PFI – sub-prime mortgage Government credit crunch?

BrownCartoon1

Scottish Prime Minister, non-elect, Gordon “Bottler” Brown

As the great British IT Disaster unfolds, the emerging culprit is the PFI contract, so beloved of Bottler from his days as Chancellor.

The PFI, Private Finance Initiative, AKA PPP, Private Public Partnership, is more than a Blair Brown regime propaganda sound bite. It is an interesting form of new stealth tax.

It is emerging that the real reason for the IT Disaster, where 25 million Britons have been exposed to fraudsters and other criminals, is that a PFI supplier demanded more money than HM Revenue and Customs were prepared to pay to cover work to select the very limited information requested by the National Audit Office, to allow them to carry out their duty of auditing the Child Benefit system. This meant that cost cutting was placed above the welfare and safety of 25 million Britons, many of them children.

In itself this is a major scandal and a scandal that really took place on Bottler Brown’s watch as Chancellor, to emerge on his watch as Prime Minister, suggesting that the honourable course would be for him to offer his resignation to HM The Queen and return to private life. This would be justified on this scandal alone but it is emerging that there are a series of serious failures in addition to the scandal that became public this week.

In many ways it is an unedifying story of cowardice, not just the cowardice that we are coming to associate as a central strand of Bottler Brown’s character, but Tony Blair’s cowardice in not firing Bottler as Chancellor long, long ago.

However, the real scandal is far greater than the emerging IT Disaster. It can only be understood fully by looking at the history of PFI under the Blair Brown regime. Study suggests that it may hold huge risk in a new credit crunch of sub-prime mortgage proportions. At its heart lies the Blair Brown regime’s dependence on spin over substance and the urge to conceal and deny, almost for the joy of being devious and getting away with it.

The Old System of Government Budgeting
British Governments once prohibited rental and contract services. The fundamental principle was that the State only took responsibility for those things that could not be done by citizens for themselves. Those public services were provided by creating and staffing a bureaucratic agency, which would also need capital projects funding. Each year the Chancellor of the day prepared a Budget where he estimated how much money he would need in the coming Fiscal Year to pay for these public services. He set out where the money was coming from. Much would be raised in taxes, but some would be borrowed on the money markets and paid back as Government finances permitted. This was a clear and transparent system with two disadvantages.

If the Chancellor got his sums wrong, Government would either have to borrow the shortfall, or introduce additional taxes, or find cuts somewhere in the expenditure to balance the books. Cuts usually meant postponing purchases or reducing services, usually in health, education, or defence.

The second issue was in spending dates. Once money had been allocated to departments, they had to spend it before the end of the Fiscal Year. If they failed to spend the money, their next estimates were cut back by the Chancellor, on the grounds that they had over estimated need in the previous Fiscal Year and could manage on reduced funds. The result was that each new Fiscal Year started with a period of very low spending which then increased dramatically in the final months of the Fiscal Year as departments rushed to spend all of their current allocation.

There was also one further difficulty with the system. When a new hospital or school was required, the Budget had to include all of the capital funds required for payment in the forthcoming Fiscal Year. That then either required additional tax income or borrowing and it was immediately visible in the accounts. This could create all sorts of difficulties for Governments particularly when a Government held power by a slim majority, leading to bitter debate of every policy and political pressure being exerted by the Opposition in return for letting some spending through.

In Britain the situation was made more difficult because a series of Labour Governments had tried to bring huge areas of private and commercial activity within public ownership and control. That had resulted in a huge expansion of bureaucracy, massive waste and a rapidly deteriorating social environment.

There were a number of areas of Government financing that needed reform and the Conservative Governments under Thatcher and Major looked at ways of reducing or removing the annual spending frenzy, the budget overruns, and the need to hire in some services rather than directly employing civil servants and raising funds for capital expenditure. In particular to reduce the size of Government and obtain value for money in those areas that remained.

Private Public Partnership
One area they looked at was PPP, as it was then known. PPP had produced some advantages for those countries that had used the approach to fund major infrastructure projects such as dams, bridges and tunnels. These large projects were funded directly by the companies or consortia that won the contracts to build them. Government repaid some money in stages and the builders were allowed to charge some form of rental or toll to complete the payment. One typical contract gave the builder, who might be a local authority subcontracting most of the construction work to contractors, a number of years when they could charge users a toll. At the end of the period, the bridge or road became State property and the State was responsible for maintaining or replacing the road, possibly under a new PPP.

Where the project was a well-defined capital acquisition, PPP usually worked very well, delivered the project much earlier than when a Government had to raise money in one large lump, and often took care of the maintenance issues. The disadvantage was that it committed a future Government to expenditure. Most democracies are very keen to avoid that form of burden on a new Government that has been voted in to replace the one that made the PPP commitment. The usual mitigation was that Government payments were made in a current Fiscal Year and then the organization building and running the facility charged the users some form of fee. At the end of the contract period, the Government of the day either acquired a new asset without any payment, or had an option. The option might be to pay one final amount or to allow the supplier a further period when they could collect tolls. That decision was a decision for a current Government.

US GSA Procurement
Another system looked at was the United States Federal Government GSA, General Services Administration, programme. GSA was an interesting procurement system that had produced good results for US Administrations, buying virtually anything Federal Government might require. It also had its critics and like any system it was not flawless. The Thatcher Government looked at the principles rather than the details and in the end adopted some parts of the GSA system, particularly in MOD procurement.

One GSA service was a catalogue purchasing system negotiated regularly with suppliers of smaller items, such as computer equipment. In effect, GSA negotiated a bulk discount price with a small number of suppliers and then Federal Agencies could make relatively small purchases from the catalogue without having the expense and delay of running a competitive procurement just for a few Personal Computers or a new set of computer printers. In reality, the GSA catalogue came to be used creatively by some Agencies and there were other issues in the detail, but the principle was very sound. MOD adopted the catalogue in a slightly different form in detail, but the principle was that products were paid for as needed from current approved budgets within the current FY. The suppliers committed to a price on expectation of business but Government gave no guarantee of how much business would go through the catalogue.

GSA also enabled Federal Agencies to procure products and services under rental or leasing arrangements. Some of these acquisitions could form very large projects and represent major expenditure. The GSA system neatly got round some of the potential difficulties in renting. Contractors had to agree that they were only guaranteed payment for the current FY. On the face of it, this looked like a system that forced suppliers to accept significant commercial risks. In reality, it worked very well for both parties most of the time. The supplier decided how long the rental would last and calculated the monthly or quarterly price accordingly. If the Agency was unable to obtain funding for the second or subsequent year payments the supplier took the hit and removed the equipment. In reality, that very rarely happened. When it did happen, another Agency could take over the service or system at the current agreed price, which was usually cheaper than taking a new contract to meet that Agency’s needs. There might be a relocation fee, but supplier and Government were both happy and Federal Government had accepted no commitment beyond the current FY, or imposed commitment on a future Administration.

The Thatcher Government decided that the US system would not transplant to the UK and one reason for that was that British Governments do not serve fixed terms. The Blair Brown regime is currently half way through its forth term in Government, although it has only been in office for a decade which is only just over the period of two full terms. Each Administration is elected for a period, which only has a maximum term. If a Prime Minister decides to end his or her Government, application is made to HM The Queen, as Head of State to accept the resignation of the Government and the calling of a General Election to vote in a new governing party. The Thatcher Government accepted that any new Government should be free to introduce a new Budget, which significantly changed policies and expenditure. However, the requirement to introduce new roads and information systems presented several challenges and it was decided to try out some of the principles of GSA for specified major procurements. This led to some evaluation contracts being placed under the Major Administration, before the Blair Brown regime took power in 1997.

Private Finance Initiative
One evaluation PFI contract was for information systems for HM Treasury and there were soon differences between Government and the contractor, which emerged in the early days of 1997. Although “Bottler” Brown, as Chancellor, must have been acutely aware of the difficulties, he fell deeply in love with PFI. It appealed to him because it could be horribly complex and bureaucratic and because it allowed him to hide huge amounts of Government financial commitment. A thirty year PFI contract for a hospital only shows in each FY as the amount paid in that year and can include staffing costs, reducing the public employment roll. The annual costs will rise steadily and, in some years, very rapidly.

That original Treasury PFI system became increasingly sour and resulted in HM Treasury threatening to take the supplier, a large US company, to court. In the end the supplier agreed to pay back millions of pounds, but only if the Government guaranteed to place significant new business in compensation for the repayments. In effect, the supplier was saying, “you know you don’t want the publicity of fighting through the courts and you know we are big enough to make it a painful and costly process, but there is a solution. We will offer to repay large amounts of money to compensate for the failures on our part under this contract, provided that you guarantee to give us a long line of new highly profitable contracts that will allow us to recover every penny we pay you back on this contract and new profit”.

Of course Brown ‘bottled’ it and gave in. Subsequently HM Treasury has made several attempts to change the terms of that agreement to resolve supply failures, but the supplier has continued to prosper and take new highly lucrative contracts from Government, in some areas forming a monopoly to all intents and purposes. The supplier is currently at the heart of yet another IT supply scandal, this time with MOD on a contract originally estimated at GP£4 billion, now revised to GB£5 billion, and likely to exceed GB£9 billion, or accept a greatly reduced functionality.

PFI has been employed by the Blair Brown regime on an epic scale. The amount of forward commitment to commercial organizations is enormous and stretches far into the future, some contracts apparently being for thirty years. It is beginning to look as though Blair and Brown hoped to create their Hundred Year Reich by putting Britain in hock (debt) for a hundred years.

Solving this problem will be an unenviable challenge for the next Government and that Government might be formed in the next few months, and certainly within the next two years.

It would be unfair to attempt to blame the commercial companies or the principles of PFI. Companies have been doing what they are there to do and that is to maximise profit. In the overwhelming proportion of PFI contracts the Blair Brown regime has simply been out-negotiated. Lawyers and salesmen working for PFI providers have ensured that maximum risk is transferred to Government and away from their employers. At each turn they have proved more nimble and capable. The Blair Brown regime is victim to its own greed, arrogance and ignorance. It has prospered politically by using propaganda to spin the unbelievable hidden commitments to funding hospitals, schools, quangos, bureaucracy and non-jobs into a triumph for fiscal prudence. That’s just like any of us rushing out and signing a host of agreements for things we cannot afford and trying to convince everyone else that we are just very wealthy prudent managers of our personal budgets. Eventually, we either have to make some very tough decisions to clear the debits, or watch the eye-catching assets being repossessed.

PFI suppliers may yet come to cry foul as a future Government attempts to get to grips with the lavish and badly negotiated contracts, but that will be much like the banks who now cry foul over their profligate sub-prime mortgage spending. They took huge risks and made huge profits that were distributed in bonus payments to management and to stockholders. The real victims are the unfortunate poor who were persuaded to take out mortgages that they had no means to repay. If the banks suffer a cut in their standard of living it will be nothing like the hardship experienced by the poor they exploited.

In the same way, the people exploited under PFI are not politicians but the people of Britain. They will have to pay the butcher’s bill because Governments have no money, only the money of the people. For example, the rash commitments, made recently by Chancellor Darling, to save Northern Rock, translate into a new tax burden of more than GB£1,000 for every person in Britain – the final bill may be far higher.

The curse of badly employed PFI is that the pain continues long into the future. In thirty years there may be towns and cities that have only an obsolete, broken-down PFI hospital that is now paid off by near useless and where there is no money available to pay for the doctors and nurses to work in its crumbling shell.

To this is added the ‘cost-plus’ aspect of PFI contracts. Once the basic contract is signed, the supplier can offer additional non-competed services. The bill for those services can be very high because there is no real pressure on the supplier. As in the case of the IT Disaster revealed this week, the supplier appears to have said, in effect, is, ” what you ask is not in the contract, but we would be pleased to supply it for an additional extortionate fee.” Unable, or unwilling, to pay, HM Treasury and Customs appear to have told a junior clerk to make two CD copies of and entire database and toss them in the unregistered post to save money.

The problem is made far worse because the Blair Brown regime façade has been propped up by encouraging very high levels of personal debt in addition to the huge invisible mountain of PFI debt run up by the Government. That is already producing its first victims and the numbers of personal bankruptcies and house repossessions continues to rise to alarming proportions. This may lead on into a serious recession where almost everyone loses. Behind it all is a decade of disguised fiscal profligacy and irresponsibility on an epic scale.

IJB

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