The problems of the Private Finance Initiative mount

The crossover and interrelationship between the private and public-sectors is a big economic issue. I was reminded of it on Saturday evening as I watched the excellent fireworks display in Battersea Park but from outside the park itself. The reason for this is that it used to be council run and free albeit partly funded by sponsors such as Heart Radio if I recall correctly. But these days like so much in Battersea Park it is run by a company called Enable who charge between £6 and £10 depending on how early you pay. You may note that GDP or Gross Domestic Product will be boosted but the event is the same. However there is a difference as the charge means that extra security is required and the park is fenced in with barriers. I often wonder how much of the charges collected pays for the staff and infrastructure to collect the charge?! There is definitely a loss to public utility as the park sees more and more fences go up in the run-up to the event and I often wonder about how the blind gentlemen who I see regularly in the park with his stick copes.

Private Finance Initiative

Elements of the fireworks changes apply here as PFI is a way of reducing both the current fiscal deficit and the national debt as HM Parliament explains here.

National Accounts use the European System of accounts (ESA) to distinguish between on and off balance sheet debt. If the risks and reward of a project is believed to be passed to the private sector, it is not recorded in the government borrowing figures, and remains off balance sheet. Approximately 90% of all PFI investment is off balance sheet, and is not recorded in National Accounts. Public
spending statistics, such as the Public Sector Net Debt, also follow ESA.

I like the phrase “believed to be” about risk being passed to the private-sector as we mull how much risk there actually is in building a hospital for the NHS which will then pay you a fee for 25/30 years? However we see why governments like this as what would otherwise be state spending on a new hospital or prison that would add to that year’s expenditure and fiscal deficit/national debt suddenly disappears from the national accounts. Perfect for a politician who can take the credit with no apparent cost.

Problems

The magic trick for the public finances does not last however as each year a lease payment is made. So there is a switch from current spending to future spending which of course is the main reason why politician’s like the scheme. However the claim that the scheme’s offer value for money gets rather hard when you see numbers like this from a Freedom of Information reply last month.

The Calderdale and Huddersfield Hospitals NHS Foundation Trust entered into a PFI with a company called Calderdale Hospitals SPC Ltd. Prior to May 2002, the all in interest rate in respect of bank loans that the company had
taken from its bankers was 7.955% per annum. After May 2002, when the PFI Company refinanced its loan, it was 6.700% per annum.

As you can see the politicians at that time in effect took a large interest-rate or more specifically Gilt yield punt and got is spectacularly wrong. Even with the refinancing the 6.7% looks dreadful especially as we note that we are now a bit beyond the average term for a UK Gilt. So if a Gilt had been issued back then on average it would be being refinanced now at say 1.5%. Care is needed as of course politicians back then had no idea about what was going to happen in the credit crunch but on the other hand I suspect some would be around saying how clever they were is yields were now 15%! On that note let me apologise to younger readers who in many cases will simply not understand such an interest-rate, unless of course they venture into the world of sub-prime finance or get a student loan.

In terms of pounds,shillings and pence here is the data as of 2015.

The total annual unitary charge across all PFI projects active in 2013/14 was £10bn. The cumulative unitary charge payments sum to £310bn: of this £88 billion has been paid (up to and including 2014/15) and £222 billion is outstanding. The unitary charge figures will peak at
0.5% of GDP in 2017/18.

Inflexibility

This is not only an issue on the finance side it is often difficult for the contracts to be changed as the world moves on. Or as HM Parliament puts it.

It can be difficult to make alterations to projects, and take into account changes in the public sector’s service requirements.

Are supporters losing faith?

Today the Financial Times is reporting this.

Olivier Brousse, chief executive of John Laing, which invests in and manages PFI hospitals, schools, and prisons, said PFI had lost “public goodwill” and needs “reinventing” with providers subject to a “payment by results” mechanism where money is clawed back for missed targets.

That is true although he then moves onto what looks like special pleading.

“The market in the UK is going away so we need to get back around the table and agree something acceptable,” said Mr Brousse. “The UK’s need for new infrastructure is significant and urgent. The private sector stands ready to deliver this . . . If the current PFI framework isn’t fit for purpose — then let’s completely rethink it to make it work.”

Indeed we then seem to move onto the rather bizarre.

“The problem with PFI isn’t transparency. It is outcomes,” he said. “I’m a citizen and if a school is built under PFI I also want it to commit to reducing bullying and violence.”

Surely the school should be run by the Governors rather than the company that built it? Perhaps he is trying to sneak in an increase in his company’s role.

There were also mentions of this which as I note the comments to the article seems set to be an ongoing problem whether it s in the public or private sectors.

In August John Laing agreed to hand back a lossmaking £3.8bn 25-year PFI waste project in Greater Manchester for an undisclosed sum. One of Britain’s biggest PFIs, the Greater Manchester waste disposal authority bin clearance, recycling, incinerator and green power station project had struggled to remain profitable. Manchester council said it would save £20m a year immediately from access to cheaper loans and £37m a year from April 2019.

Comment

To my mind the concept of PFI conflated two different things. The fact that private businesses can run things more efficiently than the public-sector which is often but not always true. For that to be true you need a clear objective which is something which is difficult in more than a few areas. The two main dangers are of missing things which turn out to be important as time passes and over regulation and complexity which may arrive together. Then we had the issue that whilst it was convenient for the political class to kick expenditure like a can into the future this meant a larger bill would eventually be paid by taxpayers. Even worse they have ended up trapping taxpayers into deals at what now seem usurious rates of interest.

Pretty much all big contracts with the private-sector seem to hit trouble as this from the National Audit Office on the Hinkley Point nuclear power project points out.

The Department has committed electricity consumers and taxpayers to a high cost and risky deal in a changing energy marketplace. We cannot say the Department has maximised the chances that it will achieve value for money.

There is of course the ever more expensive HS2 railway plan to add to the mix.

Thus we see that some of the trouble faced by UK PFI is true of many infrastructure projects. Yet some of it is specific to them and frankly it is hard to make a case for it right now because of some of the consequences of the credit crunch era. Firstly governments are able to borrow very cheaply by historical standards and secondly because adding to the national debt bothers debt investors much less than it once did especially if it is also simply a different form of accounting for an unaltered reality.

One of the arguments of my late father was that the UK needed an infrastructure plan set for obvious reasons a long way ahead. In many ways now would be a good time because the finance would be cheap but sadly we just seem to play a game of tennis as the ball gets hit from the private side of the net to the public side and back again.

 

 

 

 

 

The madness of UK Council and PFI finance and finances

Back in the dim and distant days when I was starting work as a graduate in the City of London I found myself helping with deals with Hammersmith and Fulham council. It was entering into various swap contracts which later hit trouble. Assumptions that the government would stand behind it proved unfounded and the council was in the end rescued by the courts declaring much of the business as Ultra Vires. So I note some of the recent movements in local public finance with some disquiet. Let me start to explain with this from The Guardian.

Aberdeen city council has taken the unusual step of appointing economic advisers to assess its prospects for the bond market, as a growing number of local authorities turn to the world of high finance amid central government cuts.

Let us now look at the trend driving this development.

The move comes amid the increasing financialisation of local authorities. Whitehall cuts are pushing councils to either scrap services or borrow to invest in profit-making schemes. Although devolution means Scottish councils are funded differently to the rest of the UK, Holyrood has also come under criticism for squeezing local authorities,

 

Let us now move to a more general view of UK council finance.

As well as using the bond markets, authorities are taking out cheap loans from the Public Works Loan Board, a Treasury agency, as they plough money into property developments and other investments.

If this was the USS Enterprise in Star Trek Captain Kirk would be declaring a yellow alert as he read this from the Financial Times last April.

 

UK local councils are engaging in what is known in the financial jargon familiar to hedge fund managers as a carry trade — a form of arbitrage whereby they borrow at rates much lower than private sector borrowers can obtain in order to invest in property that shows a much higher yield. Money borrowed at 2.5 per cent or so is typically going into property yielding 6-8 per cent or more.

Regular readers will be very aware of carry trades and are perhaps already thinking, what could go wrong? The problem with the Swiss Franc carry trade was of course a higher Swiss Franc which caused capital losses for the borrowers and the equivalent here would be falls in commercial property prices. At this point I am reminded of the freezing of some commercial property funds after the EU leave vote which must have sent a shiver down the spine of some council’s. I hope that they factored into their calculations the issue of property investment’s being a very illiquid form of investing especially in falling markets.

How do they get cheap money?

The Financial Times explains.

 

Where Britain differs from bubble-period Japan is in the financing of the property binge, which comes mainly from the public sector. If local authorities can outbid almost all other participants in the commercial property market, it is because they have access to cheap and flexible funding from the Public Works Loan Board, an arm of the Treasury that has been helping finance capital spending by local government since 1793. Its interest rates are linked to those in the gilt-edged market which have been at exceptionally low levels since the financial crisis of 2007-08.

The Public Works Loan Board or PWLB updates its fixed interest rates twice a day and this morning’s varied between 1.1% for a year or two to 2.77% for long-dated funds. So as the band Middle of the Road put it.

Chirpy Chirpy, Cheep Cheep

It also provides data on borrowing in July where for example Kingston Borough Council took out several loans totalling £40 million and Torbay Borough Council £19 million.

The Financial Time summarised the dealings as follows.

 

The spending spree has been at its fiercest for shopping centres. Surrey Heath borough council last year spent £86m on The Mall, Camberley; Canterbury city council bought half of the £79m Whitefriars centre in the cathedral city, Stockport borough council bought the Merseyway centre in the town for £75m, while Mid Sussex district council spent £23m on another in Haywards Heath. They have also been busy buying offices, retail warehouses, industrial parks, solar farms, hotels, garages and country clubs. Increasingly this speculative investment activity is taking place beyond council boundaries.

The Private Finance Initiative

If we look at PFI the concept of cheap finance due to the UK’s ability to borrow cheaply vanishes like a Klingon Warbird with a cloaking device. From the Centre for Health and the Public Interest.

There are currently 125 PFI contracts with private companies overseen by the Department of Health. The capital value of the assets which have been built is £12.4bn. However, over the course of the life of the contracts, the NHS will pay in the region of £80.8bn to PFI companies for the use of these assets.

It also points out this.

In 2011 the Treasury Committee found that the cost of financing a PFI scheme through loans and equity stakes was double the cost of government borrowing.

Parliament looked at the numbers in 2015 and concluded this.

The implied interest rate for government borrowing was around 3% in 2013/14, whilst the implied interest rate for private finance was around 7%.

Things have got cheaper since in bond markets but if the margins remain the same for PFI deals then relatively they may look even worse. Exact numbers are not always easy to calculate which is another worrying sign. Back to the CHPI.

With a PFI contract, a public body such as an NHS hospital trust contracts with a private company set up for the purpose known as a Special Purpose Vehicle (SPV).

Sadly the positive thoughts generated by thoughts of Captain Scarlet and indeed Captain Blue driving a SPV which seemed a marvel when I was a child soon disappear. The SPVs of the finance world are there to hide things and lay a smoke screen especially if combined with use of the word “innovative”.

Comment

The main purpose of the PFI era was essentially to allow government’s to borrow without the numbers raising the national debt. The downside of that is that taxpayers have to pay higher deficits in the future as the annual cost was as we have seen earlier around double the alternative of outright government borrowing. As the NHS has been particularly afflicted by this there is a particular irony in politicians pumping in money which then goes towards paying for poor value deals. But it is not only the NHS as the Airtanker deal to provide 14 Airbus tankers for the RAF poses all sorts of questions.

Now we see that we are letting council’s borrow much more cheaply to “invest” in commercial property. So this is more of a priority than national health or defence? For a start should they not be using such funds for social housing which might help quite a few problems in one go? Also if the example of Aberdeen Council is any guide there may be another worrying trend. From the Guardian.

Stephen Boyle, RBS’s chief economist, Hanan Morsy, an economist at the European Bank for Reconstruction and Development, and Douglas Peedle, chief economic adviser to Jersey, will sit on the panel of experts. They will be paid as much as £17,000 a year for working one day a month, for a term of up to three years.

The idea that the higher echelons of RBS are “experts” in anything other than losing large sums of money is bizarre. Or perhaps they will have their excuses for failure ready.

But the system where we pay over the odds for what seems vital projects whilst allowing councils to take a punt with cheap funds requires the Nutty Boys.

Madness, madness, they call it madness
But if this is madness
Man, I know I’m filled with gladness
It’s gonna be rougher, rough, it’s gonna be tougher, tough
And I won’t be the one oh, no, no who’s gonna suffer