PFI: Risk and Reward

Another micro-blog, this time on PFI, and a not very hot take on Carillion and Capita.

I was going to avoid talking about the collapse of Carillion.  I get a bit frustrated talking about PFI because lots of people strongly dislike it without knowing much about it, which makes for a less than fun debate.   The same is true of Government outsourcing, which isn’t the same as PFI, but tends to get bundled together with it because lots of PFI schemes involve the outsourcing of some or all facilities management services as part of the PFI deal.

I’m not as hostile towards PFI as some people, partly because I worked on a couple of Hospital PFI schemes.   It’s not a bad capital sourcing route when the Treasury cost of capital is very high, but when the interest rates the Government can borrow at are as low as they are right now there is no point in PFI at all.

I do however have a big problem with off balance sheet accounting, which is a technique associated (but not the same as) PFI where Governments hide the amount of debt they have run up.  The reason why PFI and other off balance sheet wheezes continue to be popular with Labour and Tories is because Politicians don’t want to be honest about the amount of debt they want to incur.

I don’t have a problem with outsourcing either – I just believe that there are some bits of the public sector like basic administrative tasks which work well on an outsourced model, and lots of bits of the public sector which should never be outsourced; including all of Criminal Justice.  I also think that there are lots of parts of the public sector where the costs of administering outsourcing are so high they outweigh any advantages outsourcing might have – the NHS for example.

One of the main factors with PFI and any kind of outsourcing is the extent to which the Government or the NHS transfers risk to the Private Sector.   There a lots of good reasons why the State would outsource work or sign a PFI deal – they need short term but not long term capacity, or they want specialist skills in building or managing a project.  Whatever the reason for the PFI project or the outsourcing decision the contractual arrangements should always show a transference of risk.  The private sector takes on work because it wants profit, and any profit/reward should reflect the degree of risk the contractor takes on.

While I was sad that Carillion collapsed this is essentially the consequence of PFI working properly.  It’s not meant to be risk free.  The problems with Carillion aren’t a sign that PFI has failed. The show that it is working.  Carillion either got greedy, or it failed to appreciate the degree of risk it was taking on over the 400+ Public Sector contracts they took on.

This is a graph showing Carillion’s income from PFI contracts when they went bankrupt:

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This is a graph which shows total PFI payments past and present across the whole industry:

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The 2 graphs aren’t exactly the same shape, but the similarity is striking.  Carillion was pretty typical slice of the PFI market.

All this really tells us is the size of the reward. The question is – did Carillion simply have more risk than other companies?  Was it just badly run?  Or is there more systemic risk in the PFI market than we thought?

I changed my mind about writing about Carillion because I saw the headlines on Capita.   They issued another profit warning this week, disclosing a £513.1m pre-tax loss due to £850.7m of “specific non-underlying items” which dragged on its performance.  This compares with an £89.8m loss in 2016.    Capita have over 1000 public sector contracts and their collapse would be much messier.

I visited some of Capita’s outsourcing sites a few years ago when I was assessing potential outsourcing partners for the DWP Quango I was working for.   They have lots of high profile, mission critical, outsourcing work, including the Congestion Charge, Teachers Pensions, TV Licensing and lots of NHS back office work.  Some of their work in criminal justice is scary stuff – offender tagging, and 999 systems.    Notably they haven’t been awarded any new Government contracts this year, which suggests that there is a growing reluctance to give them work.   Knowing a bit about the rigid thinking of public sector procurement teams there must be something very scary in the financials to put them off.

The shape of the 2 graphs above and the scary state of Capita suggests that Carillion’s problems might actually be systemic across the industry, rather than just the result of poor risk management.

When Carilion went under there was an obvious solution to their problems.  HMG could have borrowed cheaply, bought out the PFI contracts from Carillion.  This would have given the remaining private sector division of Carlillion enough capital to keep it afloat, while cutting the long costs (because the PFI contracts would effectively had been refinanced more cheaply).  A clever person would have taken over all of Carillions PFI division and used it as a state owned infrastructure company which could have taken over other expensive or problematical PFI or outsourcing contracts from other contractors.

But that would have been ideologically impossible to either Political Party.

Billy Bragg Mini Blog

I was a Miner, I was a Banker/I was a Quantitative Analyst/Between the Wars/I played at Glastonbury/In time of austerity

A bit of a follow up from last weeks look at the ways property wealth, property tax and pension wealth interact and how monetary policy can change how wealth is re-distributed.  

While I was writing it Andy Haldane (did I mention he was my favourite Central Banker?) invited Billy Bragg to give a lecture on Monetary Policy at Threadneedle Street. This is the video of it:

Just to manage your expectations he doesn’t do “Levis Stubbs Tears”.    Billy Bragg at the Bank of England may sound odd, but it was meant to expose Central Bankers to a broader range of views outside of their own bubble.  There was a predictably mixed response, with people liking or disliking his speech based mostly on where they were politically before the speech rather than the actual content of it.

Billy’s big point, I think, is that the lack of accountability by Institutions is driving support for authoritarianism.  This is spot on. This lack of accountability is a huge problem for public institutions and faith in democratic politics – politicians are mired in scandal and yet no-one resigns.  Since Gordon Brown made the Bank of England independent in 1997 there has been an assumption that interest rates and monetary policy are politically neutral, but when decisions are taken that re-distribute wealth that can’t be apolitical.   It’s worth reflecting on this next time someone suggests taking the NHS out of political control in the same way as the BofE.

He also talks about the way that the money spent on things like QE could have been spent more usefully on building schools or hospitals.  I think that Billy is actually describing 2 similar but subtly different approaches.

The first is that the Government could borrow money very cheaply and spend it doing things that would help improve society and the economy.  This is spot on.  Over the last few years we could have borrowed cheaply, fixed every pot hole, every leaky classroom roof, bought a brand new set of state of the art NHS diagnostic kit.  Not only would this have saved money in the long run, but it would have helped grow the economy too.

We could also have bought out any PFI deals signed at high interest rates before the Credit Crunch with a long time left to run on them.   A couple of the NHS Trusts I worked for have done just that, using low interest rates and some of the financial flexibilities available to Foundation Trusts to buy out historic PFI:

I like the way that the FT describes both of them as the first.   Just goes to show that even the best newspapers struggle to follow the boring detail of public borrowing and PFI deals. 

The second approach is the possibility of using QE style asset purchases to do something more ambitious than buy Bank Bonds.   We could, for example, issue Local Government Bonds, which the Bank of England could buy, and use this money to build Council Houses.  This idea was promoted by John McDonnell under the heading of Peoples QE.

I’m a bit more sceptical of Peoples QE.  The most obvious reason is that we could just use conventional public sector borrowing to achieve this, particularly when interest rates are low.  It’s a solution to a problem which doesn’t need another solution.   The reluctance to use cheap borrowing is because politicians don’t want to be honest about how much they are borrowing, and that doesn’t help improve accountability.

Both plans – traditional Government borrowing and Peoples QE – share some similar problems.  When the Government spends capital it almost always needs a flow of revenue to go with it.  A new Hospital needs on-going spend on Doctors and Nurses, Schools need Teachers, Roads have pot holes.   The only areas of Government capital spend which don’t have this problem are things like Council House building where the capital spend brings in rent.    

Having run public services myself there are very few uses for capital which doesn’t come with revenue consequences if only to fund the interest payments.

There is also an even nerdier problem with using Government spending or Peoples QE rather than traditional QE.   The traditional QE model benefits from the magnifying effect of fractional reserve banking.    The size of the lending that Banks can release into the economy is much greater than the size of the asset purchase. 

But peoples QE has a more profound problem.  While the Global economy is dependent on QE no-one knows when or whether it has negative long term consequences.   It may be that it distorts capital markets, increases volatility, or decreases long term growth.  It might even be that Andy Haldane is wrong and it increases inequality.

With conventional QE it is easy to reverse the process.   The Bank can sell off the bonds it purchased and reduce the amount of QE.   With unconventional or Peoples QE it is much harder to reverse the process if you need to reduce the amount of QE in circulation.  If you have used the funds to build Council Houses the only way to reduce the QE is to start selling off the Council Houses.   If you have used the funds to build Hospitals then they will have to be sold too.

It’s easy to see how this produces an almost impossible dilemma for a future Government.   If QE is causing inflation, or making the poor into paupers but the only cure was selling off Council Houses or Hospitals how would a Government act?  How would a Corbyn led Government survive this kind of dilemma?

This is a more conventional clip of Billy:\\

More to come tomorrow….

The biggest stealth tax cut in British History: Quantitative easing, Pensions and my flat in Leeds

Last month I wrote about attitudes to inequality specifically why I think that recent headlines about Rampant Inequality are way off the mark.  The belief that we live in an era of great inequality is so prevalent that a lot of people reacted with disbelief when I wrote that wealth inequality in the UK was at a historic low, despite recent small rises.  For me it is poverty that matters more than inequality. 

The Golden Age of Equality

I wanted to balance that by writing about the changes in the way that the distribution of different forms of wealth accumulation – property and pensions  – has changed over the last few decades. 

Since the Credit Crunch there has been an accumulation of property wealth in fewer and fewer hands.  In the immediate aftermath of the Crunch house prices fell sharply but the lack of liquidity in the financial system made it difficult for anyone without a big deposit to get a mortgage.  First time buyers who would normally have benefited from cheaper prices were squeezed out, while people who could access lots of capital found it easy to amass big property portfolios.  That’s why they call it capitalism.

I will admit that I was a beneficiary of this.  I took a job in Leeds just after the Crunch and rather than sleep in hotels I bought a flat, whose value had fallen significantly, and which was conveniently situated near the bars on Call Lane.  In the years up to the credit crunch large numbers of flats were built in and around Leeds City Centre, possibly as many as 20,000.  By 2009 when I was shopping for a flat 10% of them were empty, many for over a year.   

These flats saw very big falls in value, in developments like Aspect 24.  As I travelled around the City viewing flats whose occupiers had bought them new and which had lost over 20% of their value, wiping out all of the cash buyers had put in.  People like me who could access capital were able to buy choice properties cheaply, with mortgages at very low rates.   

A recent speech by Andy Haldane from the Bank of England sets out the economics behind these experiences.   Andy is my favourite Central Banker.  I realise that having a fave Central Banker is an unusual thing, and marks me out as a bit of a policy nerd.

The Bank of England, like most Central Banks, reacted to the Credit Crunch with the most expansionary monetary policy in history.   Interest rates were cut to their lowest ever levels, close to zero.  Additional stimulus was provided through asset purchases – so-called Quantitative Easing or QE. These asset purchases by Central Banks are currently running at around a cumulative 15% of annual global GDP.  

This pushed an awful lot of money through the Banking system and into the economy, to counteract the affects of the Credit Crunch.  Bit by bit monetary policy changes helped to reflate the economy, and restart the housing market.  By 2010 house prices were rising again, and continued to rise in areas like London all the way through to the Brexit vote.  Those who had acquired additional properties during the Credit Crunch accumulated wealth as monetary policy pushed up prices. 

It is a common assumption that the people who made money in the years following the credit crunch were the top 1% with gold hats, but a much broader group of people with plenty of capital, a property portfolio or stocks and shares benefitted too from expansionary monetary policy.

Despite this Andy Haldane argues that 10 years after the credit crunch Bank of England actions hadn’t made inequality worse – income distribution and the Gini coefficient today are the same as they were 10 years ago. 

I am sceptical about some of the claims made about inequality but even I am baffled by Haldane’s views.   He argues that the impacts on jobs and wages in lower incomes groups balances the increase in property wealth, and he has lots of graphs to prove it:

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There are 8 pages of graphs to illustrate his point.  I do like a good graph.

No matter how good the Bank of England’s graphs department are they can’t touch this graph from the Resolution Foundation, which is by far and away my favourite graph at the moment.  Yes, I know that having a favourite graph is as odd as having a fave Central Banker.

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You can find this graph and a great money other fine diagrams in this report:

When Harold Wilson became Prime Minister total property wealth was worth 3 times annual GDP.   Total wealth taxes brought into the Government a sum equivalent to just over 2% of GDP.   

Today total property wealth is 7 times GDP, but the taxes on property still only bring in just over 2% of GDP for the Government.

Without being hyperbolic this has been the biggest stealth tax cut of all time.   The tax cuts is partly caused by Governments fiddling with property taxes for political gain, but mostly due to the failure to reform or even rebase Council tax.  This failure to update Council tax is a wholly regressive policy which gives an effective tax cut to those in the most expensive properties

If the Government take from property taxes had kept up with the increases in property wealth there would have been no need for the age of austerity.

I have long advocated using the accumulated property wealth of richer older cohorts to help fund the care costs of the baby boom generation.   This is very unpopular, particularly where the care costs are as a result of an illness like Dementia.  The Conservatives proposed some moderately progressive proposals to use property wealth to fund care at the last general election.  Labour made hay opposing the “Dementia Tax” even though it put them in the position of defending inherited wealth.

Both parties in their own way are committed to defending inherited property wealth, largely because both main political parties are largely made up of people with property wealth.   Looking at the graph above not only has the property market been a source of widening inequality since the Credit Crunch, but this as actually been going on for a very long time, Labour and Tory.   

Even an inequality sceptic like me can see that housing and other assets like stocks and shares have become concentrated in fewer hands since the credit crunch.   Rates of home ownership are back were they were before Margaret Thatcher started selling off Council Houses, and rates of share ownership are back where they were before the same Prime Minister sold off shares in public utilities.  Stealth tax cuts just make this worse.  

At this point I had convinced myself that there was something I was missing about the view of wealth and inequality.    I am a big fan of Andy Haldane, but the size of wealth accumulation from property since the Credit Crunch, facilitated by BofE policy, must have increased inequality.   I couldn’t see how he could be right.

I checked his findings against the latest data from the Office of National Statistics.  This shows that even the recent rises in inequality has come to an end, and the current gap between rich and poor is static.  The BofE were right:

What the ONS data sets shows is that the rise in wealth inequality due to property wealth is being offset by changes in pension wealth – over the last few years nearly £1tn has been added to the value of private pensions. Given that the total GDP of the UK is just under £2tn this is a huge amount.   

For most people of my generation the most valuable things we own are our homes and our pensions, given that our collections of rare Morrissey solo records are plummeting in value.   We tend to track the value of our houses much more carefully than the value of our pensions, despite the fact that as we get older some of us will have pension funds worth a lot more than our houses.  Senior Doctors in NHS Super An can easily hit the £1m tax free limit.

Most people I know didn’t really notice the 2008 pensions act when it was passed, or when it was implemented a few years afterwards   I certainly didn’t spot it, and I was working for a Quango sponsored by DWP.   Frankly pensions are boring and complex, and even I struggle to keep track of it.   For those who missed it the 2008 Act requires all employers to set up an occupational pension scheme, which employees are automatically enrolled in unless they opt out.  The Act also established the National Employee Savings Trust, a public pension provider for those who do not have an occupational pensions, which functions as a low-fee pension scheme in competition with existing funds.

Part of the reason why the 2008 Act passed un-noticed is because most of the people who I know work in big companies or the public sector where access to good quality pensions is still widespread.   We have grown used to reading pension horror stories, many of which are true, about the closure of final salary schemes .  This has created the impression that whole pensions system is in crisis, but for most of my generation we are still in really good schemes.   The people who are benefiting the most from the 2008 Act are low paid workers in the private sector, who for the first time are benefiting from the kind of occupational pensions that white collar public sector and private sector employees take for granted.

The impact of the increase in pension wealth for people on lower incomes following the 2008 Act is as great as the increase in property wealth for people on higher incomes since the Credit Crunch.   This is a huge and progressive re-distribution of wealth, which will continue for years to come.

The generally accepted story of the New Labour years is that they did lots of stuff about tackling poverty but largely didn’t really do much on inequality, despite passing progressive legislation like the National Minimum Wage.    Peter Mandelson’s view that he was intensely relaxed about people getting filthy rich as long as they pay their taxes” has come to define our view of the New Labour era as one where tackling inequality wasn’t a priority.  

In retrospect the  2008 Act may well turn out to be one of the most significant pieces of redistributive legislation of the last few decades, worth more in total than the NMW.   I honestly find it incredible that such a huge change in wealth distribution could have happened without my noticing, but I don’t think I am alone.  After all pensions are boring, and most people I know aren’t affected by the changes in the 2008 Act.

In the meantime I new set of developers have announced another round of flat building in Leeds.  9,000 more flats on the Quarry Hill site, with unrivalled views of Britains finest example of neo-Stalinist architecture.  

What could possibly go wrong?

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