PFI Comes Home To Roost

Enron accounting has its price

BOM's friend Ted Bromund of the US Heritage Foundation has an interesting piece highlighting the damaging impact of PFI payments on Britain's already stretched defence budget:

"Labour’s sketchy accounting methods for the cost of these PFI contracts has created another snare for Britain’s defenses... In essence, the Labour government has created another affordability crisis in defense – one that it can now use as yet one more reason to reduce defense spending even further...

Labour has been in power since 1997, and yet it now argues that the MoD has somehow, mysteriously, developed plans it cannot afford to fund. It’s now setting itself up to play the same game all over again: use the PFI contract spending to which it had once agreed to accuse the Ministry of unaffordable future profligacy. That would be a bad move at any time, but it’s particularly unbearable when British forces are operating alongside U.S. ones in Afghanistan."

And today we have a new study examining precisely what the budget pressure might mean for our defence capability. The Royal United Services Institute (RUSI) says:

• The next six years are likely to see a cut in the defence budget of around 10-15% in real terms, alongside unit cost growth of between 1% and 2% per annum.
• The number of trained service personnel is projected to fall by around 20%: from 175,000 in 2010 to around 142,000 in 2016.
• If cutbacks are evenly spread, ground formations would have to fall from 97 to 79, available aircraft (fixed wing and rotary) would be reduced from 760 to 615, and major vessels would fall from 57 to 46.

It's a scary picture, especially if the government remains in denial about the squeeze and continues to over-commit our forces.

But even setting aside the prospective overall budget cuts, how much damage is already being done by PFI?

Next year, MoD's budget (current and capital DEL) will be £45.5bn. Of that, it will have to shell out £1.5bn on paying for existing PFI contracts - the largest amount of any government department, and 3.3% of its overall budget.

To put that in context, 10 years ago MoD's annual PFI bill was running at just £0.2bn, less than 1% of its overall budget. So there has been a considerable growth in the PFI burden - well over 2% extra taken out of the budget to pay the PFI contracts.

And that's the problem with PFI: initially it looks like a terrific wheeze for spending money without having it show up in the government's accounts. Just like those terrific accounting wizards at Enron always promised.

But all too soon, the cost chickens come home to roost. And boy, can they cause problems then.

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www.gudanggrosiran.com Categories: debt, PFI

M25 Debacle

For some reason the Department for Transport's offical vid forgot to ask him about the outrageous costs

A few days ago, one of BOM's old friends was out and about in leafy Buckinghamshire. Sadiq Kahn has moved up since he ate that poor IT guy who dared to suggest the NHS Supercomputer wasn't going to work . These days he's the Transport Minister, and he'd come to mark the start of the M25 widening project. Standing in front of the DfT's corporate banner, he said:

"Today marks a major step forward in our commitment to building Britain's future and increasing capacity on the busiest sections of motorways and trunk roads. Everyone who uses these important stretches of motorway, whether business or leisure travellers, will benefit from the massive investment."

Commitment to the future... massive investment... if you think that sounds like another huge bill for taxpayers, you'd be right.

Now let's all agree we need good transport infrastructure. And let's all agree our major roads would be much better shape to handle today's congestion had this clothead government not put a hippy moratorium on new projects during its first term (see this blog).

Let's simply focus on the monstrous cost of the current widening scheme, and how it has escalated since first approved.

The M25 project is a PFI deal comprising two elements. First, the widening of some of the motorway, and second the running and maintenance of the entire M25 network over the next 30 years.

The project was first approved by ministers in April 2004. At that stage, the capital works to widen 63 miles of motorway were estimated to cost £1.6bn, and the 30 year maintenance concession would cost £3bn (£100m pa). Giving a total of around £4.5bn (which was the figure quoted by ministers).

Two years later, in 2006, a shortlist of 3 bidders was announced. And in 2008 the winner was announced - Connect Plus, a consortium made up of Balfour Beatty, Skanska, Atkins and Egis Projects (er, yes... the same BB and Atkins who were also involved in the Metronet disaster).

At that stage, the cost was still put at £4.5bn, and an early deal close was eagerly anticipated - not least because it was hoped to get much of the work out of the way in time for the 2012 Olympics.

But the months ticked by, and the close was postponed. And the quoted cost figure stealthily crept up to £5bn. It seemed the project had encountered some late snag.

Then last autumn the banking crisis struck, and the entire PFI market was thrown into turmoil. That's because - as we've blogged before - PFI deals depend crucially on bank finance, and if the banks won't lend, there's no deal.

Well, there's no deal unless the government is prepared to juice up the terms so much that even cash strapped bankers can't resist.

And in the case of the M25 widening, that's precisely what happened.

Because when the deal finally closed in May this year, the cost had escalated yet again - from £5bn to £6.2bn - a 38% increase over the originally quoted £4.5bn budget.

And that wasn't all.

Whereas the original scheme had called for the widening of 63 miles of motorway, under the final deal only 35 miles are to be widened - a 45% reduction.

So once again, taxpayers are left paying hugely more and getting hugely less.

Of course, the government does have an explanation. According to the Highways Agency:

"This [cost increase] was because margins paid to the banks have increased as a result of the current economic climate."

That is, because of the international financial crisis - which as you know, was nothing to do with this government - the commercial banks have racked up their interest charges - the margin they charge on top of market interest rates. So the costs of this deal have naturally escalated.

What a load of piffle.

HTF can higher interest charges possibly explain a cost escalation from £5bn to £6.2bn (let alone the escalation from the original £4.5bn, or the 45% reduction in road widening)?

Let's do the math.

The consortium is raising £925m of commercial bank debt. But the overall cost to us has escalated by a minimum of £1.2bn. So if that increase is entirely accounted for by higher interest charges, it means that such charges are an average £40m pa higher than previously planned. Which implies that the average interest rate charged has gone up by at least 4.3% pa (40/925). And in reality it would have to be much more, because most of that debt will be paid off long before the end of 30 years.

But how can interest rates have gone up that much? Market interest rates (including LIBOR) have come down - not gone up. And although the margins banks add on to those market rates for their loans have increased, the increase is of the order of two percentage points - not 4-5%.

So what's really going on?

Yup, you guessed it - once again, we taxpayers are being screwed to the floor courtesy of the Simple Shopper.

Ministers were so desperate to push the project through, because of all those jobs and grandstanding opportunities (see vid), they were prepared to pay any price. In fact they were so desperate, work started within hours of the final deal being signed.

The consortium, not unnaturally, took full advantage.

And before you squawk about grasping capitalists, let's remember they are only earning a perfectly legal crust. They can't be held responsible for the idiocies of government. We don't blame them one little bit.

No, next time you're fuming in an M25 superjam, grinding your teeth at the higher fuel duties you've been forced to pay to clear the nation's debts, just make sure you remember where the real blame lies.

PS As we've blogged before, we've changed our mind about PFI. In principle, it ought to give taxpayers a good deal, but in practice - in the hands of the Simple Shopper - it's a recipe for rip-off, especially with one-off megaprojects like the M25.

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www.gudanggrosiran.com Categories: PFI, transport

Giving Privatisation A Bad Name

Don't judge privatisation by the results of PFI

We've blogged the disaster of PFI many times. In principle, it sounds like a great way for taxpayers to get better value for money, but in practice, it's been an horrific saga of overpaying, perverse incentives, and downright failure.

An interesting paper by Ted Bromund of the US Heritage Foundation takes a close look at how it's been used by the Ministry of Defence. And as you'd expect with that particular money-pit, it's not a very pretty picture.

Ted gives a good account of the dismal story for his US audience, who apparently still harbour some delusion that Labour's use of PFI was for genuine efficiency reasons. But he also draws out some broader conclusions that are well worth summarising:

• Risks cannot be wholly transferred to the private sector - that's because in some areas - certainly defence, but also key infrastructure - outright failure is not an option for government.
• Contracting out should promote efficiency and improved quality, not hide spending - Labour's Enron approach to PFI has been costly and inefficient, and PFI contracts have also been used to meet top-down targets for "staff cuts".
• Contracts with the private sector require effective government contractors - as we've seen over and over again, the public sector simply does not have the staff to negotiate and manage cost effective contracts.

But the Big Point we should take from Ted's paper is this:

"Contracting out [such as PFI] is not privatization because it does not reduce the government’s responsibilities: it increases them.

The government must decide what it wants to buy, negotiate the contract, and then—like any other buyer—ensure that the other party fulfills its side of the bargain."

So let's just take that in.

When government enters into a PFI deal, it is not offloading its reponsibilities. Instead, it's delegating some operational authority, while retaining the overall responsibility for delivery to the final customers (ie us taxpayers). It is also adding a new responsibility to manage the PFI contractor. It has not privatised anything, any more than a company does when it hires contract cleaners.

Compare that to real privatisation. With real privatisation, the government takes itself out of the loop altogether.

For example, let's say Gove really does take us down the school voucher route. He dishes out the vouchers, and then he sits back. The privatised schools are now responsible directly to parents for providing good education, not the government. It's just like... well, it's just like the existing private school system.

That is completely different to a local council entering into a contract for a new PFI school. With real privatisation, the Simple Shopper is no longer intermediating his hopeless bungling presence between the customer and the supplier.

Unfortunately, the manifest failure of PFI under Labour has got real privatisation a bad name. It has allowed the left to claim that the fault lies with greedy private sector providers - the very same people who would run privatised schools 'n' hospitals.

Ted's risk transfer point is also a crucial one. There is absolutely no point in taxpayers paying a private sector provider to assume risks it is not capable of assuming. As we saw with the Metronet disaster (eg see this blog), thinly capitalised PFI contractors can prove to be very expensive if they collapse.

And even where a private sector counterparty does have deeper pockets, they are useless if the terms of the contract allow it to walk away when the going gets rough (as National Express has just done with the East Coast rail franchise).

Whether for PFI or private rail franchises, the Simple Shopper's inability to manage contracts has done serious damage to the cause of privatisation.

Somehow we've got to find a way of explaining that such bungles are nothing to do with real privatisation.

PS Talking of risk transfer, today's waffly proposals on bank regulation leave me feeling distinctly queazy. What the banking crisis has put up in lights is that we taxpayers are currently guaranteeing the banks without limit. And like St Vince says, we're taking these risks of catastrophic failure even though it's the bankers who take the upside. So just why aren't we separating the high street banks from the casinos, Glass-Steagall style? Yeah, sure, if we had superb regulators and superhuman bank boards we wouldn't need to. But we don't. And we do.

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www.gudanggrosiran.com Categories: PFI

PFI Millstone - How Heavy Is It Now?

It's definitely heavier

Regular readers may recall an extraordinary exchange at a Public Accounts meeting in November 2007. The PAC were grilling Treasury mandarins on the PFI millstone, and they wanted to know how big the debt had become.

Now, you might have thought that would be simple to answer. After all, PFI involves some pretty chunky liabilities, so the mandarins would surely have the figures at their fingertips.

Er, no. The mandarins floundered around all over the place. Finally, one PAC member - the redoubtable Richard Bacon - got so frustrated, he whipped out his own pocket calculator and literally added up the numbers for himself.

You see, the projected annual contractual payments under outstanding PFI deals are published on the HM Treasury website (see here - the "Signed Projects List"). What HMT doesn't publish is their total compounded value, and that's the figure we really need to know. Otherwise, we cannot understand how big the PFI liability has become in the context of the government's overall debt.

So let's re-run Bacon's calculation and see how big that future liability now is.

First, here's the latest HMT projection (April 2009) of annual payments under existing PFI contracts:

As we can see, annual payments are projected to peak at £8-9bn pa in the middle of the next decade (ie the decade when we won't have any money). And they then remain above £7bn pa all the way until 2028.

The first calculation we can do is to add up all the annual payments to give the grand total over the whole of the projection period. That comes to £206.6bn.

Which in itself is quite worrying, since when Mr Bacon did his calculation, the total was "only" £157.9bn. So in just 18 months, the total has increased by £50bn, or around one-third.

But of course, simply adding the numbers doesn't give us a figure we can properly compare to the rest of the government's debt mountain. For that we need to discount the future PFI payments by an appropriate interest rate. And in this case, the appropriate rate is the yield on government debt (ie gilts) which currently stands at about 4.5% pa.

And when we do that, we get a figure of £124bn.

So we estimate that our PFI debt currently stands at £124bn, up from £100bn the last time we crunched the numbers.

There - that wasn't so hard, was it.

In which case, how come there's so much confusion about the right figure? As Mr B put it:

"I have been trying for several years to get to the bottom of how big is PFI, and it seems to be quite difficult to get an accurate answer. I have been told by various people, including by the National Audit Office, answers such as, “Well, really they do not know.”

The truth is that the mandarins don't like debt calculations like ours. They prefer to quote a much smaller number that comprises the so-called "capital value" of the PFI projects. And that currently stands at £63.8bn, only about half our number.

Why the difference?

In essence, it's because the mandarins' number only measures the capital cost of building the PFI school or hospital (although, to be frank, it isn't entirely clear that it even measures that). Our number, on the other hand, includes not just the capital cost, but also the future cost of various services that come as part of the PFI contract - everything from maintaining a hospital to running a prison. Our number also includes the funding costs of the PFI contractor.

So our number measures the whole shebang, whereas the mandarins prefer to focus on just one element of the total PFI cost. Which - surprise surpise - is much smaller.

In fairness, they do wheel out an argument to support this apparent trickery. They say that the element of future PFI payments that represent service charges (such as cleaning and maintenance), is nothing to do with borrowing to fund a capital asset. And just as we don't count the future salaries of government employees in our measure of government debt, we shouldn't include the future payments for these PFI services.

Hmm.

You see, the big difference is that future payments for PFI services are a clear contractual liability, whereas future salary payments to government employees are not.

Government employees can always be made redundant (watch this space), but PFI contracts cannot be broken unless the government can prove (probably in court) that the contractor has failed to provide the agreed service. Which means we are skewered firmly on the hook.

And fundamentally, that's also why the Office for National Statistics' tortuous distinction between different types of PFI contracts is also bogus.

(As you may recall, the ONS distinguishes between so-called operating leases - which don't count towards government debt - and financing leases - which do count. And guess what... according to them, the vast majority of PFI deals are operating leases, so don't count. How very convenient. See this post).

The bottom line is that PFI represents a substantial contractual liability for taxpayers. One that has now soared well over £100bn.

PS Someone said to me recently that PFI debt is now pretty small potatoes compared to the gzillions of debt being run up everywhere else. But of course, as always, a hundred billion here, a hundred billion there, and pretty soon you're talking real sponduliks. Either that, or national bankruptcy.

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www.gudanggrosiran.com Categories: debt, PFI

Meanwhile, Back In The Real(ish) World...

I assure you - I'm a real financial wizard

The long and expensive saga of PFI continues...

The story so far (see many previous posts gathered here):

Once upon a time, PFI was meant to save taxpayers money. The idea was that by leasing schools, hospitals and roads from private sector providers, we'd benefit from their superior efficiency in designing, building, and operating such facilities. It would be so much cheaper than the traditional approach of hiring a firm of builders and extending the mortgage to pay them.

Simple.

Except that PFI hasn't quite worked out like that. For a start, the public sector (aka the Simple Shopper) has proved to be total pants at negotiating good deals with private sector operators (aka the Sharks). And also, although private suppliers ought to be cheaper because they are more efficient, the cost of their funding is always higher than that obtainable by the public sector directly (in the gilt market). So net net, they might not be cheaper at all.

PFI was introduced by the Tories, but the problems multiplied hugely under Labour. That was because Brown and Balls twisted PFI into an Enron-style off-balance sheet borrowing scam, geared primarily to keeping official debt within their spurious fiscal rule targets. To that end, they put huge pressure on local councils and health authorities to fund projects via PFI, rather than via direct borrowing. Costs naturally soared.

Then in 2008, this entire charade hit a major problem. The near-collapse of our banks meant that private sector funding for PFI suddenly dried up. Banks were no longer willing to provide the debt finance essential to virtually all PFI deals. Scores of projects were threatened with the axe (see this post).

Big spending Labour couldn't have that, so back in March, Darling acted (will he still be Chancellor by the time I finish this?). He established a publicly owned bank, snappily named The Infrastructure Finance Unit, or TIFU, to provide government funding for PFI projects that could no longer access commercial bank finance "on acceptable terms"...

Now read on...


TIFU did its first deal in April. It funded Britain's biggest waste project, in Manchester (yes, yet another one of those costly composting/recycling jobs forced on us by EU landfill regulations).

The precise terms under which the deal was done have not been revealed, but we do know that TIFU will be providing £120m of the project's total £640m capital value. However, that is in addition to some £180m coming from the European Investment Bank, and another £40m from local councils round Manchester. So overall, there will be £350m of taxpayer funding, which is over half the total.

Taxpayers should be choking: WTF is the point of a PFI deal where we are having to stump up over half the cash ourselves?

And what about the blockbuster PFI deal to widen the M25?After massive wrangling, that deal finally closed (ie got signed) in May. Amazingly, it did not in the end require any capital injection from TIFU at all.

How come? Simple - the terms of the deal were sweetened so much that the commercial banks, who had been threatening to quit, scrabbled back on board.

Once again, taxpayers should be choking. The all-in cost over 30 years has cranked up from £5bn to £6.25bn - a 25% rise. But on top of that, we'll be getting considerably less for the money, with the widening scaled back drastically. So the true cost increase is even higher.

WTF?

The official line is that our busted banks have increased the risk margins charged on all forms of lending. In the case of PFI projects it seems their typical margin has gone up from less than 1% pa, to something more like 3% pa (ie they now charge something like 3% pa over their cost of funding).

But that can't be the whole story. Banks may have increased their risk margins across the board, but they won't have forgotten that PFI loans are still ultimately a claim on the public sector - the most secure borrower there is. Given the current low level of market interest rates, increased margins should not have increased costs by well over 25%. Also, at a time when contractor costs in general have fallen, shouldn't we actually be seeing a smaller overall bill?

The obvious explanation is that we're now being legged-over even more comprehensively than usual.

Now, as we've said many times, we cannot and should not blame the PFI providers. They are commercial operators just trying to earn a perfectly legitimate crust. It's not their fault that the Simple Shopper is such a dumbcluck pushover.

No, the underlying problem here is that the government is absolutely committed to PFI: committed at virtually any price.

There are no less than £8bn of PFI deals in the pipeline, scheduled to close over the next 18 months. And we currently have a government desperate to avoid further pratfalls pre-election. In the circs, there's no way they're going to scrap their promised new hospitals, or add yet more construction workers to the dole queue.

Well, OK, you say, why can't they go ahead with the projects, but simply switch back to traditional gilts funding and at least save us some money?

Nice idea. Excellent idea.

And in the case of the 2012 Olympic Village that's pretty well what they have done.

As BOM readers will recall, while never a standard PFI deal, the Village was supposed to be largely funded by the private sector on normal commerical terms. We never thought that was realistic, even before the banking crisis, and sure enough, no commercial developer has been prepared to take it on, except on truly outrageous terms.

Of course, we wouldn't have started from here in the first place (ie we would never have bid for the 2012 Circus at all). But fair play - the government did at least have the sense not to accept those outrageous terms. Instead, the whole shebang will now be funded by us (either from within the formal 2012 budget, or as borrowing from the EIB and various commercial lenders).

So if they did it with the Village, why not do the same for all those stalled PFI projects, thereby avoiding all the extra leg-over costs?

Two reasons. First, it would mean long and electorally awkward delays, as each individual PFI deal got unpicked and painstakingly restructured along traditional lines. And second, it would bring all that borrowing directly and visibly onto the government's official balance sheet - which is the very thing this bunch of card-maxxing shysters have been working so hard to avoid.

And just to underline that very point, the Treasury is about to announce the most flagrant Enron accounting outrage ever. According to the FT (and others), they are to fiddle their way round their own promise to clean up PFI accounting:

"In spite of the widespread expectation that almost all PFI projects would go on the books as the Treasury fulfils a longstanding promise to move the public sector to international financial reporting standards, the Treasury has now issued all-but-final guidance to Whitehall departments indicating that, while they will count on departmental accounts, a different accounting standard will apply for the Treasury's budgeting purposes.

That will be based on the European accounting standard that is applied by the Office for National Statistics to the national accounts. It has the effect that many projects will continue to count as off-balance sheet."

This latest con is apparently known as "decoupling", which just has to be a bad joke. Because these days, HM Treasury - our once proud guardian of fiscal rectitude and the national purse - seems to inhabit a world which is almost entirely decoupled from reality.

Taxpayers really should be jumping up and down and screaming about all this. In fact, things are so bad, we find ourselves agreeing with George Monbiot.

While everyone's attention is distracted by the Westminster soap opera, the PFI money fire is once again threatening to burn down vast swathes of our future prosperity. The other George will need to start beating out the flames on Day One.

And to think - once upon a time, PFI seemed such a wonderful idea.

PS The other day we reported on a Tyler foray into the first-time buyers property market. We wondered WTF Northern Crock is offering the market leading mortgage deal - given that it went bust, and it therefore doesn't have any money to chuck around, and any money it does have rightfully belongs to us, etc etc. Well, it turns out their offer is bogus. Or more precisely, when our first time buyers attempted to lay their actual hands on an actual mortgage, they suddenly discovered they would need a deposit of 40%. Two points here. First, is 40% something your typical first time buyer can rustle up? Even with the Bank of Mummy and Daddy's 24/7 special loans service, it sounds like a stretch. And second, how come our buyers only discovered the catch after they'd been given an "agreement in principle" with a much lower deposit, an agreement that had been negotiated by no less an expert than the Artful Dodger himself. Anyone would think the Crock didn't really want to lend. Anyone would think it is trailing attractive loan offers merely to placate Comrade Stalin, who announced back in February that his bank would resume mortgage lending on 90% loan to value ratios to help hard-working families and first time buyers etc etc... even though he must know that in the real world there's no actual money.

Can someone just remind me - what does the Real World actually look like?

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www.gudanggrosiran.com Categories: PFI