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What Could Possibly Go Wrong With Infrastructure Investment Bonds?

The G-20 leaders are dining out on your tab in Los Cabos, Mexico. They are no doubt celebrating their own importance over fine wine and rich food. We should be grateful for all the rich meals, though. When a politician is stuffing his gob it prevents him from talking. That’s a relief.

Julia Gillard and Wayne Swan must have anticipated the inability to eat and speak at the same time. They released a letter to the other G-20 leaders with an impressive amount of self-serving verbiage. There were the usual exhortations to do something. But what caught our eye was this bit:

‘Bringing forward investments in key infrastructure projects is an example of policies that can create jobs and boost demand in the short-run and add to productive capacity in the longer term. While the overall short term pace of fiscal consolidation will need to vary according to country circumstances, spending and taxation decisions can still be calibrated towards supporting growth.’

Blah blah blah. The same old tired tripe of spending more of other people’s money to create jobs. It’s the age-old apologia for increasing public debt. In this sense, Australia is not leading but following. It’s not news to anybody in Europe that you can borrow money to spend on public infrastructure. They’ve been doing that for years. The jobs, the corruption, the misallocation of capital…it’s all part of the European model.

And that model could soon be coming to an Australian council near you!

‘Local councils will be able to finance infrastructure investment through bonds raised by a national financing authority,’ reports Pip Freebairn in today’s Australian Financial Review. Regional and Local Government Minister Simon Crean will release a review of local government infrastructure financing when he speaks at the National General Assembly of Local Government in Canberra today. Don’t worry, though. If you’re not able to make it, we’ll tell you what Crean is likely to propose.

According to Freebairn, the report will make 13 recommendations on how councils ‘plan, finance, and deliver infrastructure investments.’ The key recommendation, in our view, is that a national financing authority would be established to directly invest in local projects. Reading this reminded us of how local government infrastructure projects are financed in China…and also the US subprime crisis. Why?

A national infrastructure financing authority (let’s go ahead and call it NIFA) could bundle up various council projects and securitize them. The Federal government could underwrite a bond offering. And the bonds could be sold to investors. Those investors just might be super funds.

You see what they did there?

Local projects that create jobs for connected local contractors and ensure votes for local politicians will be financed by a national authority that packages up the bonds and sells them so institutional investors, who use your money, can buy the bonds. Hopefully you’ll get a return on your investment. But if you don’t, you should be satisfied that your tax dollars are creating work and jobs for people in government and construction and in the retirement industry. Perhaps you could get a job in one of those industries as well.

This whole idea goes hand in hand with an issue we wrote about recently in Australian Wealth Gameplan: the backlash against stocks. Nervous economists and national planners know that investors can’t retire on gains made in the stock market – especially when the stock market isn’t making gains. Instead, they’re trying to engineer a shift in the allocation of Australia’s retirement assets from shares to government bonds, including infrastructure bonds.

But isn’t this all about taking on more debt at the local level to create busy-work and jobs for political reasons? ‘Local governments, which have very low levels of gearing, have plenty of scope to take on more debt,’ Freebairn summarises from the forthcoming report. Another recommendation is, ‘for the federal government to change laws so that councils can borrow against their forecast rate increases…This would involve local councils forecasting the increases in rates and taxes resulting from an infrastructure development.’

Hmm. What could possibly go wrong with that? A council makes an ‘estimate’ of the tax revenue generated from a new project. It treats this forecast future revenue as income and borrows against it. A debt is incurred on the basis of projected income from an asset that doesn’t exist.

Does that sound like a good development model for you Australia? Granted, you may get some mix of local assets that might not otherwise be built. But it’ll cost you. And what will the return on your investment be?

We realise there are some readers who think this is exactly the role of government at the local level: to deliver projects the private sector wouldn’t otherwise touch. But ask yourself, why won’t the private sector touch them? Is it because there’s no demand for it? No profit to be made from it?

All the lining up at the trough – the finance industry, the bankers, the underwriters, the bureaucrats, the local council officials who will cut ribbons, the politicians who will give speeches, the construction firms that will pour concrete and build buildings – they will all be in favour of this.

But will the productive capacity of the country be added to in a meaningful way? Or will the pockets of one group of voters be lined at the expense of another group? Is Australia set to become even more like Europe at just the moment that the European model is collapsing under the weight of its own bloat, waste, and corruption?

Regards,

Dan Denning
for The Daily Reckoning Australia

From the Archives…

The Disconnect Between US Household Wealth and GDP Growth
2012-06-15 – Bill Bonner

Playing The Financial Markets – The Greatest Game of All
2012-06-14 – Greg Canavan

The RBA’s Mortgage Market Denial
2012-06-13 – Dan Denning

Spanish “Assistance” or “Bailout”
2012-06-12 – Satyajit Das

Priming Your Investment Returns
2012-06-11 – Nick Hubble

Dan Denning
Dan Denning is the Editor-in-Chief of The Daily Reckoning Australia and the author of 2005’s best-selling The Bull Hunter (John Wiley & Sons). He began his financial publishing career in 1997 as a small-cap analyst. From 2000 to 2005 he was the managing editor of Strategic Investment, where he recommended gold and warned of the US housing bubble. Dan has covered financial markets from Baltimore, Paris, London and, beginning in 2005, Melbourne Australia, where he is the Publisher of Port Phillip Publishing. To follow Dan's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails.
Dan Denning

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3 Comments

  1. Don says:

    No real suprises here. The next step is to legislate that all super funds (including self managed ones) must hold a minimum % of their portfolio as government or now council bonds. I pick 10% intially and they just jack it up from there as the various crisis develope over the years.

  2. Rob CA says:

    Dear Don. Was already done by the then broke Whitlam Government in the 70′s when super funds, to remain compliant, needed to hold 30% of their assets in Commonwealth Government bonds 20% and State debt 10%.

  3. Ian Lucas says:

    The same old tired tripe of spending more of other people’s money to create jobs. It’s the age-old apologia for increasing public debt. In this sense, Australia is not leading but following. It’s not news to anybody in Europe that you can borrow money to spend on public infrastructure. They’ve been doing that for years. The jobs, the corruption, the misallocation of capital.

    Ahem… Couldn’t you apply the same analysis, in spades, to the private sector? If you want to see some real jobs, corruption and misallocation of capital, check out the FIRE sector.

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