Affordable Housing Institute : US

I have devoted the last week to two lengthy multi-part posts illustrating the fundamental problems that capital faces when it pays an entrepreneur before the entrepreneur performs the desired and valuable public-policy service, and listing fundamental do’s and don’ts of designing such programs.

 

That these two structurally similar cases are factually quite remarkably diverse — what can an NFL football player have to do with an oil pipeline in Chad? — demonstrates, I claim,

 

 

“I claim these insights in the name of AHI!”

 

that the core problems of Pay-Before-Performance (PBP) are universal, and applicable to affordable housing development programs.  

 

Pay-Before-Performance examined structurally.  We can set up the three situations as follows:

 

Pay-Before-Performance

Structural analogous cases including affordable housing development

 

Entrepreneur	Capital source	PBP funding provided	Desired outcome
NFL football player	NFL team	Contract signing bonus	Quality on-field play
Autocrat or dictator	Multinational (World Bank)	Development grants, loans, or guarantees	Public infrastructure for poverty alleviation
Housing developer	Government funder	Grants, hard-debt loans, loan guarantees	Sustainable affordable housing

 

In each case, the capital wants a long-term outcome but has to provide money up front, which shifts the risks from the entrepreneur to the capital.  This upsets normal enforcement dynamics in all sorts of ways, all of them hurtful to capital’s objectives:

 

1.         Performance control versus payment.  It is axiomatic that the person who has control should be in the first-loss risk position.  But paying money before performance shifts first-loss risk to the non-controlling party.  The person who has control has less risk than the person who has more capital and less control, so the entrepreneur can ignore the back-seat driver.

 

 

“I’m keeping a close watch on your activities.”

 

            2.         Funds not used for desired purpose.  If capital pays before the goods or services are delivered, there’s always a risk they will not be delivered as promised:

 

A 2004 World Bank report on corruption noted that bribery is a trillion-dollar industry, causing far more wealth to flow from poor countries to rich countries than the poor countries receive in foreign aid.  

 

Kenya ministry of Lands and Housing, summer, 2005

 

Whereas an estimated trillion dollars of foreign aid was given to poor countries between 1950 and 2000, at least 5% of the world’s domestic product (amounting to $1.5 trillion in 2001) goes into the financial markets of wealthy countries in the form of money laundering.  Focusing on Africa, The Economist reported that 80% of the funds lent between 1970 and 1996 “flowed out as capital flight in the same year.”

 

If only we had Cary on the case ….

 

            3.         Misaligns OODA loops.  Relative to capital sources, which are large lumbering bureaucracies, entrepreneurs are small, nimble, and have much faster OODA loops.  As a result, entrepreneurs can shift their tactics mutably, with lightning quickness, and consistently wrong-foot the capital. 

 

That multiple-shifting substantially increases the chances that capital will err in its enforcement, enabling the entrepreneur to escape justice. 

 

In Chad’s case, a cutoff of bank money raises serious geopolitical concerns as well, because it might increase the risk of a financial collapse for the government that could lead to Chad joining other neighboring countries as a failed state and a haven for terrorists. The cash-strapped government has already fallen into arrears on salary payments to civil servants. Doing the same to the military raises the danger of a bloody coup against Deby, who has ruled Chad since seizing power in 1990.

 

(Mr. Owens, for all that I have chided him, has consistently demonstrated a genius for new tactics that disorient the enforcers and win sympathy from bystanders.)

 

 

Terrell Owens, after catching a touchdown pass, pulled out a Sharpie pen, autographed the ball, and tossed it into the crowd.

 

            4.         Clawback is often toothless because the money is gone.  Give a dictator money to build a dam, and your best outcome is the dam gets built, but you cannot repossess a dam.  So clawback, even if theoretically contractual, is often toothless.

 

Allowing the [Chad] government to take money from the London escrow fund might only invite further waste and would set a terrible precedent for future projects in the oil and mining sector, bank officials fear, by signaling that such “ring-fencing” arrangements don’t work.

 

Similarly, once a bonus has been paid to an NFL player, it is gone forever.  In the specific Terrell Owens case, the Eagles demonstrated additional forethought in their move:

 

For the second time in five months, the Philadelphia Eagles have requested that exiled wide receiver Terrell Owens repay part of the signing bonus that he received when the club signed him to a seven-year, $49 million contract in 2004.

 

The Eagles crafted Owens’ contract carefully and precisely, in part to protect themselves financially, and there is very specific “default” language which provided the team the prerogative to seek repayment of a prorated portion of his signing bonus if he was suspended for more than one game.  

 

[T]here is a chance that the club will garnish Owens’ wages for the final five games of the season, or $191,176 per week, as part of the repayment.   [It appears they did. — Ed.]

 

Even the Eagles’ careful precautions merely demonstrate that in PBP cases, it takes exceptional care to avoid having toothless clawback provisions.   The World Bank has no such remedy available to it.

 

            5.         The clawback hostage problem.  If capital seeks to recapture (or, in Anglo-speak, claw back) its funds, it faces the problem that reclaiming the money normally hurts not the malefactor but the beneficiaries.  In the World Bank’s case, the dam has been built; the beneficiaries are Chad’s poor, but to assist them, the bank must deal with Chad’s elected dictator, Idress Deby, and he has shown complete willingness to use them as involuntary economic human shields.

 

The bank has the legal right to take punitive measures in response to any action by the Chadian government to change the agreement, which so far has generated more than $300 million in revenue for public purposes in Chad.  The measures could include barring new aid to the country and insisting on immediate repayment of the loans it made for the pipeline. But the bank is instinctively loath to cut off financial ties with a country; it argues that the country’s poor are likely to suffer most from the withholding of aid — a painful prospect in Chad, one of the world’s most impoverished nations, where 80% of the population relies on subsistence farming and livestock raising.

 

Implications for housing program design.  But, asks the attentive reader, doesn’t affordable housing always cost money?  How else can one close the cost-value gap?  Isn’t payment up front an intrinsic condition of property development? 

 

Yes … and no.

 

 

“Man, the personal-computer biz is a lot easier ….”

 

Somebody has to pay before performance, but it needn’t be government.  Government can pay after performance by using soft equity, paid after performance but sold based on the future promise.  In other words, post-completion tax incentives.

 

Like tax credits.

 

In structural terms, the great beauty of tax credits is that they shift performance risk from government to the private sector.  That’s why government pays its discount (between credit face price and the equity raised), because:

 

• Government pays only after performance even as the private sector pays before.
• When it comes time to claw back funds, the investors are collectible.

No appropriated grant can replicate these features.  They can be stimulated, and approached, but not matched.

 

You really want to try colleting this from little old ladies?

 

By no means does this make tax credits foolproof or infinitely portable.  But in funding programs that are intrinsically Pay-Before-Performance, a soft-equity-driven system accomplishes a risk shift, one whose value has been proven (the hard way) by decades of experience and billions in grant losses.

 

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