Will Midway Lease Re-Start U.S. Airport Privatization?

Like toll roads, other countries are far ahead of the U.S. in airport privatization

Two years ago this month, the City of Chicago received a check for $1.8 billion for the 99-year lease of the Chicago Skyway lease. Two years before that, most pundits would have considered the idea as some kind of libertarian pipe-dream. But today, not only has the high valuation been validated by subsequent leases of the Indiana Toll Road and the Pocahontas Parkway, but serious efforts are under way, with bipartisan support, to lease the Illinois State Toll Highway system, the New Jersey Turnpike, and the Pennsylvania Turnpike.

So Mayor Richard Daley’s current efforts to lease Midway Airport should be taken very seriously. To begin with, as with toll roads, the rest of the world has long since accepted airport privatization as a sensible policy. To be sure, when Margaret Thatcher sold what was then the British Airports Authority via an IPO in 1987, it was viewed as a one-off transaction, as radical as the Skyway privatization in 2005. But in the two decades since 1987, over a hundred airports have been privatized worldwide-in Europe (Belfast, Brussels, Budapest, Copenhagen, Dusseldorf, Frankfurt, Hamburg, Rome, among others), South Africa, Latin America (Argentina, Chile, Colombia, Mexico), and Asia-Pacific (Auckland, Brisbane, Melbourne, Sydney, and others, with Hong Kong and Tokyo in the pipeline). About a dozen global airport companies are on the prowl for acquisitions, and as it has done in toll roads, Macquarie has created a privatized airports mutual fund for global investors.

Why has the United States been virtually untouched by this phenomenon? As with highways, several uniquely American institutions have kept airports as an almost exclusively public-sector enterprise. First is a user tax/trust fund system analogous to the fuel tax and Highway Trust Fund system in highways. Second is the availability of low-cost capital via tax-exempt revenue bonds for airports. But third-unique to the U.S. airport sector-has been the joint-venture nature of airport governance.

In most countries, prior to the wave of airport privatizations, state-owned airports generally operated like shopping malls: the state-run airport company related to the airlines as landlord to tenant. Generally, this meant that the airport controlled all the space, including gates, assigning them dynamically to airlines as needed (common-use gates). Airlines paid landing fees and space rentals, at pre-set rates, based on how much of the facilities they used. This businesslike model has continued under privatization, meaning very little change for the airlines.

In sharp contrast, the typical U.S. model is one in which the anchor-tenant airlines signed long-term lease-and-use agreements, giving them exclusive control of entire terminals or concourses and the right to approve or veto capital spending plans. And under the common “residual cost” lease agreement, what such an airline paid each year in landing fees and space rentals was determined by the airport’s prior-year budget outcome. The difference between total (non-airline) revenue and total expenses was defined as the residual cost, and was to be recovered out of landing charges and space rentals in the following year.

This type of arrangement made the “signatory airlines” joint venturers with the airport. If times were good and passengers were abundant, the airport would take in lots of revenue from car rentals, parking, and retail sales, leaving a small amount to be divvied up among the airlines. But the airlines also took the risk that in bad years, precisely when their own revenue from fares fell short, the airport would also do poorly on non-airline revenues, and hence have to hit the airlines with higher landing fees and rental rates. However, in exchange for sharing in the risks, the airlines gained the very useful ability to veto what they considered extravagant capital spending-or terminal expansions that would make it easy for new competitor airlines to add a lot of service.

In the early 1990s, quite a few U.S. mayors saw what Margaret Thatcher had done and wanted to sell or lease their airports. But the airlines raised a hue and cry about potentially huge increases in airline charges, which they would have to pass through as higher air fares. And they also pointed to the very restrictive conditions attached to federal airport grants. Those grant agreements implied (though pro-privatization attorneys argued for different interpretations) that should an airport be privatized, the city in question would have to repay all previous federal airport grants. Moreover, the FAA interpreted a provision requiring that all “airport revenues” remain on the airport and be used solely for airport purposes to apply to lease or sale proceeds.

In the face of these arguments, privatization proponents went to Congress for relief, resulting in the 1996 Airport Privatization Pilot Program. It allowed exemptions from the most onerous provisions of the airport grant agreements for up to five airports. Cities whose airports were accepted for the pilot program would not have to repay previous grants. And they would be able to take the sale or lease proceeds downtown. But the airlines lobbied hard for what some described as a poison pill on the latter provision. In order to make use of lease or sale proceeds, a city has to get the approval of 65% of the airlines serving the airport-which the airlines assumed would never happen.

And that is pretty much the explanation for why not much happened in the 10 years since the pilot program law was passed. The only airport actually privatized under it-Stewart Airport in Newburgh, NY-did not get the airline approval. Therefore, New York State is required to use its lease revenues for improvements to Stewart and other state-owned airports.

So why does Mayor Daley think he can lease Midway? For one thing, there has been a sea change in the U.S. airline market since the mid-1990s. The major airlines (now called “legacy carriers”) have lost a fortune in recent years, as well as losing about one-third of the market to the new generation of low-cost carriers (LCCs). In their much weaker financial condition, today’s airlines are more risk-averse and more cost-conscious than ever before. The old risk-sharing residual-cost model of shared airport governance has lost a lot of its charms. Moreover, the legacy carriers (American, Delta, Northwest, United, etc.) have had another decade’s worth of experience working with privatized airports in Europe and elsewhere. Even Southwest-the archetypical LCC-sees merits in the idea of stable, predictable landing fees and space rental rates, as a Southwest official admitted to this newsletter last summer (PWF, July-August 2006).

So I find it plausible that Chicago and potential airport acquirers would be focused on coming up with a deal that Midway’s airlines could find attractive. But if they can’t, Mayor Daley could decide to go forward with the privatization anyway, like New York State did. Without airline approval, he’d be constrained in the use of the lease revenues, to be sure. They could only be used for airport purposes. But the City of Chicago just happens to have another airport, O’Hare, that’s embarked on a $15 billion expansion. If a good-size chunk of that could be funded by Midway privatization proceeds, the city and O’Hare’s airlines would both be better off. Since the only important Midway airline that does not serve O’Hare is Southwest, it will be under some pressure to strike a deal at Midway that gives it as good a deal as possible, rather than a deal done without its consent that helps its competitors at O’Hare.

Thus, assuming Mayor Daley is re-elected in February, I think the Midway lease is likely to go through. And if it does, we may well see a repeat in the airport sector of what has been happening in toll roads since the Chicago Skyway lease.

Robert Poole is director of transportation at Reason Foundation. An archive of Poole’s work is available here and Reason’s privatization research and commentary is here.