24 October 2008
As credit crunch turns into recession, it's time for a revival in public sector banking, argue Chris Leslie and Stephen Cirell. And local authorities could lead the way
Declarations of 'accessibility', 'trust' and 'transparency' have been thrown around in the commercial banking world for generations – littering the glossy adverts and brochures that entice eager investors. Yet it has been only over the past few months that these abstract concepts have crystallised into critical tests, which it now appears that some in the banking sector have been unable to pass. For generations, we have taken for granted the regular exchange of savings, loans, contracts and promissory notes. Now many people are questioning whether there really can be security and genuine guarantees for transactions in the 24-hour global finance system.
Confidence in the private banks is exceptionally delicate, as we know from the public's attitude to Northern Rock last year when there was even a mere hint that savings might not have been secure. Rumours and speculation can strike fear right across society – and not only in individuals. Private companies and public bodies also need to have confidence in the banking system; running a going concern means maintaining cash flows to cover payroll and reserves for unforeseen contingencies.
Local authorities are currently under the spotlight because of reserves invested in the Icelandic banking system. Ministers have admitted that 13 councils are experiencing short-term difficulties, with three singled out for emergency help from Whitehall's financial experts. If councils, like private individuals, feel that there is uncertainty about their savings in the internationalised banking system, then they will rationally withdraw these funds and seek a safer haven. The last thing the banks need is a run on their funds, especially from the wider public sector – and so the government is going to have to act as a guarantor of final resort.
In a world where confidence and trust have been severely undermined, local authorities might have a far more crucial role to play than can currently be imagined. Perhaps we should look beyond the current short-term thinking towards a longer-term and more radical solution.
In the meantime, though, we need to cover all bases. There will be a multiplicity of different things to do as a result of the vulnerability of investments, so cruelly exposed by the situation in Landisbank, Kaupthing and Glitnir, which unravelled this month. Some of the investments were short term, and the consequences are more serious; others are long term, but also with painful consequences. The question that must be resonating round local government is: who's next? This means that each local authority needs to conduct a thorough, and urgent, review of its various investments. It needs to revisit credit ratings (which might be done on different bases) and check the terms and conditions of the products accepted. Many authorities will be taking advice on whether they can withdraw deposits now and are planning next steps.
There is a real danger, though, that as we mimic the rabbit standing in the headlights, we fail to see the bigger picture. We have to start a national/local government debate on how to co-ordinate financial matters better and refocus local government's role to help communities through the next few difficult years.
This work is already under way. Over the summer, the New Local Government Network and several local authority leaders called on the Treasury to encourage a revival of public sector banking, specifically of council mortgage and remortgage availability. Whereas trust between the private banks dried up, the gilt-edged markets were still open to governments, both local and national. Councils have access through prudential borrowing rules to capital that can be offered to their residents in the same way as a bank could offer a mortgage. Secured loans from councils to prime householders in need of mortgage finance could even provide a strong return for the council tax payer over the typical 25-year lifespan of the loan, as the interest payments would supplement the capital repayment. Any risk of default could be secured against the property in question in the normal way, and councils would have a particularly close interest in adding value and appreciating the prosperity of the neighbourhoods in question.
In short, local authority mortgages could offer some of the liquidity that the housing market so desperately needs. Councils do not require the permission of the government to offer mortgages – they already have the legal powers to do so. They might want some flexibility, particularly the suspension or abolition of the standard national interest rate at which all council mortgages must be set. This rigidity was put in place more than 20 years ago, when the then government sought to shift all home finance into the private banking sector.
But in such times of international stress and anxiety, there could be an even greater role for local authorities. There is a changing mood across society with growing scepticism about the integrity of the global banks that slice up, sell on and trade in what used to be straightforward savings and loans. The old-fashioned virtues of the original British banks, grounded in their communities and lending only what their deposits could afford, might yet return to favour. With today's banks spread across the world and separated from their clients, and their ownership almost impossible to discern, it is no wonder that many people are questioning where their life savings are truly held.
These fundamental desires for transparent local governance and a rootedness in the real world might lead to a renaissance of local banking. The building societies that sprung up during the twentieth century were fundamentally localist organisations, built on a not-for-profit basis and in dialogue with their investors.
Credit unions have been slowly growing in popularity because of their ability to reach into neighbourhoods most in need of small-scale credit. Local authorities, too, should be considering a new future, encouraging sturdy community-based savings and loans institutions designed to serve their customers rather than shareholders. They could perhaps consider using their own position of trust in the community to facilitate credit.
Without credit, no modern society can function. The credit crunch is putting at risk not just householders facing repossession but also businesses unable to pay their wages and regeneration development schemes unable to get off the ground because of the housing market collapse. If the 'power of community wellbeing' means anything, it means ensuring that local communities have access to affordable credit. In the absence of a functioning banking sector, local government has a duty to intervene – just as national government does.
Active local government should be thinking beyond its traditional service offerings and considering whether it could be using its own 'triple-A' rating to access resources that their residents might struggle to obtain on their own. The trading powers that local councils have in law might allow local authorities to establish arm's-length banking activities, with stewardship of savings as well as basic credit and mortgage facilities. Such arrangements could, for example, fund the whole programme that is currently privately financed through mechanisms such as the Private Finance Initiative, with the benefits flowing back to the authorities concerned.
Local authority banking would of course need to comply with the regulatory regime, and probably import skills from outside the set of capabilities available in-house at present. But at a time when people are sceptical about where to place deposits or borrow funds, the local council could well rank as a more trustworthy source than most. In this way, the current crisis might have a silver lining, showing us that there is a better way, and encouraging the government to let us find it. Local authorities acting together constitute an extremely powerful and well-funded body that rivals the large financial institutions. Is this the answer?
We cannot yet foresee where the collapse in banking confidence will lead and we must hope that some level of normality resumes soon. Yet when trust breaks down it takes a long time to repair. Local government has the same obligation as national government to think creatively and act decisively. The best councils will be those that roll up their sleeves and help their residents through this difficult time.
PFoct2008
