Tuesday, November 28, 2023

England’s Slow-Motion Debt Crisis Rolls Into View


The slow-motion debt crisis rippling through England’s local governments is getting too big to ignore. 

Over the past two years, a handful of authorities responsible for essential services, such as social care, waste collection and maintaining roads, have declared they are unable to balance the books, inviting central government intervention. The issue gained a new level of prominence this month when Birmingham City Council became the latest to join the club after discovering a previously unaccounted-for liability of up to £760 million ($930 million) related to a historical equal pay claim.

Call it a Lehman moment for UK local government. With no disrespect to Thurrock, Woking or Slough (Matthew’s home town), few people outside these modest-sized boroughs are going to lose sleep about their municipal financial difficulties. Birmingham is a different matter. It’s the country’s second-largest city, with a population of 1.1 million, a £32 billion economy and a former manufacturing hub that is now a major employment center for education, health and public administration. If Birmingham is in trouble, there’s reason to be concerned.

The first thing to know about the financial black hole facing local authorities is that no one knows with certainty how big it is. Only 12% of audits for the fiscal year ended in 2022 had been completed by an extended deadline of Nov. 30 that year, Moody’s Investors Service said in a report this month. Audit delays mean accounting misstatements can go undetected for years. What can be said with confidence is that more cases of financial distress are likely to emerge. A list of the most indebted authorities suggests there are plenty more that may be at risk of being overextended.

Birmingham doesn’t even feature in the top 10, either by total debt or borrowing as a multiple of revenue. Neither do several of the other authorities that have issued so-called Section 114 notices since 2021. Media have often reported this as councils “declaring bankruptcy,” though technically this is a misnomer. Local authorities can’t go bankrupt. Councils must issue the notice if they believe they are unable to meet budget commitments from their income. This restricts their future spending and gives the central government power to take control.

At first glance, the troubled councils have little in common. Thurrock gambled disastrously on solar farms. Woking got into the hotel development business as part of an ill-fated town-center regeneration project. Croydon succumbed to what an independent investigator called “collective corporate blindness.” Slough’s accounts were such a mess that no one had a clear idea of what was happening — not least its auditors, who issued an unprecedented disclaimer. And failure to account properly for the equal pay claim did it for Birmingham.

There is a common thread, though. Central government funding for local councils has been cut drastically since 2010, when the government of Prime Minister David Cameron embarked on a program of austerity. Spending power funded by the UK government fell by more than half in real terms in the decade through 2020-2021, according to a National Audit Office analysis of UK government data. After factoring in increases in locally raised council tax in the second half of that period, local authorities’ overall spending power still dropped by more than a quarter.

This funding squeeze coincided with increasing demand for services such as adult social care and housing — the result of an aging society, population growth and rising numbers of homeless people (who local authorities have a legal duty to house). Councils have been operating “at the margins of viability,” says Kevin Muldoon-Smith, an associate professor at Northumbria University who studies local government finance.

While cutting funding, the government also relaxed controls on borrowing. One way local authorities can raise extra revenue is to make capital investments that produce income. In an environment of ultra-low interest rates, borrowing to invest in commercial property that yielded positive returns must have looked to many like a tempting way to plug budget gaps. The government has taken steps since 2020 to tighten the rules, but the bill for much of this investment binge has yet to come due.

The Bank of England’s benchmark interest rate has soared to 5.25% from 0.1% in late 2021, and the outlook for commercial real estate has turned grim. Moody’s says more council failures may emerge if commercial property prices fall by the expected range of between 5% and 15%.

The sudden monetary shift is an age-old story of how financial distress happens and one that is central to probably the most famous example of a local authority blowing up: the 1994 bankruptcy of Orange County in California. But while the UK version may feature individual cases of incompetence and recklessness (certainly the commissioners’ report into Thurrock makes for colorful reading), the problems can’t be separated from the wider context of severe funding cuts.

The impact on UK markets and credit ratings is likely to be limited, given that most of the debt that councils have run up is owed to each other or the central government. Some authorities may avoid issuing Section 114 notices by cutting services to the bone instead, according to Tony Travers, a professor at the London School of Economics. Local residents rather than investors are more likely bear the brunt, via more infrequent refuse collections and less regular road maintenance.

It’s a theme that bears watching, all the same. Keep an eye out for the potholes, too.

More From Bloomberg Opinion:

• Pension Savings Are an Emerging UK Political Battleground: Marcus Ashworth

• Commercial Asteroid Mining Has a Astronomical Cost Issue: Javier Blas

• Where Are All the Private Equity Bankruptcies?: Chris Bryant

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Matthew Brooker is a Bloomberg Opinion columnist covering business and infrastructure. Formerly, he was an editor for Bloomberg News and the South China Morning Post.

Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. Previously, he was chief markets strategist for Haitong Securities in London.

More stories like this are available on bloomberg.com/opinion

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