Infrastructure Boom: Potholes Ahead

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A report released by the National Surface Transportation Policy & Revenue Study Commission in early 2008 weighed input from transportation industry executives, environmental and social equity constituents, and public advocates, and called for a thorough overhaul of the system before investing in new projects, says Puentes. Among other things, the commission proposed a shift from a cumbersome, overly complex program consisting of 108 individual priorities to a more manageable program comprised of 12 pieces focused on practical outcomes such as traffic congestion relief, metropolitan mobility, and safety.

But implementing such reforms won't be so easy. The federal government could decide it wants to spend money on congestion relief, but states aren't set up to do that right now because they're not trained to think in terms of outcomes or performance measures, says Puentes. "That would require states to think differently about their own transportation programs and that would take some time," he says. Some states, however, including Massachusetts and New Jersey, have histories of giving priority to ensuring that existing systems work properly over building new systems, he adds.

Continuing to funnel money into the old system would also run up against the current transportation debate, which largely centers on breaking away from a carbon-based economy, says Kris Nielsen, chairman and president of Pegasus Global Holdings, a Cle Elum (Wash.) firm that consults on infrastructure projects. "Does that mean we should build more transit systems or long-haul railroads or go to other modes that are less petroleum-intensive, or do we invest in continuing what historically we have always done?" he says. That's a question Nielsen is currently addressing for a handful of engineering and construction contractors.

How maintenance and repairs of highways across the U.S. are paid for gets to the core of the carbon fuels issue. The highway trust fund, which covers those costs, is funded almost entirely by the gasoline tax, which has been dwindling for the past few years as Americans have been driving less and driving more fuel-efficient vehicles, says Puentes at Brookings. In September 2008, $8 billion had to be shifted from the general fund to cover a shortfall in the highway trust fund, he says. What may be the most viable alternative to using gas taxes to fund the highway trust fund is sure to be a hot political topic this year, predicts Nielsen.

A Tricky Muni-Bond Market

Issuance of municipal bonds, which traditionally comprise a significant portion of state and local government funding of infrastructure projects, has fallen sharply, particularly for variable-rate bonds that are a preferred source of short-term funding. While the volume of five-year variable-rate bond issuance more than doubled for all of 2008 from 2007, issuance for December fell 35% from the prior year, says George Friedlander, a muni-bond analyst at Citigroup (C). On the fixed-rate side, stronger credit-quality bonds rallied in the second half of December, widening the discount at which weaker-quality issues are trading.

The primary draw of the variable-rate bonds is how low borrowing costs are on the short end of the yield curve. The problem is that many state and local governments don't have access to that part of the market because their credit ratings aren't high enough for their debt to be eligible to be held by money market funds and they require a liquidity backstop from banks, which are scarce and very costly, he says.

A bigger challenge for state and local governments than financing infrastructure, however, is getting the funding needed to allow basic government services to continue to be provided, he says. "It would be counterproductive for the states and their subdivisions to be forced to cut spending too much—lay off workers and provide less services," says Friedlander. Unless the states are given support to meet their budget needs, their access to the municipal bond market is sure to erode more quickly as a result of worsening credit problems, he says.

Limited Access for Smaller Contractors

There's no shortage of road, bridge, and dam construction projects on the shelf ready to go once federal funds starts flowing. The bigger projects that are typically awarded to the big contracting outfits will probably swallow up most of this money, but more jobs would be created by financing small projects that are usually done by smaller contractors that need to finance every project, says Nielsen at Pegasus. Since advance payments are prohibited by U.S. bidding statutes and since most of these contractors live job to job, they may be passed over by local governments awarding contracts that need to be assured a contractor has the financial wherewithal to complete a project.

"Without some change, particularly in public bidding laws, I fear there won't be as quick and as responsive a stimulus as is being forecasted," he says. "I'm not saying at all that pubic bidding laws should be relaxed, but that is something that has to be addressed or considered" in order for a bigger group of cash-strapped contractors to be able to compete for parts of the infrastructure pie, he says.

Bogoslaw is a reporter for BusinessWeek's Investing channel.