On Friday the 13th of February, the City of Chicago saw the first of a planned series of parking meter rate hikes which will eventually quadruple the hourly parking rate in the downtown area.  This is happening because last year the City of Chicago sold the cash flow from parking fees for approximately $1 billion to a private investment fund.  (No doubt soon to be securitized and tranched into Meter-Backed Securities.  Quick:  tell me how to price CDS protection against the event that Daley renegs once the billion is spent.)

The deal enables Chicago Parking LLC to raise fees according to a set schedule over the next ten years.  After that, further rate increases must be approved by the City Council.  The contract expires in 75 years.

Why would the City go for such a deal?  Yes it is starved for cash and parking meters currently hard-wired at 50 cents an hour in most of the city are long overdue for an uptick.  But this just argues for a fee increase, it doesnt explain why the meters should be privatized.

The economics of privatization are straightforward in this case.  The city seeks bids for the parking meter cash flow.  A bidder offers an upfront payment and a schedule for price increases.  The upfront payment will be no less than the present value of the cash flow as determined by the new prices.  Competition will ensure that the payment will be exactly this cash flow.  This means that the high bidder will be the one who demands a price that maximizes the present value of cash flows.  In other words, the monopoly price.

Remember from your textbook microeconomics that the monopoly price is associated with inefficiently low quantity.  Zero marginal cost doesnt make this any less damaging, in fact it implies that on many streets there will be empty spaces all day long.  Cozy, inviting parking spaces will be utilized by nobody.

Again the city could set the monopoly price on its own, so we still have the puzzle of why, if the City is willing to allow monopoly pricing it has to use a private entity as its agent.  The answer is not because the City wants its cash up front.  Apparently it does want its cash up front but it could always just borrow against the parking cash flows.

The only answer I can come up with is a commitment problem.  The City could certainly borrow against the cash flows and set the monopoly price but then the City itself would be the target of the uproar that will soon occur when drivers in the city realize that their cars are now worthless.  The political pressure would force the fees to be kept low and the City would then have to find another way to finance its parking debt.  In fact, foreseeing this, no lender would be willing to lend the full present value of monopoly cash flows.

By contractually delegating the fee-setting to a private agent, the City effectively commits never to lower fees so that the monopoly cash flow is guaranteed and the City can extract it all in an upfront payment.