PFI decouples from reality

It's difficult to recall now, but 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.

But it hasn't worked out like that (see many previous posts gathered here). For a start, the public sector (aka the Simple Shopper) has proved to be awful at negotiating good deals with private sector operators (aka the Carnivores). 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 Conservatives, but it's under Labour that the big problems have emerged. That's because Mssrs Brown and Balls twisted PFI into an Enron-style off-balance sheet borrowing scam, geared primarily to keeping official debt within their spurious fiscal rules. 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 all PFI deals. Scores of projects were threatened with the axe.

With the economy sliding into recession and an election looming, the government was desperate to avoid that, so back in March, Chancellor Darling stepped in. He established a special government bank - The Infrastructure Finance Unit, or TIFU - to provide government funding for PFI projects that could no longer access commercial bank finance "on acceptable terms".

TIFU did its first deal in April. It funded Britain's biggest waste project, in Manchester (a costly composting/recycling facility forced on Manchester 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 were left choking: what on earth is the point of a PFI deal where we are having to stump up over half the cash ourselves?

And then there's the blockbuster PFI deal to widen the M25. After massive wrangling, that deal finally closed (ie got signed) in May. And amazingly, it did not in the end require any capital injection from TIFU at all.

Unfortunately, taxpayers were still left choking. Because the only reason it did not need TIFU cash was that the terms of the deal had been sweetened massively. The all-in cost over 30 years had been cranked up from £5bn to £6.25bn - a 25% rise. And on top of that, we'll now be getting considerably less for the money, with the motorway widening scaled back drastically. So the true cost increase is even higher.

But why?

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 getting an even worse PFI deal than we've had over the last decade.

Now, as we've said many times, we cannot and should not blame the PFI providers. They are commercial operators earning a perfectly legitimate crust in very tough times. It's not their fault that the Simple Shopper is so poor at negotiation.

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 circumstances, 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 might 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 wouldn't have bid for the costly Olympics at all). But fair play - the government did at least have the sense not to accept those outrageous terms. Instead, the entire Village 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 the government funded the Village, why not do the same for all those stalled PFI projects?

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 card-maxxing government has worked so hard to avoid.

And just to underline that very point, the Treasury is reportedly about to announce the most flagrant Enron accounting fudge 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 public purse - seems to inhabit a world which is almost entirely decoupled from reality.

Taxpayers really should be jumping up and down and screaming about this. Whatever our political views, we can all agree that PFI has gone seriously wrong (eg see this post by George Monbiot, not a commentator with whom we often agree).

While everyone's attention is distracted by the Westminster soap opera, the costs of PFI are racking up alarmingly. It is yet another problem George Osborne will need to grip on Day One.

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

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