Should Council's be doing this?

I understand the financial imperative for local authorities to seek investments that will provide (possibly) assured future income. But there is a point at which you have to ask whether using the Public Works Loan Board (PWLB) to invest in commercial property is either fair or the proper use of such borrowing:

Through this innovative partnership, local authorities borrow money from central Government via the Public Works Loan board at a fixed low interest rate and regenerate surplus land that they own by building a Travelodge hotel as either a stand-alone project or as part of a mixed-use development. Not only does this create jobs and boost the local economy but it also provides a substantial return of profit for the council.

It looks great, doesn't it? After all the commercial interest (Travelodge in this case but it could be other businesses) gets access to cheaper finance than would be the case had they borrowed from normal commercial sources. And the Council gets that much vaunted 'regeneration' and an income from owning the freehold. It all seems like a brilliant idea but it does raise questions especially where the deal is less of a partnership that the one described here.

The first question is how local authorities with preferential borrowing rates and a benign tax environment are affecting the property market, especially for the sorts of investment - shopping malls, car parks, supermarket sites and so forth - that are favoured because of their (hopefully) reliable income. It may well be the case that the value of these assets is inflated by the capacity of local councils to invest larger sums given low interest rates on their borrowing.

The second question is whether the PWLB exists for the purpose of commercial property investment - especially the sort of investment Bradford Council has undertaken by simply buying an existing car park for several million quid. Surely the operation of the PWLB shouldn't be merely 'prudential' (does the ground rent exceed the cost of borrowing) but should contain some recognisable social value.

Finally, do local councils have the expertise to engage in this sort of property investment - what looks like low risk may turn out to be more problematic. Imagine buying up a freehold only to find that the income from ground rent dries up or becomes difficult to collect? Local councils are looking for long term income here without necessarily appreciating how market and social change will affect that long run - what happens to car parks in a world of self-drive cars? Do AirBnB type models undermine the budget hotel? And how will the medium term play out in the world of retail letting?

Councils will, of course, turn round and say, 'but we've no choice as we've no money'. This merely returns to the original driver of such investments - falling council revenue budgets - while the risks associated with such strategies are unclear and the impact on property markets elsewhere store up further problems. And this is all before we consider how many billions councils will add to public borrowing.

Should councils be doing this?

....

It's the price isn't it?

****

In a fit of populist fervour the government is proposing a scheme to help first time buyers get on the housing ladder:

David Cameron will today formally open the NewBuy Guarantee scheme, where the Government guarantees part of a homebuyer’s mortgage, allowing them to take out much larger loans than they might otherwise be eligible for.

The guarantee will allow people buying new-build properties to borrow up to 95 per cent of the value of their new home. 

Two quick observations here - firstly wasn't giving housing loans to people who can't afford them the biggest reason for the current financial train crash? And if so why on earth are we repeating this mistake?

And secondly, isn't the big problem price rather than access to finance? House values have (as the fortunate owners know) risen considerably faster than general wages for several decades - barring the occasional and inevitable price crash. This means that fewer people can afford to buy those houses.

So this scheme isn't about helping people who want to buy houses at all. It's actually about helping people who want to sell houses. The best way to help buyers is to build more houses in places (like the South East) where there is work and where people want to live. But I guess there's no votes in that, is there?

....

Can we reduce the "poverty premium" without repeating those sub-prime mistakes?

****

Niall Cooper from Church Action on Poverty has written a piece of what he calls “fair pricing”:

And secondly, fair prices.  Much of the ‘logic’ of the way markets have developed in recent years is to move towards ‘risk (or cost) pricing’ and away from shared risk.  Some of the assumptions behind this are extremely dodgy:  The majority of high cost lenders claim that their premium prices are based on the ‘risk’ of lending to low income customers… any yet, when customers pay week after week, year after year, the cost doesn’t go down.  But fundamentally, is it socially (or morally) acceptable to operate ‘cost’ pricing models which force the poorest to pay most?  How can companies square all their talk in recent years of corporate social responsibility, with charging their poorest customers the most?

It has become a mantra of anti-poverty campaigners that poor people pay something they call the “poverty premium”:

Lack of access to the best online prices, bank accounts and managing their budget via cash all adds together to give the poorest families the worst deals around. The result is a poverty premium that costs the poorest families more for the same energy, cookers and household items, credit and insurance than their wealthier peers.

The two prime culprits for this premium are energy and financial services especially lending. In the case of energy this is mostly about methods of payment – the understandable reluctance of people on low incomes to use direct debit as a means of payment. So, in reality, the whole problem is – as Niall Cooper implies – down to financial services. Especially since the ‘food desert’ argument turns out to be a bit of a myth.

“The U.S. Department of Agriculture defines a food desert as a low-income census tract where a large number of residents are more than a mile from a grocery store…. [L]ess than 4.5 percent of the U.S. population [falls into that category].

The question then is how to make is easier for poor people to access affordable financial services given that those poor people are less likely to repay loans, more likely to over draw and live in places where car crime and burglary heighten insurance risks. For this Niall Cooper suggests intervening in the market:

And if individual businesses are unwilling to offer products to low income consumers at fair prices (not least by claiming they can’t do so if their competitors don’t), then is there not a role for market intervention?

The problem is that – certainly where lending is concerned – we have been down this route before. After all mandating lending to high risk borrowers was a central driver in creating sub-prime problems especially in the USA. And if you introduce price caps (as Stella Creasy wants) without mandating lending to poor people then you kill the market entirely. The consequence of this is to create an even bigger problem for which the only solution is unregulated and illegal lending.

Rather than looking at forcing price cuts on suppliers, we should instead consider whether block buying is an option. Social landlords could, for example, purchase energy more cheaply than tenants and have the systems to collect payments in place already. And, certainly for contents insurance, the same should apply. It would be interesting too to look at whether local councils or social landlords could broker other insurances such as third party car insurance helping to spread risks and reduce costs.

If we look to new generation mutuals such as credit unions there are perhaps similar opportunities to reduce costs and spread risks. What we can’t do is wholly eliminate those risks (something the world is finding out very painfully right this minute) meaning that poor people will continue to have problems with access and pricing in financial services. In using co-operative solutions we can ameliorate these considerably and, in market terms, safely. Mandating prices simply takes us back into the financial disaster of sub-prime lending.

...

A thought about debt...

This morning while trundling along going nowhere on the treadmill my mind wandered onto this thorny problem of "the debt". After all it's the subject of great discussion by our masters across Europe as we come to terms with the impact that years of artificially low interest rates and profligate governments have had on the national balance sheets.

One argument out there is what we might term "debt denial" - or rather the belief that by taxing rich people and rich companies a little more all the problems will go away. The more sophisticated voices out there put on their best frowny clever-person faces and tell us that, of course, government debt is different:

What I have in mind is this idea that you can keep running deficits which, if they grow no faster than GDP, can create a debt that is stable at a desired share of GDP.

Got that folks? Spotted the problem haven't you! It's the Mr Micawber principle:

"Annual income twenty pounds, annual expenditure nineteen nineteen six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery." 

The problem is the fundamental rule of debt. At some point you have to pay it back - with interest. Government debt is objectively no different at all from the debt that you and I may have as private persons - we borrow money and, at an agreed point, pay that money back. To pretend otherwise is to believe a nonsense.

Right now we are playing two games to avoid having to face up to repayment - firstly we're inflating the economy with freshly printed moolah. If the value of the pound in your pocket gets smaller through this inflation it means the debt on the government's balance sheets (including all that private debt they nationalised when they "bailed out" the banks) also gets smaller. Less to repay!

Secondly we're urging economic growth - using exactly the same methods (low interest rates, government funny money, infrastructure projects) that created the problem in the first place. The bet is (and it's a bet with your and my money) that the extra money in the economy will stimulate economic growth which will help solve the problem by producing more tax income and thereby reduce the need to borrow.

In the meantime government continues that borrowing (and the Bank of England its printing of money to lend to the government) so as to avoid the discussion about that first principle of debt - you have to pay it back.

As Mr Micawber knew and clever economists, bankers and politicians forget, we should live within our means.

....

Mick and Gerard discuss the banking crisis...

****
Mick is a gardener – a fictional gardener to be sure but he could be real. Mick cuts grass, trims bushes, digs over and plants up flower beds and, for doing this, gets paid by grateful customers. Being an honest citizen, Mick tots up all he earns in a little book and subtracts from that the amount he spends – on diesel, maintenance and insurance for the pick-up, on gardening gloves, on the fuel for the mowers, on sharpening the tools (and replacing them when they’re broken or worn) and on a host of other bits and bobs he buys to do the job.


When he buys stuff for customers, maybe bedding plants or some compost, Mick adds a little margin for his trouble. Not a lot or else folk would stop asking him to buy things. And this is carefully recorded in his little book.

Once a year Mick gives the book (and a shoebox filled with receipts and so forth) to Gerard, his accountant, so the tax can be done. Gerard checks Mick’s adding up and subtracting, adds in a little advice (‘you do know you can claim for that, don’t you’) to justify the £300 he’s charging Mick (who will, of course, dutifully write that amount into his little book). Once all the form filling is done, Mick has a bill for taxes which he pays since, being sensible and organised, he’s set aside a little each week in anticipation of this tax bill.

With this done, and by way of thanks, Mick takes Gerard down to the pub for a celebratory (if the paying of taxes can ever be a celebration) pint or two. And they get to talking like you do when you’ve had a beer.

Now Mick knows that Gerard – unlike him – is an educated bloke, been to university and accountant school, knows some long words about money. And Mick, who as a good citizen, makes sure he watches the news most days, asks Gerard about the banking crisis. After all, not only is Gerard an educated bloke, but he’s an accountant. And that means money. Gerard must be able to explain what all went wrong.

However, Gerard isn’t at all sure. For him, the bank is just a place through which money flows – mostly away from him and his clients. For sure, Gerard knows about borrowing – paying a price for having something now rather than waiting until we can afford it was the way Gerard’s shopkeeper dad always described it. And he knows that the banking crisis is something to do with borrowing. Or rather, the consequence of borrowing – debt. So he tells Mick this.

Now Mick, too, understands borrowing and debt. He’s got a mortgage – not a big one – and he had to take out a loan to buy the pick-up he uses for work. Mick appreciates how borrowing means that – at a price – he can have something now, like the pick-up or somewhere to live that he would otherwise be unable to afford. But he has another question for Gerard: “where does the borrowing come from,” asks Mick?

Gerard takes a long sup of his pint – he would have sucked on the stem of his pipe but they banned that in pubs – and thinks. “Did you ever watch Jimmy Stewart in ‘It’s a Wonderful Life”, asks Gerard?

“Oh yes,” said Mick, “one of my favourite films – a Christmas classic!”

“Good,” replied Gerard, “then you’ll remember the scene with the run on the bank when all the Savings & Loan customers crowd in to get their money out?”

“Absolutely, and at the end Jimmy Stewart and the others dance round the room with Papa Dollar and Mama Dollar in a wire paper tray!”

“Well during that scene, George Bailey – he’s the Jimmy Stewart character – explains to the crowd that the money isn’t in the bank, it’s in other people’s houses and businesses. It’s been lent out and these folk are paying it back with a little added as the price of having the money before you’re earned it.”

“Oh yes,” smiled Mick, “and George used his wedding cash to pay out on the run and the Savings & Loan stayed open.”

“Correct, correct,” Gerard leant back on his chair beginning to relish the explanation, “the problem is that modern banks – unlike that in the film – have made a really big bet. They’ve bet that everyone won’t arrive at once asking for their deposits back and have lent £10 for every £1 they have on deposit. In effect they’ve magicked 90% of the money we use from out of thin air.”

“But people still pay back,” Mick was fascinated by this exposition, “so the new money isn’t a problem until that stops?”

“Yes, or until people want to take more money out. You need another pint?”

“I think so,” Mick’s mind was spinning a little – he could see how his little business worked. And even how the bank’s role in lending money worked – but how could they lend so much?

Gerard returned from the bar and Mick was straight in, “but how could the bank take such a big risk, make such a massive bet?”

“I think,” said Gerard, “that it’s to do with deposit protection. In the film, the deposits were at risk, people stood to lose their savings if the bank closed. Today, the Government guarantees the deposits in banks – your and my money simply isn’t at risk so the bank can take whatever big bet it wants with the money.”

“So it wasn’t just the banks, it was government too,” spluttered Mick.

“And there’s more,” explained Gerard, “not only did government guarantee the deposits so banks could lend £10 for every £1 they had on deposit, most of that extra money wasn’t lent to folk like you to buy pick-ups and houses but was lent to the government. The same government who set the rules that made the lending possible.”

“Now you’re losing me,” Mick frowned, “the government gets all those taxes from people like me, why does it need to borrow?”

“You know you keep that little book, the one you give to me once a year so I can prepare your accounts and your tax return?”

“Yes.”

“You know how you’re very careful to make sure that what you take in exceeds what you spend?”

“Absolutely, I’d go bust otherwise.”

“Well the government doesn’t think it has to do that..."

"You what?"

"...most years in recent times governments, here in Britain, in the US and in Europe, have spent more than they raised in taxes. I know that’s hard to comprehend given how much we pay in tax – nearly half of all we earn – but governments didn’t think they had to worry because they’d set the rules so those nice banks would provide the cash. Government simply borrowed more and more each year.”

“So the government fixed the banking system so the banks could lend more, then borrowed that money to fill in the hole in their budget? Sounds like a criminal enterprise to me! Why did it go wrong?”

“Just like in the film, people started wanting their money out. The banks all lent money backwards and forwards between them – like a carousel with dollars on. One day some of them decided to stop the carousel, to stop passing the money round.”

“And…?”

“The system seized up. Banks were threatened, for a minute the whole thing looked like it might collapse. But the governments had a plan, instead of getting the banks to create new money by lending £10 for every £1, they would simply make up some new money of their own, give it to the banks and then borrow it back.”

“Sorry, say that again,” Mick was amazed

“Yes,” said Gerard, “they called it ‘quantitative easing’ but all it did was provide cash for the banks so they didn’t have to stop lending. And the government needed that lending, not to help your business like they said, but because otherwise they’d need to make big cuts in public spending or have a huge increase in taxes.”

“So let me get this right, the government allowed banks to lend more money than they had on deposit by protecting those deposits, then when people wanted their money out, the government printed more money and put it into the banks so the same government could go on borrowing? Where do we live, fairy land?”

The mournful sound of the pub bell sounded as the landlord called time.

“Guess I’d better scoot,” said Gerard, “been great talking and thanks for the beer.”

“Cheers," said Mick, “I’m hoping for some afters so I’ll stick around. There’s a couple of people here I’d like a word with and the place needs all the cash it can earn to keep going. One last question.”

“OK.”

“So all this inventing of money by the banks and the government,” muses Mick, “at some point it has to be earned by someone doesn’t it?”

“I suppose so. Probably us. We’ll be paying a load of taxes just to pay the banks back for lending the government all that money the government gave to the banks to keep them lending.”

Gerard smiled wryly, stood up and left. Mick was left wondering. Maybe Gerard was wrong, perhaps the chatty bloke on the telly from the Bank of England was right and we’ve nothing to fret about, there’ll be some hard times but it will turn out OK. But maybe not, maybe if all the money goes on paying back yesterday's debts, if the government keeps on borrowing and even printing more cash, maybe we’ll never pay it back. And that would be wrong Mick thought. We have to pay our debts.

....