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Innovative Investment Strategies Can Increase Money for Safe and Clean Water

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Funding model and investment strategy innovations pioneered by New York and Connecticut provide a roadmap for the country as it faces a critical and growing safe drinking water and wastewater infrastructure funding gap.

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We will need to invest at least $636 billion over the next two decades to keep our water systems in safe working order, according to EPA estimates. That could mean Americans will pay higher water bills in the coming years. But we can curb that increase if clean water and drinking water state revolving funds—the vehicles through which most water infrastructure investment is done—make better use of their existing resources.

State water funds, which make low-interest loans to water infrastructure projects, are not optimally investing their assets and are not getting the kind of returns necessary to meet future needs. These federally backed “revolving funds” could generate billions more without any more taxpayer funding if they invested their money better, according to a recent report by the Environmental Protection Agency’s Financial Advisory Board.

That’s what New York and Connecticut revolving fund administrators have done in recent years, investing in longer-maturity, high-grade bonds that yield more than comparable Treasury securities, and thereby increasing capital available to finance water infrastructure projects. Congress and the EPA, which oversees and financially supports these funds, should encourage more states to adopt similar investment practices.

“If … states followed the innovative approach used by the New York and Connecticut state revolving funds, more public funds would be available to help cover the cost of needed drinking and waste water system upgrades,” says advisory board Chairman Brad Abelow.

Today, state revolving loan funds receive more than 80 percent of their money from the federal government, which amounts to slightly more than $3 billion annually. The rest comes from states. As with a pension fund, some of a fund’s money is invested to ensure it has enough capital to support future financing commitments.

The similarity ends there.

The EPA’s Financial Advisory Board report notes that, unlike pension funds, the majority of states invest their funds in traditional low-yield savings accounts or conservative short-term investments such as short-maturity municipal bonds and Treasury notes. Those types of investments today earn far less than 1 percent a year, which means they do not grow capital sufficient to help meet future infrastructure needs.

The report notes, however, that some state revolving funds have adopted strategies that allow for greater returns on fund assets. New York’s revolving fund, for example, uses portfolio management methods similar to that of education endowments and pension funds. It invests in both short-term and long-term investments, in a variety of asset classes, to allow for greater capital growth and increased lending capacity.

The New York fund’s investment portfolio today consists of short-term securities as well as highly rated and long-term fixed-income securities, such as taxable municipal bonds, which are higher yielding yet safe investments. The shift in New York’s investment strategy requires less capital and has allowed the state to deliver financial assistance benefits to local governments with greater capital efficiency. The fund has been able to invest a portion of its capital at rates of return sufficient to annually free up more than 25 percent in additional project funding. That’s good news for a state that will need to spend more than $38 billion on water infrastructure investment over the next 20 years.

So why aren’t more states adopting similar strategies? One reason is that states are concerned that these types of innovative financing strategies run afoul of the federal laws that created the state revolving loan funds in the first place. That’s why Congress should amend the Clean Water and Safe Drinking Water Acts to make it clear that these innovations are permitted. In doing so, Congress should require all states to employ the loan management model now used in a majority of states where a combination of tax-exempt bonds and reserve funds increase the portfolio earnings over time. Congress should go a step further and explicitly provide fund administrators with the investment authority necessary to invest in high-quality, long-term fixed-income assets that allow for greater returns and increased capital available for lending.

Of course, there is greater market and credit risk in investing in assets beyond conservative, short-term fixed-income securities. These risks can be effectively managed by matching investment horizons with project-financing horizons and by adopting portfolio diversification requirements and sound due diligence standards for evaluating credit risk. The EPA and Congress can develop regulatory and investment standards, similar to those employed by pension funds and university endowments, to ensure administrators do not take on excessive levels of risk.

The funding model and investment strategy innovations pioneered by New York and Connecticut provide a roadmap for the country as it faces a critical and growing safe drinking water and wastewater infrastructure funding gap. Unless states harness these gains and strive for continued innovations to better put these funds to work today, we won’t be able to meet our infrastructure needs tomorrow.

At a time when government budgets are tight, we must use public money as efficiently as possible. CAP suggests that policymakers read our simple “how-to guide” for increasing the flow of funds for water improvements by tapping the earnings potential in the private marketplace. New York and Connecticut have found good ways to do that. Other states should, too.

Donna Cooper is a Senior Fellow and Jordan Eizenga is a Policy Analyst at the Center for American Progress.

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