Risky business: how cutbacks are leading local authorities into ‘exotic’ waters

Increasingly, local authorities are being asked to stand on their own two feet and fund welfare provision, economic development and urban regeneration themselves. Mirroring developments in Western Europe and North America, urban policy is increasingly fragmented, dispersed and financialised.

The opportunity for new financial powers and fiscal decentralisation has been welcomed by some civic leaders in the UK as an opportunity for territorial freedom, governance and power. What these leaders want is power and the roll back of centuries of centralised government, echoing the level of subsidiarity seen in most of Europe and North America.

However, findings from a research project I’ve undertaken with Paul Greenhalgh at R3intelligence, based at Northumbria University, suggest enhanced power for local authorities also brings with it certain risks in uncharted territory. This is because recent forays into fiscal decentralisation have coincided with unprecedented levels of austerity and local authority cuts.

Consequently, local authorities are engaging with unfamiliar financial methods and products to plug widening budget deficits. The Local Government Association estimates the local government funding gap will be £9.5bn by 2020 under the current spending plans.

Witness the call in recent weeks for an independent inquiry into so-called Lobo loans that councils have entered in to with international financial institutions to secure funding for local welfare provision and development. Following initial low interest rates, they have subsequently been saddled with convoluted bank loans estimated to be in the region of £15bn. For example, the London Borough of Newham, home to the 2012 Olympics, has exposed itself to the tune of £563m and is stuck with an interest rate of 7.6% during a period of rock bottom borrowing rates because it can’t afford to pay the multi-million pound penalty charges associated with early repayment or breaking.

‘Without careful consideration, the reliance upon commercial real estate could lead to a period of overbuilding where development, financial markets and local authority officers operate in overdrive to build new income-generating structures in order to repay loans and capture value’

Other financial models operating in the UK include the better known enterprise zones, new development deals (the government’s version of tax increment finance) and the business rate retention strategy. The uniting factor in all of these models is the symbiotic relationship with commercial real estate development. This is either direct, where they are pegged to business rate growth and expansion, or, in the case of Lobo loans, indirect, where the proceeds of new development is expected to repay loans which often stretch over 70 years. The result is an emerging tension between the need to create financial growth and the traditional local authority imperative to mediate a healthy balance of land and premises that supports social, economic and environmental development.

Without careful consideration, the reliance upon commercial real estate could lead to a period of overbuilding where development, financial markets and local authority officers operate in overdrive to build new income-generating structures in order to repay loans and capture value.

To guard against this risk, as practitioners and scholars we must be aware of the assumptions, quite literally built into the ideas, techniques and organisational structures of financialised welfare policy. Local authorities are in an invidious position. On the one hand they are expected to maintain the appropriate mix and supply of employment land and premises in order to support economic, social and environmental development. On the other hand, they must create new development in order to fund their own future.

It is essential that local authorities take stock of their respective office, retail and industrial real estate markets in order to appraise their strengths and weaknesses. This will help to mitigate against inappropriate property decisions that may do more harm than good. This is essential for two main reasons: firstly, in order to maintain an appropriate balance of land and property in local areas; and secondly, to make sure that local authority borrowing and investment decisions are based upon sound real estate economics. Paraphrasing the chancellor in his emergency Budget speech, you only have to look at Greece to realise that if a country is not in control of its borrowing, the borrowing quickly takes control of the country.

The chancellor was strangely silent on local government funding, hence all eyes will now be on the autumn spending review to see how the new Conservative government will interact with public spending. However, unless the current levels of cuts are reversed, the onus will still be on local authorities to explore more exotic methods of finance, which will expose them to even greater levels of risk.