Written evidence from Debt Resistance UK

1. The Local Authority Debt Audit is a project of Debt Resistance UK - a group of researchers and activists contesting the financialisation of local government - and the impacts of a growing debt interest burden on the social sustainability of communities.

2. Our research has featured in recent publications on UK local authority finance by Channel 4 Dispatches, The Financial Times, The Independent, the London Evening Standard, The Guardian, Russia Today, and Goldsmiths University.

Executive Summary:

3. The Local Authority Debt Audit[1] used FOIA to explore the financialisation of 240 UK councils, which were encouraged by banks, brokers and advisors to increasingly borrow from private banks, rather than their usual source of funding - the HM Treasury Public Works Loan Board (PWLB). 

4. The debt audit uncovered Lender Option, Borrower Option (LOBO) loans with a face value of £15 billion[2], but total repayment cost (including exit penalties unmonitored by councils based on derivatives packaged in the loans) of £25-30 billion.

5. Interest rates payable on LOBO loans are initially cheaper than equivalent PWLB loans, as they feature a “teaser rate” to dupe councils into the deals, after which the interest rates “step up” and banks have regular “options” over the remaining 60-70 years of the loan term to further increase interest rates.

6. The average duration of a PWLB loan is only 22 years, part of the reason loan exit costs on PWLB loans are just 38% of the loan value, compared with 90%+ of the loan value for LOBO loans[3].

7. LOBO loans are disastrous for the financial sustainability of councils as they:

1)      Expose councils to significant market interest rate risk - whether rates rise or fall

2)      Expose councils to refinancing risk at regular (6 month to 5 year) option dates

3)      Lock councils into ultra-long term (50-70 year) contracts with relatively high interest payments and growing exit costs as base rates fall (i.e. 2009-2016).

8. Large exposures to high-interest LOBO loans appear concentrated in poor metropolitan boroughs, with high levels of social deprivation, which can ill-afford higher interest costs.

9. Decisions to borrow taken by local authorities were based on conflicted and potentially fraudulent financial advice from CAPITA and Butlers[4] and demonstrate scant regard for the social sustainability of debt on communities and financial risks being transferred to residents forced to repay borrowing, which was not undertaken in the public interest.

10. Councils including Edinburgh, Leeds, Newham and Cornwall, having accumulated large bank debts, refuse to admit mistakes or take legal action against the banks, preferring instead to transfer the debt burden onto residents in the form of tax hikes and cuts, pursuing increasingly punitive debt recovery tactics and criminalizing those in poverty.

11. Following closure of the Audit Commission in March 2015, following extensive lobbying of the Conservative Party by audit firms[5], there is no independent audit of local government finance to collect and compares national data on cross-boundary abuse of councils by corporate actors.

12. Refusal of the Financial Conduct Authority[6] and Treasury to regulate local government presents a threat to financial sustainability, as ongoing ‘mis-selling’ remains unpunished.

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The Accumulation of Debt in UK Local Government Impacts the Household Sector

13. A large component of the growth in PWLB and LOBO loan debt on local authority books was accumulated in 2003 - 2008 following enactment of the 2003 Local Government Act (refer Fig 1) which introduced a “prudential borrowing” regime[7], giving councils more freedom to borrow, provided borrowing was sustainable.

Figure 1 - PWLB vs LOBO annual loan issuance. Data via Debt Resistance UK/DCLG/PWLB

14. Measuring the sustainability of council borrowing for communities ultimately underwriting council borrowing has proven difficult in practice. Austerity measures (shrinking economic activity) and cuts to council grant funding reduce the ability to service existing debts, let alone future borrowing.

15. As Amyas Morse of the National Audit Office points out, cuts were made to local authority funding with only a limited understanding of the impacts of those cuts.[8]

16. Despite increasingly close integration via financial markets, policy makers continue to view central Government, local authorities and households as independent actors operating in silos, not as interconnected nodes in a complex system. This allows for the outcomes of bad policy decisions in one area to be ignored, obscuring cause and effect.

17. Much of the high-interest LOBO loan debt taken on by councils like Newham and Liverpool 2003 – 2010 was done so based on central Government incentives to transfer council housing stock to housing associations, in exchange for Government repayment of existing PWLB debt, which was refinanced via LOBO loans.

The Social Sustainability of Local Government Debt

18. If the impact of variable rate LOBO loans on the financial sustainability of councils with access to capital markets and Government grants is problematic, for taxpaying residents of these councils in poverty, with no effective safety-net, it is potentially deadly.

19. The London Borough of Newham has 27 LOBO loans with a face value of £563m. The council is paying £51 million a year servicing debt interest[9].

20. The total repayment cost of Newham’s LOBO loan portfolio is a staggering £1.3billion, funds Newham, one of the most deprived boroughs in the country, cannot afford to pay.

21. Newham council remain trapped into paying punitive 7.6% interest rates on its Barclays and RBS LOBOs, despite current PWLB borrowing rates being less than 2%. 

22. The net effect of the situation is an annual interest rate premium of between £7m - £13m being paid by Newham Council to the banks[10]. Public money which should be funding council services - instead lining bankers pockets.

23. Central Government austerity has forced local authorities and the household sector to take on additional debt to plug the gap in spending as the State withdrew.

24. Goldsmiths University Professor Johnna Montgomerie notes: “The political shift to ‘Austerity’ following the 2008 financial crisis only contributes to worsening household indebtedness. Austerity supports simultaneous household and state deleveraging – or paying down debts – in order to repair the damage caused by pre-2008 credit-fuelled profligacy. In practice, public policy now directly promotes personal and household debt as a means to replace public spending. In most instances debt is downloaded onto households with the aim of reducing public debt.”[11]

25. Frozen wages and inflation mean the UK is second only to Greece in OECD countries with a 10.7% decline in real-terms worker pay since 2007.[12] Households with average incomes, families with children and people in full-time work are now those with the most risks associated with indebtedness.[13]

26. In the UK - 1.8 million people are in ‘debt denial’ and almost 9 million people (18% of UK population) are ‘over-indebted.’[14] UK Households are predicted to spend £58 billion more than they earn in 2016.[15]

Debt Interest Repayments vs Council Tax Income - London Boroughs

27. Using 2014/15 annual report figures, the local authority debt audit compared the amounts paid in annual interest charges on debt with council tax income for London Boroughs - yielding an average figure equivalent to 23% of council tax income being allocated to repaying debt interest.

28. The data identified clear outliers. Newham, with the highest bank debt of any UK local authority spend the equivalent of 79.55% of council tax income servicing interest debt, raising legitimate questions regarding the value residents obtain for their tax spend.

Figure 2 - London Boroughs Interest Payments as % of Council Tax Income

29. That Newham’s substantial debt burden is routinely ignored in discussion of ‘Olympic Legacy’ in the host borough, demonstrates the cognitive dissonance with which we treat council borrowing and the long-term impacts of indebtedness on poor communities.

30. LOBO loans taken out by Newham Council in the lead up to the 2012 Olympic games will not be repaid until 2079, long after the majority of local residents with living memory of the 2012 Olympics have passed on. Healthy life expectancy for residents in Newham is just 58 years for men and 57 years for women, the 2nd lowest in the country.

31. Newham tops the London rankings for numbers of residents registered homeless and in temporary accommodation, 2nd worst place nationally behind Birmingham.[16]

32. The LSE report: “Facing Debt” found housing to be the dominant problem in Newham, and across London, but levels of poverty and low incomes in Newham make pressures on the poorest particularly acute. The share of owner-occupiers has fallen (43% in 2001; 28% in 2012) along with the share of social housing tenants (37% in 2001; 34% in 2012). There has been a steep rise in private renting, more than doubling since 2001 from 17% - 37%. In 2012 there were 16,600 more private rented properties than in 2001[17]

33. Yet analysis of Newham Council 2014/15 spending shows council spend more money on servicing bank debt interest than housing services - the primary driver of poverty in the borough (see Figure 3 below).

Figure 3 - Newham Council Public Spending via Debt Resistance UK[18]

Scottish Councils Have Higher Levels of Debt Than Councils in England & Wales

32. Analysis of debt figures for Scottish local authorities yielded significantly higher debt levels than for English local authorities, with an average figure of 42.4% of council tax income being soaked up by debt interest repayments.[19]

33. Scotland’s largest cities Glasgow (debt payments = 55% of CT) and Edinburgh (debt payments = 50% of CT) are both well above average, while Comhairle Nan Eilean Siar (Stornoway) tops the list with 103% of council tax[20] returned straight to the banks and HM Treasury.

Impact of High Debt Levels on Financial Stability and Risk Taking in Local Government

34. Following the 2008 collapse of Icelandic banks where £1bn of local authority deposits were frozen, the Communities and Local Government (CLG) Committee led a 2009 inquiry[21] investigating how such a large amount of public funds was jeopardized by speculative council investment.

35. Central to the Icelandic bank losses was the failure of Treasury Management Advisors (TMAs) CAPITA and Butlers/ICAP (companies taking commission fees on Icelandic deposit transactions) to adequately warn Councils of mounting risks in Icelandic banks.

36. TMAs Butlers and CAPITA have played a central role in hoisting high-interest LOBO loan debt on councils, receiving over-sized, undeclared commissions from brokers Tullett Prebon and ICAP, when councils borrowed from banks, instead of Government.

37. Management of risk versus return at councils was found by the 2009 CLG Committee to be too heavily skewed towards maximising return on investment, with too little concern being paid to protecting public funds from potential losses.

38. Via the Treasury Management Code of Practice[22], DCLG and CIPFA impressed upon Council s151 Officers that their priorities for managing public funds are:

1)      Security

2)      Liquidity

3)      Yield

39. Seven years after the painful lessons of the Icelandic banking collapse, it should concern the PAC to learn neither the balance of risk and return, nor the conflicts of interest inherent with Council’s external TMA financial advisors have been resolved.

40. LB Newham, the Council with the highest bank debt, market interest rate risk exposure, and the highest weighted cost of borrowing of any local authority, is also the council with the highest rate of return on its surplus treasury cash investment.

41. This suggests that Newham is attempting to dig itself out of a hole, brought about through risky bank borrowing, by loading up risk on its unsecured cash deposits with banks, building societies and money market funds. Exposing Newham taxpayers to the prospect of further Iceland style banking losses in future.

42. At the December 08 2015 Newham full council meeting Mayor Robin Wales boasted [timing 10”38] of having the “best” return on investment of any UK council[23], without mentioning downside risks the council take with public money to achieve such returns.

43. Mayor Wales refuted concerns raised by members regarding LOBO loans in the wake of a 2015 C4 Dispatches documentary exposing the high interest rates Newham was paying on its debt[24], claiming LOBO loans were “simple to understand” and “not a problem” suggesting Newham would be “borrowing more soon” and “rapidly pass the current [debt] figure”[25]. [timing 14”00].

44. Rather than ensuring prudent management of public funds, Newham’s unsustainable debt burden appears to be prompting council to behave in a manner more typically associated with problem gamblers.

45. Credit Ratings Agency Moody’s singled out Newham Council in a recent report for a ratings downgrade, citing risks associated with further capital expenditure (borrowing) to fund revenue maximising property development activities for its negative rating.[26]

46. Roshana Arasaratnam, senior credit officer at Moody’s warned: “Borrowing to invest in commercial projects exposes local authorities to additional credit risk, as revenues that flow from these projects are inherently uncertain.
    
    “Those adopting this strategy also face increased project execution risk, and greater competition from the private sector.”[27]
     
47. Moody’s note such borrowing contrasts sharply with local authorities’ traditional investments in schools, housing and transport, which are underpinned by government grants and do not depend on maximising revenues from commercial activities.

48. Despite LOBO loans and the role of conflicted advisors being referred to the CLG Committee[28], Treasury Select Committee[29], Financial Conduct Authority and National Audit Office, no action has been taken, raising serious questions about the ability of Government to hold firms like CAPITA, committing fraud against councils to account.

Council Austerity Cuts Transfer Debts from Government onto Poor Households

48. Central Government cuts to local government grant funding amounting to a 64% reduction 2010-2020[30], coupled with the removal of targeted welfare grants such as ring-fenced council tax support and personal independence payment are having a serious impact on levels of poverty and indebtedness in communities.

49. The squeeze being applied to council budgets through austerity is forcing council administrations to engage in increasingly punitive measures including court summons, criminalisation and the use of bailiffs to violently recover small amounts of council tax.

50. The report “Still too Poor to Pay” published September 2016 by Z2K and the Child Poverty Action Group - found bailiffs were engaged by London Boroughs on 19,000 occasions to recover council tax debts in 2015/16 and a total of 48,000 times since council tax support was cut in 2013.[31]

51. 26 out of the 33 London Boroughs questioned in 2016 were found to be charging council tax to those previously considered too poor to pay.[32]

52. In 2015/16, 81,000 claimants were charged a combined total of £8.9million in court costs, an increase of 10,000 claimants and £400,000 in court fees on the year prior.[33]

53. To put these figure in perspective, the combined London total of court fees £8.9million is significantly less than the £13 million interest rate premium (above PWLB rates) Newham Council paid to banks on its LOBO loan portfolio in one calendar year. [34]

54. Newham issued legal summons on 5386 residents in council tax arrears in 2015/16 and instructed bailiffs to recover council debts on 1560 occasions in an attempt to recoup £6.97 million in unpaid council tax.[35]

55. By contrast, despite legal advice from barristers and financial experts Newham has been mis-sold LOBO loans and has a strong legal claim against the banks, one year on, Newham council refuse to take legal action, even though the amount recoverable from banks, for each of the next 60 years, dwarfs the outstanding council tax due, for which Newham is prepared to criminalise poor residents, who incur further legal & bailiff fees.

56. Forcing those known to be in poverty to pay deeply regressive council tax, at a time council services, including adult social care, disability support, libraries, and youth centres are cut is as deeply unjust, as it is economically illiterate. As Z2K note: “the basic fact low-income households have insufficient money to meet the charge is not changed by the use of enforcement agents.”

57. Vicar Paul Nicholson an 84 year old resident of the London Borough of Haringey has refused to pay his council tax in protest, as according to the Vicar: “the government’s austerity policies were cutting benefits people in my community needed for basic shelter and survival.”[36]

58. Lambeth Council, which used debt recovery bailiffs in the highest numbers 2013/14, was forced to cancel bailiff use after council tax recovery rates dropped. After switching to a more user friendly model which provides debt relief support and a free reminder service, Lambeth’s Paul McGlone said:

“These interventions have been intensive in terms of cost and officer time but we believe they are the best way to ensure fair treatment for our residents in receipt of CTS. It’s also resulted in a better CTS collection rate than the previous year, vindicating decisions to invest resources initially to support people to be able to pay in the longer term.”

59. The lesson from Lambeth is the financial sustainability of the community and that of the council are interlinked. Criminalising poor residents, adding a layer of debt recovery and legal charges to existing council tax debt simply delays the repayment horizon for council tax collection, taking more money out of local economies where it would otherwise be spent, ultimately undermining the financial position of the council.

Policy Makers Are Blind to the Impact of Systemic Financial Risks on Local Authorities

60. The March 2015 report of the Public Administration Select Committee (PASC); ‘Leadership for the Long Term’[37] outlined the failure of the Cabinet Office and Treasury to include systemic financial risks to the National Risk Register and public sector post 2008 contingency planning.

61. Whilst regulators and Government has expended considerable energy firewalling the financial sector from future financial shocks, the impacts of such shocks, and the modes of their transmission from the financial sector to the public sector have effectively been ignored.

62. The most surprising and urgent gap found by the PASC was in HM Treasury:

“We have not seen sufficient evidence that [Treasury] has absorbed a key lesson of the 2007-08 financial crash: how best to prepare for another financial crisis. Financial and economic risks are not included in the Government’s National Risk Register, so the Government does not consider these systemic risks alongside other, non-financial risks, such as pandemic flu and antimicrobial resistance”

63. One obvious source of future financial shock for the local government sector is in the event of future banking crises where the £33 billion of public funds on deposit in banks, building societies and money market funds[38] would be subject to depositor ‘bail-in.’

64. Since the 2008 financial crisis, Bank Recovery and Resolution Directive (BRRD) policy implemented by the EU and HM Treasury has shifted from permitting Government bail-outs, to requiring depositor and investors to suffer losses prior to Government rescue.

65. Under the BRRD regime, the £33 billion of local authority deposits with financial institutions[39] constitute “unsecured deposits” at growing risk of bail-in losses. Councils failed to diversify deposits away from the Too Big To Fail banks previously deemed ‘safe’ and enjoying ‘full Government backstop’ following the 2008 crash.

66. The problem is most pronounced among Scottish councils, where in 2014, 51% of all Treasury cash deposits were found to be consolidated within just two banks, RBS and Bank of Scotland, with “some local authorities depositing up to 80% of funds with these two banks”.[40]

Abolition of the Public Works Loan Board and Transfer of Functions to HM Treasury

67. An additional risk for local authorities is presented by the abolition of the Public Works Loan Board.[41] Currently the PWLB is ‘lender of last resort’ to councils in a financial crisis.

68. Treasury has refused to confirm if lender of last resort function crucial to council financial stability in a crisis will be retained, in an era when 90% of Council CEO’s polled by PwC expect local authorities to get into financial difficulty within the next three years.

7 October 2016

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