateral. The average local banker is not in business to take risks but to allocate capital to secure investments where they can make a fair return. (Note that large, government-backed banks that securitize, hypothicate and flip debt do not hold these same concerns, one of the reasons our financial sector is a threat to the very existence of our country.) For nearly every dollar spent on infrastructure and capital improvements, our cities need a banker mentality.
There is a place here -- absolutely -- for a little risk. The second three examples rely on a venture capital mentality. These are investments that, because of their modest size, have very little downside. If they fail, not much is lost. On the other hand, where they work out, the upside is potentially tremendous. Limitless, in fact. A city that does not make these fine-grained, small investments is leaving tremendous growth opportunities on the table. A small fraction of every dollar spent on infrastructure and capital improvements needs to be high risk, high reward.
As we are growing the endowment that is our city, improving its overall wealth and prosperity, most of our investments need to be riskless, but a small fraction need to be high risk, high reward. This contrasts with the current approach used by nearly all cities, one where there is relatively high risk (higher than most people realize) and only a very limited capacity for return. We need to be savvier with our limited resources.
We need a Strong Towns approach.
Last week I got hit (via email) with a handful of very technical, detailed questions on this approach. Do us all a favor and, if you have that kind of question, head on over to the Strong Towns Network and bring it up there. I'll do my best to jump in but, even if I have another really hectic week (looking that way so far), there are a lot of really bright people there that would love to delve into it with you.