Taxi Medallion Bubble Bursts

Medallion owners have started defaulting on their loans. Drivers won't rent from them at high daily prices when they can drive UberX on their own. So the owners' income has fallen, along with medallion prices. They can't keep up with their loan payments.
09/23/2015 04:51 pm ET Updated Sep 23, 2016

While riding home from the airport in a Chicago taxicab recently, I got into an interesting discussion with the driver, who also drives for Uber. He explained that he "rents" his cab from the taxi company because he sold his two medallions a year ago, when he realized the value of the medallion (an exclusive license to drive) would go down as UberX started allowing individuals to drive their own cars.

It seems there had been a thriving market in the limited number of medallions, but the entrance of UBER broke the monopoly power of these licenses, crushing their value. In April 2014, thirteen medallions were sold in Chicago, for an average price of $342,150. In July 2015, only one medallion sold -- for a price of $150,000. And when I contacted the largest medallion broker in the city, he said he currently has 11 medallions for sale at an offering price of $150,000 -- but no one is willing to bid for them, and he hasn't even received a lowball bid!

The price of taxi medallions has crashed. But that's not the only problem.

My driver explained that many of the smaller taxi companies had "pledged" their medallions as collateral for loans to acquire additional cars and attract more drivers. Now the collateral for those loans is underwater, and owners (and their banks) have the same problem the mortgage companies had eight years ago: falling prices.

Medallion owners have started defaulting on their loans. Drivers won't rent from them at high daily prices when they can drive UberX on their own. So the owners' income has fallen, along with medallion prices. They can't keep up with their loan payments.

I was still musing about this free market impact, when I received an email report from economist Brian Wesbury of First Trust Advisors (www.FTPortfolios.com) in Wheaton, Ill. It seems that the economics of taxi medallions in Chicago is just a microcosm of a problem that is emerging nationally, and especially in New York -- with serious consequences for the banking industry.

Wesbury's commentary centers on the takeover late last week of New York's Montauk Credit Union by the state department of financial services. This credit union had a sudden, and quickly rising, percentage of loan defaults. These weren't loans to real estate speculators or risky businesses. The credit union specialized in loans to taxi medallion owners!

Similar to the situation in Chicago, but on a larger scale, New York taxi medallions have plummeted in value as their state's highest court recently affirmed the legality of ride-sharing services, overruling an attempt to ban them in New York City. Wesbury explains that Montauk and three other credit unions have an estimated $2.5 billion in loans outstanding to the owners of 5,331 taxi medallions. That means many other financial institutions may be similarly impacted by medallion loan defaults.

Further investigation may reveal that some financial institutions, worried about the value of their loan portfolios, may have actually financed some medallion sales at above-market prices -- in order to be able to value their current holdings at higher prices (shades of the mortgage banking fiasco)! Investment manager James Hickman, of HVM Capital, has written extensively on the subject. If his allegations are substantiated, there could be criminal charges for those involved.

But the economic issues surrounding the sudden demise of the taxi cartel are actually very simple ones.

The first is a lesson learned early in Econ 101. Monopolies, especially state-sponsored monopolies, create artificial barriers to entry -- and keep prices artificially high.

Artificially high prices hurt consumers, distort market incentives and create profits for those protected from competition. But when the barriers to competition break down, commerce flows more freely and prices more accurately reflect supply and demand. The bubble bursts, and prices come down to reflect reality.

If you then add to that the ability to use leverage -- loans against that high value -- you get a situation that is sustainable only as long as the monopoly lasts. And the leverage makes the downside more intense.

Of course, the city of Chicago regulates the prices taxis can charge their riders. There is a place for regulation in the public interest. Otherwise drivers might concentrate in the most lucrative areas of the city, denying service to outlying neighborhoods. And the city has the right to keep competition out of the venues it owns, including airports and convention centers.

But the demand for the less expensive services is putting pressure on the city to allow the ride-share companies to serve these venues. So the city is trying to exact a price -- a $5 fee for each ride-share passenger picked up at those venues, along with higher meter prices for taxis and traditional Uber rides. That upsets the cabbies who rent their cabs on a daily basis; they know that the cab companies will simply charge higher rents.

So the second Econ 101 lesson is also apparent. Taxes impact behavior. But it's not the "incidence" of the tax but the "burden" of the tax that counts.

That is, the city might get the benefit of the higher taxes. But it's not the cab companies that will pay. The money will come from the cab drivers, and the true burden will fall on the passengers. Even worse, if the impact of higher prices is to discourage taxi riders, then no one will be better off. And that's The Savage Truth.