The Rotten Core of our Most Spectacular Privatization — the CNR
Canada’s picture poster of successful privatizations has suddenly made the front pages. The Globe and Mail (27/11, "CN slashes 5% of work force – Asbestos claims bring $175 million charge" by Paul Waldie) reports: "Canadian National Railway Co. announced 1,146 job cuts yesterday and a $175 million provision to settle a growing number of personal injury and asbestos claims in the US." The shares of the company fell by a full 6% on the Toronto Stock Exchange. The job losses are the result in part of the drought in Western Canada which has reduced the CN’s grain revenue by 13%. It also needs fewer workers because it has been cutting the number of locomotives and rail cars in recent years by 32% and 12.5% respectively.
"Asbestos lawsuits have become a huge issue in the US where the number of cases has quadrupled in the past decade. Railways currently face nearly 10,000 claims from employees who say they were exposed to asbestos and repair shops."
The bad weather of the past year would hardly in itself justify massive layoffs. The CNR’s shopping spree buying up American railways has transformed it into the largest North American railway. It has turned its axis from east-west – the purpose for which it was created at considerable cost to the Canadian taxpayer – to north-south – once again at the cost to the Canadian taxpayers in money and services. One might imagine that such decisions were best left to our government, rather than to a corporation adept at seeking private advantage at public expense.
The Iron Lady Put in the Shade
In certain respects, the details of the CNR privatization leave even Maggie Thatcher’s classic disposals of public assets in the shade.
As the world’s industrial pioneer, Britain almost inevitably ended up with many obsolescent industries, that became ideal candidates for either nationalization or privatization as the political winds might blow. Moreover, corporations having to do with communications like railroads or telephones may hold hidden crown jewels beneath pools of red ink. These could become tempting to civil servants themselves poised on the brink of privatization.
In The National Wealth – Who Gets What in Britain1 Dominic Hobson summarizes the complex record of privatization in Britain: "By 1997, privatization had become the stock-in-trade of satirical comedians. Their efforts, and those of tabloid journalists, gradually reduced the public appreciation of privatization to massive pay rises for bosses, higher prices for customers, and a pay cut or sack for employees. Caricature has erased memories of what went before. At the time it was privatized BT had 250,000 customers waiting for a telephone line to be installed. The public telephone boxes doubled as public lavatories. Electricity and gas prices went down before elections, and up after them. In the water industry, the sewers were crumbling, the beaches a disgrace, the rivers were filthy, and water shortages commonplace. The public images of British Rail, its timetables regularly undone by ‘the wrong sort of snow’ and leaves on the line, was of grubby trains and surly staff." Clearly the author of this book is no doctrinal opponent of privatizations.
Hobson continues, "Few remember these things now. After twenty years of privatization, how public assets were sold matters more than why. The main criticism is that they were sold for less than they were worth. From 150 sales between 1979 and 1997, the government raised £90 billion in real terms, or about half the net value of the nationalized industries. The size of this gap is the reason why the shares in privatized companies almost always soared in value in the first few days after the sale. Shares in Amersham International, British Airways, British Telecom and Rolls-Royce were all worth a third more than the offer price within a week. A reluctance to sell shares in stages, or organize competitive auctions, usually denied the taxpayer any stake in the appreciation of the stock.
"The chief architects of privatization, Margaret Thatcher and Nigel Lawson, have both admitted that they were prepared to sell nationalized industries cheaply to speed their exit from the public sector and to widen share ownership. In February 1982, Lawson was responsible for the privatization of Amersham International, the radio-chemical company. Its shares soared to a premium of 35% in early trading after being oversubscribed 25 times at the offer price. But the former chancellor is unapologetic: ‘The serious underpricing of Amersham, though in no sense deliberate, may have been no bad thing. The enormous publicity given to the profits enjoyed by subscribers conveyed the clear message that investing in privatization was a good thing.’ There lies the crux of much of the world’s trouble – "the good thing" consisted largely of the illusion that such outrageous speculative profits could be actually earned by the efficiency of the private companies, rather than in a give-away of public assets, a waning condition for such state of bliss.
"To attract ordinary people, privatization shares also had to be sold at a fixed price rather than by auction, because they could not guess the right price to pay. The two sales priced by auction, Britoil and Enterprise, both flopped, But the subsequent performance of fixed price issues often made the initial valuation embarrassing. BT shares, which City advisers had insisted would flood the market, went to an immediate premium of 91%. Under pressure from the National Audit Office (NAO) and the Public Accounts Committee, the government slowly got better at pricing privatization issues It appointed an independent adviser on pricing, and began to take a more sceptical view of City advice.
"At privatization, nobody even thought to charge a premium for the public land under which BT cables were laid. The NAO later believed the government had sold the English and Welsh water industry for £2.3 billion less than it was worth. The Medway Ports, bought by the management for £29.7 million in March 1992, were sold eighteen months later to Mersey Docks and Harbour Company for £103.7 million. Ownership of the National Grid was transferred to the regional electricity companies at a valuation of £1 billion in 1991. Just four years later the companies themselves valued it for sale at four times this amount. Even the Conservatives were sufficiently embarrassed by this cheeky plan to threaten its owners with a windfall tax. Royal Ordnance, sold to British Aerospace in April 1987 for £190 million, turned out a bargain. Within a year, unwanted factories sold by the taxpayers for £5 million were sold to property developers for £450 million."
Unheeded Lessons for the CNR Privatization
All this is highly relevant to the privatization of Canadian National Railways. Even Margaret Thatcher eventually learned that privatizations could take place in several installments , so that by the time the market had come to appreciate the give-away feature of the first offering, the government could at least participate in the share prices that reflected these in the later installments.
That was not done in the case of the CNR. To prepare it for privatization in May 1995, the government as seller reduced its long-term debt by $1.4 billion, and threw in a $900 million equity contribution. It transferred to itself all non-rail assets for future sales, where the Thatcher government relied on a claw-back clause that gave the right of the state to half of the proceeds of future sales of such assets when the privatized company sold them. In this way instead of exposing itself to the greed of the stock market and its own record of incompetence in the very deal it was negotiating with the privatized railway, it would piggy-back on the resale deals that company might strike with other private companies.
"‘Clawbacks,’ in which the government reserved the right to reclaim the proceeds of post-privatization asset disposals, became a regular feature of sales as the British programme matured. When electricity was privatized, the government reserved the right to clawback half the profits made by the regional companies on the sale of surplus property, and withdrew the Central Electricity Generating Board headquarters (near St. Paul’s) and Bankside Station (in Southwark) from the sale rather than see them sold or redeveloped after privatization. When the bus companies were privatized, many of their most attractive city centre properties were withheld and sold separately.
"The sale of British coal which put one of the greatest landed estates on the market, was shaped by this growing [very British] awareness of the value of real estate. Though its land holdings were much reduced since the 1940s, British Coal still owned around 250,000 acres and in its last years of public ownership, earned £35 million a year from sales of unwanted property. R.J. Budge, which bought virtually the whole of the English coal industry, acquired a mere 14,000 acres of freehold land, and other buyers acquired negligible leaseholds. Any profits from property disposal by the new owners were clawed back fiercely, and the bulk of the estate was retained for future sale.
"The privatization of British Rail, sometime owner of an estate of over 200,000 acres, was accompanied by a similar division of the spoils. The operational assets of the railways – tracks, stations, signalling equipment and engineering works – now belong to Railtrack PLC. But non-operational land was retained by the British Railways Board. Its property subsidiary is now landlord to outmoded buildings, disused yards, vacant plots and disused viaducts and bridges. (British Rail did not know how much property it owned.)
"In its anxiety to privatize the railways, the government allowed some gems to escape. One reason Railtrack shares rose from £3.90 on flotation in May 1996 to over £10 less than two years later was the over-endowment of the company with property. Railtrack owns a portfolio crammed with rent-producing assets and commercial sites ripe for redevelopment or disposal.
"Most of the 2,500 stations are leased to the train operating companies, but Railtrack has retained the right to redevelop the most promising. Railtrack will make £1 billion from property rents and developments during its first years in private ownership.
"The first train franchises to be sold had to be fattened with high subsidies." At least the Brits have had the educational advantage of their National Audit Office conducting a post-mortem that helped them recognize that they had been had. Nothing of the sort has happened in Canada. Hence the botched privatizations of Ontario Hydro. A post-mortem on the CNR scam could have saved the Ontario public much wealth and sorrow. According to the NAO, the seven British Rail train maintenance depots were sold for only £32 million when they had £17 million of cash on their balance sheets. The track maintenance units went cheaply too. A construction company called Jarvis bought the Northern Infrastructure Maintenance Unit for £11 million in 1995. A year later it was worth £50 million. These losses escaped public censure. But the underpricing of the rolling stock leasing companies (Roscos) was too large to lose in the financial pages. Assets valued at £3 billion were sold for £1.3 billion. Within two years, all three Roscos were sold to new buyers for an additional £790 million. A Japanese bank made £330 million when one of them was sold. The management buyout team at another turned a joint investment of £300,000 into £83.7 million, a three hundred-fold increase in a matter of months.
For an idea of the extent to which the Canadian public was taken to the cleaners appears from the course of CNR stock. The high in its first year 1996 was $28.50 which was roughly double its low for that year. By 1999 it had touched a high of $54.58. Options were issued to insiders exercisable for as little as $13.50 a share. In March 2001 the CNR completed the sale of its 50% interest in the Detroit River Terminal Company, showing a post-tax profit of $82 million over the book value at the time of the sale.
We also miss the sage provisions in some lands that prevent an ex-civil servant from dealing in public assets for some years after his retirement. But Paul Tellier, the CEO of the privatized CNR had been Clerk of the Privy Council, who knew where all the dead bodies and the family jewels were buried.2 All in all it was done in a style that could have made a central Asian ex-Soviet republic proud. By slipping up on the nationalization of the CNR, the government and its watchdogs were emitting encouragement to the privatizers of Ontario Hydro. However, this did help instill some signs of life in an already moribund stock market. That in fact was the prime purpose of the operation.
The ultimate theme of Hobson book is the relative merit of nationalization and privatization. But to see that more clearly we must satisfy ourselves on at least two matters:
(1) Does the accountancy of the public sector distinguish between a capital investment by amortizing it over its useful life, or not? Obviously if it does not, there is no basis for comparing real as opposed to reported costs of nationalized and privatized services.
(2) Were near-interest-free credit of the central bank available to the government for essential public services, the scandalous giveaways that passed for sales would have been unnecessary. Inexpensive capital could have been raised for rationalizing essential public companies via the central bank against government guarantee. Since the interest paid on such loans would revert to the sole shareholder of the Bank of Canada – the Government of Canada – it would have been a virtual interest-free loan. That might have made privatization unnecessary.
The Hobson book is thus useful on a variety of planes. It discloses some of the safeguards against the corrupt exploitation of privatization that even Mrs. Thatcher eventually learned, but have still to reach our shores.3
The nationalization of the Canadian National Railways by market criteria – and not many others have been in vogue in recent years – was the most successful of our privatizations. In three or four years its market value rose by a multiple of approximately four. That paper bonanza was interpreted as a sign of the wisdom of nationalization – but it might also have raised doubts about whether the privatization was a sale , or a case of a high civil servant using his inside knowledge and his connections to make a killing.
Historically the CNR was the government’s collection of walking wounded. It had gathered into the public bosom the bankrupt and near-bankrupt railways that had provided the heavy stitching necessary to create the country called Canada. That could hardly have been left to the wisdom of the market. Naturally, unprofitable lines have been abandoned or sold off by the CNR to smaller operators. Even the first Canadian transcontinental that had joined the country together further south required generous financial lubrication by the government that left an epic scandal in its wake. However, the CPR incident besmirched our early history as a nation will in time be downgraded to kids cheating at marbles by the dubious CNR privatization in our adulthood.
1. Hammersmith, London: Harper Collins Publishers, 1999.
2. Since this was written, Tellier has resigned his post as CEO of CNR to become CEO of Bombardier, an already privatized concern that stands in need of major government assistance. The Globe and Mail (14/12) quotes a close friend: Mr. Tellier’s knowledge of how government works would be an advantage in any business."
3. The near-encyclopedic range of Hobson’s review was bound to leave some poorly covered areas. It is unfortunate, too, that the outstanding of these should be the Bank of England, the independence of which from government is treated as just another manifestation of the systole and diastole that keeps the economy pumping. "In theory, there is no reason why competition should not confer the same benefits in the markets for money as it does in the markets for other goods and services. Competition between many different private and state ‘brands’ of money would not necessarily lead to chaos. Counterparties would conduct their business in the most reliable and stable currencies, and competing currencies might or might not be convertible into a basic form, such as gold or a basket of goods and services."
This ignores the use of non-interest-bearing reserves that before the 1990s had been put up by the commercial banks as a ratio of the deposits they have accepted from the public. This had been a modest remnant of the seigniorage of ancestral monarch’s monopoly for coining precious metals. Equally important, those statutory reserves provided the central bank an alternative to higher interest rates for controlling "inflation." Interest rates are after all the revenue of an economic group that should not be encouraged to become predatory. Moreover, the very concept of "inflation" – that identifies all increase in the price level with an increase of demand – is in need of re-examination. A modern economy is unthinkable without higher educational, social, and health standards. And these do require an ever more massive investment of public capital that must show up as a deepening layer of taxation in price. It is very well talking about having private and public currencies compete for government acceptance, but that sidesteps the crucial question of the deregulation of our banks that forced national corporations to seek their capital on the stock market and in wildly leveraged derivative gambles covered in the Hobson book.
— from Economic Reform, January 2003