How much debt does a local authority need?

16 Jun 23

Councils need useful answers and real help, writes Conrad Hall, Newham’s director of resources

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It’s a question that comes to the fore given that taking on debt in pursuit of commercial objectives is probably the strongest and most consistent contributory factor to the recent spate of s114 notices.  

To this list must now be added, with regret, Woking, as possibly the most spectacular example of how not to manage local authority finances. At least, the most spectacular to date, but we don’t know what we don’t know – a theme to which I shall return.

One can’t help but wonder what sort of advice people at Woking were receiving.  

Personally, I think they might have done better to read their Tolstoy. The obvious image that comes to mind is the slow, inevitable and disastrous arrival of the train at the end of Anna Karenina, but Tolstoy is much more than a few justly famous novels.

His story ‘How much land does a man need’ is adapted, I think, from a traditional Russian folk story. Its protagonist arrives in a land peopled by rather naïve inhabitants, who promise him that he can have as much of their land as he would like, provided only that he can walk around it in a day. So he sets his cap on the ground to mark where he starts and begins walking, and the land is rich and fertile indeed.  He plans to turn left just past a certain landmark and so in time complete the circuit, but as he tops a hill he sees even more rich land beyond and so carries on so that he can add that too to his eventual estate, planning to turn left later.

So it continues and he gets in too deep and towards twilight is running back to complete his circuit of what will be a vast and rich estate. However, the exertions of the day prove too much and he suffers a heart attack and dies in sight of the finishing post. Sadly, the people gather round and dig him a grave: “Six feet from his head to his heels was all the land he needed”.

Croydon, Thurrock, Slough and Woking might have done well to have this story read to them at a cabinet meeting. Just replace land for debt and you have some pretty good advice. Each individual decision might have been great in isolation, but you need to focus more on the overall strategy than you do on individual decisions.

Here at Newham we’ve been looking at this question. It’s a genuinely difficult one, so if you’ve any thoughts please send them to me. In fact, the sector as a whole could do with a really mature debate on it, although I fear that in the current climate that DLUHC, OFLOG and others won’t really encourage this.

Alongside many other needs, we at Newham face what could almost be described as an existential housing crisis. The combination of inflation, rising interest rates and more besides is causing a huge reduction in the supply of housing, just when more and more residents are struggling to afford the often poor quality and overcrowded housing they have. In the absence of an effective central government intervention we’re doing what local authorities always do: finding a way to mitigate it ourselves. (I fear that this one may be beyond our ability to solve but we’ll keep trying).  

On an individual transaction basis buying property is likely to make financial sense in this scenario. You will avoid expensive nightly paid accommodation costs and acquiring more property reduces homelessness. However, with thousands in temporary accommodation and many thousands more on a waiting list for permanent social housing even buying enough to make a dent is expensive – and that means debt. So how much debt is too much?

Before you even get to that question you should be asking yourself what form do you want your debt in. Does it make sense to have 100% of it in PWLB (or equivalent) borrowing? The default is yes, but once you ask yourself why it becomes harder. Is it because it is “what we do?” If so, you need to get a new job, because there’s much more to the analysis than that. What’s wrong with index-linked debt, exactly? Why, in a large portfolio of debt (we have approaching £1bn and rising beyond that) shouldn’t there be a mix, linked perhaps to the income streams, especially for housing where the rental income is also likely, over time, to track or maybe even exceed any index you are likely to fix your debt to? However, it’s not easy to think through what mix is appropriate, which makes me wonder whether as a sector we have been lazy in thinking about this one.

Even if you can say with confidence that you have carefully analysed the problem and decided that the right mix of debt is, well, whatever you decided, you still need to say how much is too much. I know we calculate that every year in the Prudential Indicators, but they do seem to appear on about page 47 of appendix nine to the budget report each year, or some similarly inaccessible point, don’t they? And, one assumes, Woking’s debt of £1.9bn was within those limits.

Simpler presentation might help. Perhaps we might adopt some ‘golden rules’, following the Treasury’s lead. Could the following work?

  1. Total debt to be no more than x% of the net budget requirement (where x is surely lower than the 100:1 ratio that I think Woking were at or close to)

  2. Total interest (and capital charges?) to be no more than x% of the net budget requirement

  3. (Interest plus capital charges) on income generating assets to equate to no more than x% of the associated income (where x is obviously less than 100%, but how much less?)

Well, I could go on but I think that my point is made. You can calculate ratios for this sort of thing, and they will be valuable and useful information and they will help inform decisions. But should they dictate what a local authority ought to do?

Simple rules lead to complex, intelligent behaviour

I fear that DLUHC and OFLOG will calculate some metrics like this and then impose some sort of sanctions regime on those who exceed them. On the face of it that sounds reasonable. No-one wants another Woking (or Slough or Thurrock or Croydon), but without data like this how will we even know whether there’s one out there?

But can such a system work? I’m borrowing money to acquire housing assets because I think that it’s cheaper than paying a rather large fortune to house families in hotels near the Excel centre (which, oddly, are far from the cheapest hotels in London!). It may leave us with a debt problem, but it’s very different to Woking, who borrowed, as I understand it, for largely commercial purposes – and for the avoidance of doubt, that might have seemed a pretty sensible strategy for a district council in Surrey with little or no government grant.

In other words, local authorities are, well, local. The issues driving decisions about debt in Woking may have been different to those in Newham, which will probably be different again to those in Newcastle. Can we really think that one set of metrics will tell us the answer that such and such a local authority cannot borrow more than so much debt?

One only has to state it in these terms to lay bare the heart of the issue. Complex rules, such as I fear DLUHC will look to impose, will only lead to simple behaviour on behalf of local authorities to get around them when they don’t work for their own circumstances. (Does anyone remember the spate of sale and leaseback arrangements in the 1990s to avoid – never evade – the capital controls at the time?)

On the other hand, simple rules lead to complex, intelligent behaviour – at least on the whole, although one fears that there will be exceptions like Woking.

Some years ago I worked for a council whose elected members were proud of their debt-free status. Not just financially, although we joked that budget setting consisted largely about the interest rate assumption on our investments, but as a genuinely important point of political principle, that they were not passing debt down to their children. Now I work for a council where the elected members see a desperate need and have adopted a financially viable strategy that involves taking on much more debt accordingly.

Who am I, or any accountant, to calculate a ratio or ‘golden rule’ and say that one approach or the other is wrong? I can, and should, advise about risk, and one fears that another feature of the s114 notices is treasurers failing to do this properly and early enough.  

While I’m on that point, though, what about chief executives and the others members of the management teams, most of whom will control far larger budget than the finance director does? A big feature of their job evaluations will be their financial responsibilities, so let’s see them step up to the challenge too, not just reiterate the need to deliver ‘their’ statutory services.

However, to come back to debt, if the question is ‘How much debt should a local authority hold?’, then I have an answer for that. It won’t automatically prevent another Woking, but since it was invented it has proven pretty resilient. 

Have a simple rule – don’t go bust! – and let councillors and their advisers get on with that, accompanied by auditors looking at the real issues, not what the FRC thinks is important. And if they fail, hold them to account – individually if they are culpable and at the local level – including if need be council tax rises way beyond what we have seen to date in failing authorities. After all, why should the voters of West Didsbury have to pay for the consequences of Woking’s financial strategy?

Or, put another way, if the question is ‘How much debt should a local authority hold?’ then the answer lies in a system invented in Athens around two and a half millennia ago. For good or for ill it will produce better answers than any other system. It will fail sometimes, but no more often than some centrally supervised system run by DLUHC and OFLOG.

It’s called democracy.

  • Conrad Hall
    Conrad Hall

    Conrad Hall is corporate director of resources at the London Borough of Newham.

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