In defense of private prisons (and the bear case for private prison stocks)

In defense of private prisons (and the bear case for private prison stocks)
Jason
Stutman Photo By Jason Stutman
Written Saturday, October 1, 2016

If you watched the presidential debate earlier this week, you might remember Hillary Clinton calling for an end to private prisons at the state level, just one month after the Department of Justice revealed its plans to eventually shut down 13 for-profit prisons within the Bureau of Prisons system.

“I’m glad that we’re ending private prisons in the federal system,” Clinton remarked during the heated debate. “I want to see them ended in the state system. You shouldn’t have a profit motivation to fill prison cells with young Americans.”

The presidential hopeful’s comments caused two leading jail stocks to immediately tumble on the public market. Corrections Corp. of America (NYSE: CXW) plunged nearly 8% on Tuesday, while GEO Group (NYSE: GEO) fell 4%. Considering the vast majority of private prison business comes from the state and local levels, Hillary’s words were a legitimate cause for concern.

In the wake of the debate, questions are now being raised about the future of private prisons in the U.S. Not only has a national debate on the ethical nature of these corporations surfaced, but there’s also a tug of war happening between buyers and sellers of public jail stocks speculating on legislation.

In defense of private prisons (and the bear case for private prison stocks)
Jason
Stutman Photo By Jason Stutman
Written Saturday, October 1, 2016
If you watched the presidential debate earlier this week, you might remember Hillary Clinton calling for an end to private prisons at the state level, just one month after the Department of Justice revealed its plans to eventually shut down 13 for-profit prisons within the Bureau of Prisons system.

“I’m glad that we’re ending private prisons in the federal system,” Clinton remarked during the heated debate. “I want to see them ended in the state system. You shouldn’t have a profit motivation to fill prison cells with young Americans.”

The presidential hopeful’s comments caused two leading jail stocks to immediately tumble on the public market. Corrections Corp. of America (NYSE: CXW) plunged nearly 8% on Tuesday, while GEO Group (NYSE: GEO) fell 4%. Considering the vast majority of private prison business comes from the state and local levels, Hillary’s words were a legitimate cause for concern.

In the wake of the debate, questions are now being raised about the future of private prisons in the U.S. Not only has a national debate on the ethical nature of these corporations surfaced, but there’s also a tug of war happening between buyers and sellers of public jail stocks speculating on legislation.
Anyone developing an opinion for or against private prisons should at least understand how they work before making any hard conclusions. While there are a number of legitimate concerns regarding the ethics of for-profit prisons, common talking points like Clinton’s have a tendency to oversimplify the economic equation at work. (Spoiler: You’re not an evil, deplorable human for investing in a prison stock, though you could still be making a poor investment.)

Is it Unethical to Invest in Private Prisons?

A for-profit prison is a third-party entity that houses prisoners for the government in exchange for a stipend. These stipends are generally paid based on the number of prisoners that a prison houses. If a private company can house prisoners at a cheaper cost than the government expects to do on its own, then the government will typically contract out the job.

What this means from an economic standpoint is that the government is demand while prisons are supply. Private prisons may be guilty of lobbying government officials in an effort to keep demand high, but it’s ultimately the government that is responsible for creating that demand in the first place. Getting money out of politics is one thing, but bashing the free market altogether is another.

In other words, private, for-profit prisons can only actually exist in circumstances where there’s a void in efficient prison supply. Today, such a void exists for two reasons: 1) the over-imprisonment of American citizens, and 2) an inefficient public prison/rehabilitation system. These are both problems caused by the government, not by the free market.

The basic argument against private prisons is that no one should profit off people being put behind bars. As Hillary makes the case, profiteering off the misfortunes of others is inherently an evil deed: “You shouldn’t have a profit motivation to fill prison cells with young Americans.”

This argument, though, twists the economic and moral reality before us. It suggests that private prisons have an element of control over demand, cleverly shifting the blame of America’s prisoner crisis away from lawmakers and onto Wall Street traders and corporate executives. In reality, though, all these corporations and their investors are doing is cleaning up a mess the U.S. government has created.

Here’s another way to think of it: If you clog your toilet and it starts to overflow, is it unethical for a plumber to profit off cleaning up your mess? If you crash your car, is it wrong for a body shop to make money off your accident? If you develop cavities, do you get mad at the dentist for drilling holes in your teeth?

No one likes having to call the plumber, no one likes going to the body shop, and no one likes visiting the dentist. No one likes having to send people to prisons, either. At the end of the day, though, none of these entities are actually responsible for the demand that calls for them to exist in the first place.

Simply put, shutting down private prisons won’t result in any fewer prisoners than we have today, nor will it improve prison quality. All it will do is shift the responsibility of imprisonment back into the hands of a government that was already failing to manage those prisoners in the first place.

Will Regulations Destroy Private Prison Stocks?

Of course, the question of “should” is completely separate from the question of “could.” The DOJ has consistently leaned to the left with Loretta Lynch as Attorney General and is known for misrepresenting data in order to push this agenda. Assuming that Clinton takes the presidency, it’s entirely probable that the current status quo will continue.

As the National Review has commented regarding the DOJ’s recent decision to begin shutting down private prisons at the federal level (emphasis mine):

The Department of Justice’s recent decision that the federal Bureau of Prisons should wind down its private-prison contracting was apparently based on private prisons’ bad record of safety and security violations relative to their public counterparts. It turns out, though, that the DOJ’s understanding of private prisons’ record is informed by a serious over-reading of faulty comparative studies, in particular a recent study by the Office of the Inspector General…. The IG report didn’t control for demographics, and it recognized that this made cost comparisons inadvisable.

The Justice Department, not sharing the IG report’s caution, went ahead and read too much into its results. Where the IG’s office hedged its conclusions with caveats about comparability and merely called for greater investigation, the DOJ memo made broad claims.

Based on this slim reed, Deputy AG Sally Yates ordered the BOP to “either decline to renew” contracts as they expired “or substantially reduce [their] scope.” It’s not clear whether the DOJ was relying on studies other than the IG report, but if it was, I’d like to see those studies: All available evidence does little to suggest that private prisons are worse than public prisons overall, or that they cost more.

In other words, there is not enough empirical evidence available today to give the edge to either public or private prisons in terms of cost and quality. This is a fact that’s widely recognized by academics. The DOJ isn’t waiting for actual evidence, though. It’s making conclusions off of studies that authors have specifically deemed inconclusive.

In a political environment where facts carry no real weight, this makes prison stocks such as Corrections Corp. of America (NYSE: CXW) and GEO Group (NYSE: GEO) especially risky investments. Under a Clinton presidency, it would be very difficult to recommend either company.

At the same time, though, a Trump presidency wouldn’t exactly turn out so well for private prisons, either. While “The Donald” would likely be a less hostile president to the free market, it’s exactly this positioning that makes him a threat to for-profit prisons.

How Trump Could Kill Private Prisons

According to recent data from the Federal Bureau of Prisons, over 50% of inmates currently in federal prison today are there for drug offenses. This percentage has risen consistently over the last several decades, from just 16% in 1970 (the war on drugs was declared in 1971).

Donald Trump has a long history of opposing the war on drugs. Having argued for broad legalization as early as 1990:

We’re losing badly the war on drugs. You have to legalize drugs to win that war. You have to take the profit away from these drug czars… What I’d like to do maybe by bringing it up is cause enough controversy that you get into a dialogue on the issue of drugs and you start to realize that this is the only answer; there is no other answer.

Trump has largely reaffirmed this sentiment during his presidential run, saying he supports medical cannabis “100 percent,” jointly suggesting that he would allow states to legalize without federal interference. No doubt, ending the drug war would be a major hit to the private prison industry, as it could effectively cut its addressable market significantly.

Drug crimes, though, aren’t the only source of revenue for private prisons. In fact, over half of private prison revenue today actually comes from holding facilities for undocumented immigrants. If Trump were to successfully reduce the number of illegal immigrants in the U.S., as he has strongly suggested he will do, then this, too, would be damaging to the private prison industry.

It seems, then, that whether Trump or Hillary makes it into the White House, prison stocks aren’t exactly the soundest investment right now.

 

Is There Any Hope for the Private Prison Industry?

As of today, private prisons have a major public relations problem, and for good reason. While not directly responsible for prison demand, the current contract structure inherently makes a higher prisoner population good for business.

This allows political figures to paint private prisons as evil corporations who want to lock up as many Americans as they possibly can. It makes the lobby and even Main Street investors look deplorable to anyone without a firm understanding of free market economics.

The only way to actually change this PR nightmare is to change the incentive. Instead of structuring contracts purely on a per-prisoner basis, monetary incentives need to be baked in for successful rehabilitation.

Efforts to institute such an incentive have been proposed before, specifically in the form of the Private Prisoner Rehabilitation (PPR) credit. A PPR credit is described in NYU Law Review as a “performance-based, refundable tax credit that incentivizes private prisons to address some of the key issues plaguing today’s criminal justice system.” These incentives would include conditional payments for benchmarks such as time out of prison (reduced recidivism) or employment status after release.

Of course, private prisons are just one end of the negotiation table. If we want private prisons to have more ethical monetary incentives, the government customer will ultimately need to demand those things, and at the right price. Until that happens, for-profit prisons are treading on thin ice.

Until next time,

JS Sig

Jason Stutman

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