Nick Corbishley: Bankruptcy Looms As Cash-Starved UK Local Councils’ High-Risk Real Estate Bets Sour
Yves here. Please give a rousing welcome to Nick Corbishley, who is joining our team of regular writers, initially on alternating Tuesdays. Some of you may recognize his name from previous cross-posts here or from his regular appearances at Wolf Street. Nick started blogging during the height of Spain’s financial crisis at Raging Bullshit (now called Rigged Game), under the pseudonym of Don Quijones, which is how Wolf Richter found his work.
And why “during Spain’s financial crisis” from someone with a sturdy British-sounding name? Nick graduated in history at the University of Sheffield in the late 1990s, then set off for what he envisaged as a tour of mainland Europe and Latin America and never came back. He’s now lived for 20 years in Barcelona, working as a financial language teacher, academic translator and ghostwriter for a well-respected business and economics journal.
Nick is fluent in French as well as Spanish, and voraciously reads newspapers and blogs from Europe, Latin America and the UK each day. Lambert, Jerri-Lynn and I are keenly aware of the dangers of trying to interpret foreign developments through the English-language press. We anticipate that Nick will help Naked Capitalism venture into new territories in being early and accurate, as he is with his inaugural offering, on the looming bankruptcy wave in UK local councils. It’s not hard to draw an analogy to the US, where municipalities and states are already making deep cuts in trying to balance their books, and their budget woes are set to get worse in the near and intermediate term. However, the UK train wreck has some distinctive ugly features, like a history of councils making bad levered investments, and being on the receiving end of Government-sponsored grifting in the form of the Private Finance Initiative.
Thrilled to be a part of the Naked Capitalism team, Nick looks forward to covering topics including the final consolidation (or lack thereof) of the European project; Covid-19’s impact on Latin America; government and corporate surveillance in Europe; the future of payments in a post-pandemic world; and the City of London after Brexit. So please roll out the red carpet for Nick!
The chickens come home to roost.
In the U.S., the virus crisis has sharply exacerbated the pre-existing budgetary issues facing many state and local governments. Tax coffers are running low at the same time that public debt is soaring — the result of three simultaneous processes: a massive surge in government spending to counter the virus crisis, a vertiginous slump in tax revenues, both at the local and federal level, and a sharp decline in GDP and a dizzying slump in tax revenues, both at the local and federal level, with the result that yet more debt is needed.
As more and more jobs are destroyed and more and more companies hit the wall, the tax revenues and GDP shrink even faster. The same processes are playing out in just about every national and local economy on the planet. The worse the budgetary mess before the crisis, the bigger the problems now. In the UK, where many town and county councils not only have been starved of funds and poorly managed for years, they’ve also been making big leveraged bets on commercial real estate, the fallout is already becoming visible.
Last week, the South London borough council of Croydon (population: 385,000) declared effective bankruptcy by issuing a Section 114 Notice. This bans the council from all new expenditure with the exception of statutory services for protecting vulnerable people. It also means that the day-to-day running of the council will be handed over to government appointed commissioners. In Croydon’s case, this may not be such a bad thing given how poorly the Labour-run council has been mismanaged.
A Long History of Bad Investments
Last month, a report by Croydon council’s own auditors, Grant Thornton, lambasted the council for its lax financial controls, its failure to challenge or scrutinise financial decisions made by the top brass and its low capital reserves. By last week, those reserves amounted to just £10 million, which pale against its £66 million budget hole and the £2 billion (no typo) it has taken out in loans – over a quarter of which are tied up in risky property investments. Brick, the council’s housing firm, was lent £200 million by the council to build homes that have yet to deliver any financial return.
Croydon is not the only council that has tried to alleviate its funding pressures by betting big on the commercial real estate market. In 2018-19 alone, councils across England and Wales spent £6.6 billion acquiring offices and struggling shopping malls nobody else wanted – more than ten times the amount spent in the previous three years.
Local authorities in the UK have a long history of making bad investment decisions. In the years leading up to the Global Financial Crisis, councils dumped £1.05 billion into easy access, high-interest online savings accounts offered by Icelandic banks. When the banks went belly up, in 2008, that money vanished into the ether, although some of it was paid back, in dribs and drabs, over the following years.
That experience should have served as a salutary warning. Unfortunately, it didn’t.
One small council on the outskirts of West London, called Spelthorne, with an annual budget of just £22 million, has amassed a commercial property empire worth £1.17 billion, all of it debt financed. Like many other councils, it borrowed the money from the Public Works Loan Board (PWLB), an arm of the UK treasury that is supposed to provide relatively cheap loans to councils for building new schools and other civil projects but which is instead being used to fund speculative property investments.
Many of these councils invested in the commercial property market in order to offset recent spending cuts forced upon them by central government. But with a lot of commercial property sinking in value, the end result has been to push their finances to breaking point.
Croydon is only the third council to issue a Section 114 Notice this century, but given how many councils have bet big on the real estate market, there are likely to be many more to come. According to a study published in June by the Centre for Progressive Policy think tank, eight out of ten of England’s 151 upper-tier councils are at risk of going bust, as the financial impact of the virus crisis intensifies.
Many of these councils are in the most deprived areas of England, which have already borne the brunt of the government’s decade-long austerity onslaught. Between 2010 and 2015, local authority budgets shrank by £18 billion. According to the FT, this was “equivalent to a fifth of spending by England’s 300-plus local authorities, whose budget for running services… has been reduced at twice the rate of cuts to UK public spending as a whole”. The cuts have done nothing but grow since then.
After the last election, in late 2019, Boris Johnson pledged £3.6 billion for deprived towns, many in the north of England, after many pro-Brexit voters in those towns put their trust in him. But whether or not he actually honors that commitment remains to be seen.
Another reason why many councils are short of funds is that they are paying over the odds for essential changes to their buildings and eye-watering costs for basic maintenance jobs, thanks largely to the government’s Private Finance Initiative (PFI). First invented in 1992 by the Conservative government and then enthusiastically rolled out by the subsequent Labour government, PFI sees private companies build and run key infrastructure, leasing it to the public sector through deals usually lasting 25 to 30 years.
For the UK Treasury, the big attraction of PFI is that it allows it to keep many current liabilities off balance sheet while awarding well-connected businesses ludicrously lucrative public works contracts that provide scant value to British taxpayers. Big banks have also benefited handsomely, since the interest rate of private-sector debt — these projects are debt financed — can be as much as 2 to 3.75 percentage points higher than the cost of government borrowing.
But the cost to local councils, public service bodies and hospital trusts, even for projects that never get completed, can be crippling. One hospital trust paid more than £5,500 for a new sink while a police force paid £884 for a chair, according to figures obtained by JPI Media Investigations.
Companies involved in PFI contracts have already pocketed £100 billion since 1992, but much of the debt for projects dating as far back as the late 1990s is still outstanding. According to the Daily Telegraph, outsourcers running hospitals and other vital public services are still in line for almost £150 billion of taxpayer cash.
Last week, a government body called the County Councils Network cautioned that only a fifth of England’s largest councils are confident they can deliver a balanced budget next year without big cutbacks in basic services. With limited scope for further reductions in non-care services such as libraries, bus routes and school transport, most of the reductions are likely to fall on social care services. Over half (56%) are planning to cut access to care packages, in the midst of a global pandemic, while 27% said they will have to cut services for children in council care.
“Councils have pulled out all the stops throughout this pandemic to protect residents, maintain vital services and support the economic recovery,” said Cllr David Williams, chairman of the CCN. “To ensure that they can continue to do whatever it takes over the winter to combat Coronavirus and to prevent severe reductions to services next year, they need a significant increase in funding for 2021/22, alongside an income guarantee to protect against losses in council tax.”
Council tax is an annual fee that councils in the UK charge local residents for the local services they provide, and is one of the two main sources of funding for councils. The other is business rates, a tax levied on businesses for occupying commercial property.
The amount of council tax collected is falling, as households affected by the virus crisis have fallen behind on their payments. Business rates have also been suspended since March, even for large businesses that did not have to close during the lockdown, such as supermarket chains.
These trends are exacerbating an already grim financial situation for many local councils. Croydon borough council’s bankruptcy may have happened all of a sudden, against the backdrop of a (hopefully!) once-in-a-lifetime pandemic and largely due to problems of its own making, but many of the forces that led to its collapse were set in motion long before Covid’s arrival. And now some them are coming home to roost.