Inflation + recession = budget crisis: Local Government Chronicle


The Government’s grant increases of 4.2% and 4.4% for English councils for the next two years are significantly below the inflation rate for goods and services bought by local authorities, which have been badly hit by hikes in fuel and food costs. Added to which, local government minister John Healey told the House of Commons, councils are expected to accelerate their drive on efficiency savings: “to redouble their efforts”, as his department put it.


These are tough times indeed for council budgets. The Local Government Association has already said that it expects local authorities in London and the South East to be the hardest hit by the recession, as the financial industry’s crisis hits jobs and income.


Even small district councils are suffering a severe squeeze. Rushcliffe Borough Council in Nottinghamshire is facing a deficit for next year of three quarters of a million pounds on an annual net budget of £11.9m. Annual savings in subsequent years will have to increase to £1.4m by 2013/14 – 10% of its projected net budget for that year. The council is just coming to terms with the scale of the task ahead. “The savings have not been identified as yet,” says Neil Morton, its head of finance.


Glasgow City Council is another authority in difficulty, with a £5m overspend in the current year. Overspends against budget for the current year include a £1.9m deficit in its Development and Regeneration Services, caused by reduced advertising income and building warrant and planning application fees; £1.6m in Education Services, resulting form higher energy and transport costs, and reduced income from children’s placements from other authorities; and £1.4m in Social Work Services, mainly because of higher residential school placement costs, with social work overspending “represent[ing] a high risk to the Council’s overall financial stability” according to the authority’s latest budget monitoring report. Glasgow is also behind budget on the collection of council tax income and non-domestic rates.


Councillor Stephen Curran, City Treasurer at Glasgow City Council, says: “The perfect storm of inflation added to the credit crunch means there are significant pressures on our budgets which we will have to deal with. If we do not, we will see our reserves cut to an unacceptably low level. Over recent years we have taken difficult decisions which have allowed us to put money in the bank for a rainy day and it’s certainly raining now. While things will still be bad, they will be significantly better than they might have been.”


Councils in Northern Ireland are also very badly hit, with particular problems caused by errors by the Land and Property Services agency that told councils they would receive much more in rates income than they have actually received. In the case of Belfast City Council, it is being hit by the loss of £5m revenue for the current year, with further losses in projected revenue for the next two years, on an annual net budget of £110m. “So £5m is a sizeable change – especially when you are told after the year is over and you spent that,” says Trevor Salmon, deputy chief executive and director of corporate services at Belfast City Council.


That £5m has had to be taken from the council’s reserves, which had stood at a healthy £14m, but which have now fallen to a mere £4m or so – against what Salmon believes should be a minimum of £10m. Matters have been made worse for Belfast by severe inflation – a 50% hike in gas and electricity prices in a year, 25% rise for oil, another 25% on landfill disposal and for the current financial year a 2% rise in employer contributions to the local government pension fund (with further rises in each of the next two years).


Council income has gone down, with the loss of £300,000 on building control applications and other revenue falls at leisure centres and catering facilities. The council has also been hit by a big fall in investment income, following the cut in its reserves. In addition, the drop in property values has meant the council has put on hold plans to dispose of surplus assets, the capital receipts from which were to have gone towards investment and regeneration of key city development sites.


Belfast has already made efficiency savings in the current year, bringing down its overheads by £1.7m. Half a million pounds of this has been cut from its insurance bills, through greater tendering of policies and brokerage services. Further savings have been achieved by the adoption of e-auctions for various procurement, cutting £105,000 on IT hardware and another £130,000 on other goods and services.


Yet other councils in even the worst recession-affected areas are apparently faring better. Westminster City Council – which had £16m in Icelandic banks – says that income has stood up well, with parking fees and planning application receipts only slightly down. And the council has found £100m for emergency measures to help local businesses and residents (see box), financed by changing some spending priorities, with a small amount coming from reserves. The council says that authorities need to react differently from in the past, when they cut jobs and services in a recession.


The London Borough of Wandsworth also says that its financial situation is stable and as expected. And Manchester City Council says that it is “one of the richer councils”, without any immediate crisis.


Tower Hamlets, on the edge of the troubled Canary Wharf district, is another that is playing down the situation. “The authority has a three year budget which it agreed in February 2008, and had factored in what we have known for some time, that the economy was entering a downturn,” says spokeswoman Kelly Rickard. “For example, we anticipated that the council tax base would be increasing by a much lesser amount than the historic trend as the downturn began to affect new housing completions.”


However, Tower Hamlets says that the downturn is proving more severe and fast-hitting than it had anticipated. “The authority does not expect to be immune to the impact of the financial downturn, although it is still quite early to assess what that impact will be,” says Rickard. “The position in Tower Hamlets is complicated by the fact that, on one hand, the preparations for the Olympics may cushion the impact on the local economy, while on the other hand, the significant presence of the financial services sector in the borough may have an adverse effect. We are expecting downward pressure on income from planning fees, building control fees and local land charges. We are also anticipating that some debts, including council tax, may become harder to collect.”


As the real impact of loss of income becomes clearer, many more councils are likely to be forced to accept that more drastic surgery on their spending will be necessary.




How councils are helping their local economy


Westminster City Council has launched a 15 point programme of support for the local economy. Measures include paying local businesses quicker; loans for people struggling to pay their mortgages; creating a council-run apprenticeship scheme to create a pool of skilled labour for employers; revamping district shopping centres; creating cheap homes for the homeless; and a proposed freeze on the council tax for 2009/10.


Manchester City Council has just adopted a ‘Manchester minimum wage’, through which all council staff will be paid at least £6.74 per hour – more than a pound higher than the national minmum wage. Those benefiting include school crossing patrol staff.


Glasgow City Council has also just launched a programme to combat the local effects of the credit crunch. Measures include relaxing development rules, extending a fund providing flexible loans to small and medium-sized companies; deferring payments required from developers; creating more flexible rules on land disposal; establishing a new regeneration fund; and forming an Economic Advisory Board.

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    – Solve the loan problem.
    – Solve the derivative problem.
    – Reassemble whole loan mortgages

    The U.S. economy is shrinking fast, because businesses cannot get loans that they need to operate normally. Banks and lenders already own $ billions in bad loans, and they are afraid to make new loans. The government gave $ billions in bailout money for banks to start lending, but banks hoard the money to save themselves.

    Our financial system became untrustworthy, because it mixed $ billions in bad loans in with the good loans. Now, banks do not trust any of the loans, and the entire credit market stopped working.

    The U.S. economy will continue to shrink until we untangle the loans. Once the bad loans are isolated, they can be fixed one at a time. Then trust will be restored. Credit will flow, and the economy will grow.

    So far, our government is spending $ trillions on bailouts and pork projects, out of ignorance and political ideology. The real solution is much less expensive than that.

    The USA has fixed this problem before, and it is not hard to fix again. This is how:

    A) Start with the Resolution Trust Corporation (RTC), which the federal government setup to solve a Savings and Loan problem in the 1980s.

    B) RTC buys up securitized mortgages and derivatives to reassemble whole mortgage loans.
    1. “Securitized mortgages” are home loans that have been bundled into large groups and sold to investors. A group of about 4,000 mortgages can be “securitized” and sold just like a stock or bond. Investors like to buy groups of mortgages because they receive all the monthly house payments.
    2. Some groups of securitized mortgages were subdivided into smaller pieces, called “derivatives.” However, both of the fancy names refer to mortgage loans.
    3. The problem is that many bad loans (with no payments) got mixed in with good loans. That turned the all the securitized mortgages into bad investments, which are ruining our banks. It is a huge problem, and the government has to fix it, before our economy will recover.
    4. Total securitized mortgage and derivative market is estimated at $1.3 Trillion by a Professor of Economics at Ohio State University. (Also see the graph from Deutsche Bank at “The Death of Securitized Mortgages” )
    5. Government should buy up securitized mortgages and derivatives at the lowest market price, which is set via a reverse auction. (Google on “reverse auction”.)
    6. Squatters, who sit on their mortgage derivatives, in order to extort big $ from the rest of the system, can be forced to sell. (Law is analogous to eminent domain, or sales forced on cybersquatters that registered the domain names of well-established companies.)
    7. Government pays mortgage derivative squatters at market price set by previous reverse auctions, perhaps with a penalty to the squatters.
    8. Sellers give up all rights. No new law there.
    9. Banks, investors, and insurers now have cash instead of questionable mortgage loans and derivatives. So, the banking system is healthy with cash to lend.
    10. Credit will flow, and the economy will grow.

    C) Government reassembles whole loans from securitized mortgage components and derivatives.

    D) Government sorts the newly reassemble whole loans (mortgages) into groups according to risk/quality.
    1. Government uses traditional mortgage experts and guidelines to sort the home loans into quality groups, for example, a high quality group would include homeowners with 20% (or more) equity in their house at today’s market price; and house payments that are 25% (or less) of homeowners monthly income.

    E) Government (RTC) sells the reassembled whole loans to traditional mortgage banks.
    1. This solves the problem of renegotiating home loans with homeowners. Read on.
    2. Law must be changed so that reassembled whole loan mortgages cannot be securitized into derivatives, again.
    3. An important purpose is to reconnect each homeowner with his lender, and vice versa.
    4. It eliminates incentive for mortgage lenders to make predatory and junk loans. If the loan fails, the lender is stuck with a bad loan.
    5. Government recovers much of the $1.3 Trillion purchase cost, because government auctions off the reassembled mortgages.
    6. The lower quality, more risky mortgages would fetch a lower price at auction.
    7. Mortgage companies, that buy the risky loans, will have more room to negotiate with the homeowners.
    8. Some homeowner negotiations will not succeed. Those homeowners will move into affordable rentals. (The government does not owe everyone a free house.)
    9. Other renters would like to buy those empty homes at reduced market prices.
    10. If the government gets stuck with some homes, the government could profit by selling the homes when the housing market recovers.

    F) Insurers like AIG may be reorganized through bankruptcy.
    1. Securitized mortgage pools never made business sense, unless they were protected by various insurance schemes.
    2. Those insurance schemes always were a scam.
    3. Insurance only works when most of the insured assets are never hit with a disaster. That is why flood insurance does not work very well. A major flood ruins all the buildings in a large area, all at the same time. So, the insurance company goes broke, and people that bought the insurance are not protected. That is the problem with securitized mortgage insurance. In an economic downturn, the “disaster” hits all the houses at the same time. Securitized mortgage insurance was doomed to fail, and the insurance companies went broke in 2009.
    4. Companies that ran the insurance scam may have to go through bankruptcy.
    5. Never ending government bailouts for insurers like AIG are just throwing good money after bad. So, stop the bailouts.

    This plan is inexpensive, tried and true. It leaves the banks healthy, with cash to lend. It restores trust in the credit markets, so loans will be made. It reassembles mortgage derivatives into whole loans, and restarts traditional mortgage lending. People can get loans to buy homes. Credit will flow, and the economy will grow.*


    *The economy will grow if President Obama’s massive tax, borrow, and spending plans can be stopped, before he creates another Great Depression. Presidents Hoover and Roosevelt already tried to tax, borrow and spend their way out of a recession in the 1930s. Instead, they created the Great Depression, which lasted 12 years. Straight as he goes, President Obama is doing it, again. Nevertheless, cleaning up the securitized mortgage mess is a necessary first step.

    If President Obama announced Steps 1 and 2, today, the stock market would go up within hours. Investors love a real business plan, instead of a political pork plan. Millions of people will be wealthier, feel wealthier, and have money to spend. That is how to jump start the economic recovery within days.

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