Can it really be so hard?

Latest news: South London NHS trust declared bankrupt.  Unaffordable PFI liabilities blamed.

Setting aside the apportionment of blame (PFI liabilities were presumably one ingredient in a toxic mix), PFI liabilities more widely are being reported as a huge proportion of UK off-balance-sheet public sector debt, and thus a great pillar of the overall debt burden.  How has it come to this?

The original rationale for PFI was a good one.  Put the risk of cost overruns with the contractor, and it takes away the race-to-the-bottom where the contract goes to whoever can put in the most unrealistically-low bid, and raise it only when the contract is secured.  The idea that contracts inevitably go ten or twenty (even 100 in murkier corners) times over budget really shouldn’t be the norm.  Indeed, shouldn’t even happen in politically-driven vanity projects like the olympics, but that’s clearly too much to hope.

Trouble is, it became a vehicle for magic money: a manifestation for our times of Mephistopheles’ credit bubble[1].  Public sector commissions new projects, but hides the cost off-balance-sheet.  Current incumbents build empires: bask in the glory of shiny new hospital (or whatever).  By the time the emperor’s wardrobe malfunction can no longer be hidden, it can be made someone else’s problem.  If indeed the idea of payment ever crossed their mind in the first place.

Now, someone tell me what’s wrong with a simple solution: at the same time as a PFI contract is signed, issue a bond to cover the cost over the lifetime of the project?  Such a simple act of keeping the liabilities on-balance-sheet could prevent abuse, while retaining the genuinely useful aspect of the PFI concept.  Of course the financial wizards won’t like it (they lose a fun and profitable toy), nor will politicians and civil servants deprived of their ability to raid the future without telling the beancounters.  So a good outcome all round: just need to rewind that time machine a few years.

[1] Googling the story of Mephistopheles’ brilliant boom-and-bust based on credit notes for as-yet-undiscovered mineral riches that, when discovered, would rightly be claimed by the Emperor, finds an interesting essay.  One that not only tells the story, but claims that this part of the Faust story has been more-or-less systematically dropped since 1945, and so is not widely known.  Interesting insight or nutjob conspiracy theory?  Maybe both?  Here’s the story: read it and judge.

Posted on July 15, 2012, in banking, nhs, uk. Bookmark the permalink. 2 Comments.

  1. PFI is no more than an operating lease arrangement designed to spread the cost of both capital and operations over time. Well-drafted contracts can work, badly drafted ones are expensive and inflexible (and the public sector has many of the latter). This approach may be appropriate for private companies with tight cash flows and a high cost of borrowing, but in the public sector it has been used solely to keep heavy duty public spending off today’s balance sheet (which suits politicians with 4 to 5 year time horizons and civil servants with their sights on early retirement and a final salary pension). Now the tab has caught up with us.

    In the private sector, accounting standards have caught up too so companies indulging in such financial engineering have to declare the future liabilities of such contracts on their balance sheets (as they do with defined benefit pension liabilities). If the public sector was required to conform to the same standards of disclosure, the public debt would rocket and we’d be confronted with the true extent of the mess we’re in. However public sector accounting is somewhat selective in the standards that it adopts, so the National Audit Office et al ignore these inconvenient standards to make things look a lot less bad (that’s assuming they understand them in the first place!).

    It’s perfectly possible to manage and control cost overruns with conventional contracts and, given that government can borrow at cheaper rates than the rest of us, all other things being equal it would be far more honest and cost-effective simply to borrow the money and pay for the asset when it is procured. That would mean too that one could adapt or dispose of assets when circumstances change, rather than having to continue to finance obsolete or inappropriate projects for years and years. Public procurement has not improved as a result of PFI and project risk is not being transferred to the private contractors. Indeed the reverse has happened due to the opaque nature of these contracts, hence the problems certain NHS trusts now find themselves in (there’ll be many more to come).

    What the public sector needs is good procurement and well-drafted contracts, together with a dose of financial honesty. PFI does nothing to advance these requirements. Indeed, most of the National Egg and Spoon Race contracts (aka Olympics) were of the conventional, non-PFI variety and they seem to have have gone pretty well generally (especially on the construction side) apart from one highly-publicised security offering. Of course the initial estimates were wildly optimistic, but that was window-dressing to buy the support of the Great British Public and no-one who understood construction ever believed them.

    I like the post-1945 Faust theory – far less nutty than many of the tinfoil hat jobs that are in circulation.

  2. I’m not clear exactly what conspiracy theory is being proposed here. A shadowy network of bankers, politicians, academics and… literary publishers? Talk about herding cats.

    Anyway, for what it’s worth, if you look at the Wikipedia page on Faust Part II (and in all seriousness, who ever reads Part II anyway? Project Gutenberg doesn’t even have it in translation, and they’ve got some pretty obscure s**t nowadays, I suggest the main reason no-one[1] knows this scene is because even those who do know the play, don’t actually care much about it), it talks about the paper money subplot, and the page history confirms it’s been there since the page was first added in 2004. Which suggests that if someone did try to hide it, they didn’t do a very good job.

    [1] For values of ‘no-one’ to include up to a few tens of thousands of lit students and buffs worldwide.

    WRT PFI, I think John sounds convincingly well informed on accounting standards. and his suggestion is probably the simplest intervention that would meet the requirement, if “the requirement” is that politicians shouldn’t be able to hide the fact that they’re loading spending onto future taxpayers. But I invite you to think a little more closely: what precisely is the requirement you’re trying to meet? And whose requirement is it? – that is to say, in whose interest is it that it be met? The answer to question 2 might surprise you, and it would certainly give you a clue as to how to go about it.

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