Councils love spending other people’s money. But if it goes on for too long, the public get annoyed at rates rises and vote out the councillors. That’s how it is supposed to work. But everything changed after the GFC. Councils discovered a magic money tree!
The Local Government Funding Agency (LGFA) was created in 2011 in response to the Global Financial Crisis. Banks had stopped lending to everyone, which caused problems for debt-funded council infrastructure programmes.
As any businessperson will tell you, not all debt is bad. Borrowing for investment where the return is higher than the interest rate is good. Businesses borrow for factories, machinery and raw materials. They sell the products for more money, and keep the profit. Investment debt is good.
Councils can, and should, use debt in a different way. Long-term services and assets such as roads are expensive up-front, but provide value for a lifetime. Debt allows the cost to be spread out over that lifetime with gradual repayments by generations of ratepayers who benefit from it. In this way, the building ratepayers aren’t hit with the full cost while future ratepayers get free use. It is a user-pays investment, and far easier to manage than alternatives like toll roads.
The LGFA is a debt-funding alternative to banks, specifically for councils. It borrows money by issuing bonds and is able to offer councils a lower interest rate than banks. That is a big win for ratepayers and makes great sense.
What you haven’t been told is that the lower interest rate is achieved by using your house as the guarantee. If councils fail to pay the money back, your house could be sold.
Technically, the bonds are debentures and the LGFA is the trustee. Councils are signed up as ‘joint and several’ guarantors. This means that each council guarantees all the other councils. If Auckland or Wellington goes bankrupt, Hamilton ratepayers have to bail them out. In a debt default, the law allows debenture holders to instruct the trustee to appoint a receiver. Under the Local Government (Ratings) Act, the receiver is required to set new council rates to recover the money from ratepayers within one year. If you don’t pay, the receiver has to sell your house to get the money. Lenders really like this guarantee.
All of a sudden, councils had access to huge amounts of money without having to go cap in hand to ratepayers. They could spend, spend, spend, without voters getting upset. So far, the LGFA has loaned $23 billion to councils, or $4,500 per person. For a typical household, that is $18,000.
If this was for good business investments, it would be great news. Even a meagre 10 per cent annual profit would nearly half the average rates bill. But, as you have probably noticed, your rates are going up, not down.
The money has not been spent wisely. New Zealand’s infrastructure costs are outrageous. Data for some types shows we are four times the OECD average. Worse, much has been spent on unproductive assets like stadiums and cycleways. Some has been spent on speed bumps to increase congestion and make your daily commute harder. And a lot has been used on operating expenses rather than capital projects, meaning the money is just gone.
What went wrong?
If you go to a bank for a mortgage, the bank will look at your income minus your expenses to see how much money you have left over to pay back the loan. The LGFA does not do this. It only looks at council income. Most councils spend more than they earn. There is no way they can repay the loan.
Furthermore, when the LGFA started, it had a safety margin. It would only lend each council a maximum debt cap of 100 per cent of that council’s annual income. Over time, this has crept up. First it was 120 per cent, then a few years later, 150 per cent, followed by 180 per cent, 200 per cent, 250 per cent and, currently, 280 per cent. It is now proposing 350 per cent, with 500 per cent to council-controlled water companies.
The bank would also look at what you were buying. You would need an asset valuation or, for business loans, a business case. If the asset couldn’t be sold to cover the cost of the loan, the bank would simply say no. This is the bank’s security.
The LGFA does not look at what councils use the money for. There is some small sense in this because most council assets such as roads and parks cannot be sold. There is no security for the LGFA, so why bother looking. This is why the system requires the guarantee against your property.
It is a dangerously addictive magic money tree. Stick council’s hand out and councillors can get the white elephant of their dreams.
The spending addiction can be cured easily. The LGFA needs to look at income minus expenses, and adjust the dept cap accordingly. Suddenly councils would not have such easy access to credit. Secondly, the LGFA must look at what councils are spending the money on. If the investment return is less than the interest cost, then, like the banks, they must say no. Councils would instantly have financial discipline pushed back on them.
While that will work going forward, the $23 billion is a problem. A great number of families would struggle to come up with a spare $18,000 in a year, so their houses are potentially at risk.
The LGFA made two fundamental mistakes. The first was expecting councils to follow the law. The Local Government Act requires councils to plan their finances so their income and expenses are, at the least, balanced, unless there is a prudent reason to run a deficit. Covid was a prudent reason. That justifies one year out of the 20 since the Act started. But many councils, such as Hamilton, have failed every year. That is not how prudence works.
Secondly, the LGFA believes it is spreading the risk across a diverse portfolio of 78 councils and council-controlled organisation. This justifies the guarantee against your house, because if one council gets into trouble, the others will cover it before the auctioneer gets anywhere near your house.
The problem is that there is no diversity. All the councils are operating in the same market. The conditions that could get one into trouble will hit all of them at the same time. And because most have already been spending more than they earn, they have no capacity to cover each other.
The Covid money-printing response by central banks unsurprisingly resulted in rapid and high inflation a year later. The central banks tried to counter this with high interest rates. Borrowing costs shot up for all councils at the same time, clearly demonstrating the problem. Covid may have been a one in 100-year event, but the Ukraine war impacted the global economy, Europe is in recession, China’s property bubble has burst and Gaza came close to a Middle-East crisis with the Suez Canal too dangerous for shipping. Every year there are dozens of disasters. Another Christchurch earthquake equivalent here will break us.
I don’t have a solution other than hard work for decades to slowly pay down the debt. But I do have a warning: councils are continuing to spend and make it worse. We have to stop them. Perhaps the message should be that when the shit hits the fan, we will make sure those councillors who got us into this mess lose their houses first.
