The tragedy at Grenfell Tower, where at least 80 people burned to death just over a mile away from my west London home, has prompted a debate on UK social housing finance. Safety appears to have been compromised for the sake of cost. How much of this was a result of government policy?
To try and shed some light on this debate, Risky Finance has looked at recent Debt Management Office data on local authority borrowing, and has produced a couple of interactive charts. Unlike bank LOBO lending which has essentially been static since 2010, council borrowing from the government (via the Public Works Loan Board) has been a hive of activity.
Our chart shows the councils that have increased borrowing since 2015. The size of the bubble is proportional to the amount of new borrowing, and positioned according to the weighted average interest rate and maturity of its entire PWLB portfolio.
Clearly there are no social housing requirements here, and commentators have referred to the commercial property investments as being a potential credit bubble. However, what is striking is the degree of property investment among urban English councils with significant stock of social housing.
Portsmouth council, with 16,000 social housing stock, borrowed an additional £133 million and used the money to buy a parcel distribution centre in Birmingham and a warehouse in Gloucester. Warrington, with £169 million new debt, invested in a Swindon solar power generation facility alongside Newham council, helped by £73 million of extra lending from the PWLB.
On the other hand, Durham council, which owns 18,500 council dwellings, reduced its debt to the government by £200 million in the last two years. Most London boroughs – collectively in charge of more than 400,000 council homes – have also reduced their debts in the same period, although by smaller amounts.
To understand what is going on, we should go back to a little-appreciated reform implemented by central government in 2012. Known as the Housing Revenue Account, the reform changed the way council housing costs were funded. Hitherto, government determined how much councils needed to spend on housing and allocated central funds for them to do it.
Under an Act of Parliament passed by the coalition government in 2011, councils would gain local control of their housing revenues and expenditure. In return, a one-off settlement was enacted where councils were allocated a share of national housing debt.
Those that were big spenders of government housing subsidies (mostly councils in poorer areas with substantial social housing stock) had their debt cancelled, to reflect the fact that they would need to borrow in future to replace the old subsidy. Those in richer areas had to borrow from the PWLB in order to pay the government.
At the time the message was the reform would encourage new council house building. But it didn’t work out like that, and one reason was the incentives built into the calculation. Rather feeling empowered that these social housing assets were on their balance sheets, councils now wanted to get rid of them, or spend as little as possible. For example, an increase in renovation costs above baseline assumptions (to add fire sprinkler systems, for instance) would result in a balance sheet loss. On top of that, the government injected uncertainty into valuations by reducing social rents or changing right-to-buy rules.
This was exacerbated in 2014 by a government directive for councils to publish market values and social use values side by side. This showed that councils were effectively exposed a giant property derivative contract. The strike price of the derivative was the value of social housing revenues, including expected receipts from right-to-buy sales. The market price was the vacant resale value of council homes.
Councils that owned homes in areas of rising prices were now sitting on an effective short position in the property market. They had to pay the upkeep on properties that tenants had an increasing incentive to purchase and flip for profit. Replacing sold council homes means the local authority has to purchase new properties or land at ever higher market values.
No council in high-value areas wants to build or own additional social housing in such a situation, and neither do they want to borrow in order to do it. As a result, affordable home building has been outsourced to the private sector, while the upkeep of existing council stock has been cut to the bone. Meanwhile, councils attempt to offset the short social housing position by using their newfound freedom to invest in commercial property.
This explains some of the activity seen in our charts. It confirms what CIPFA and the Chartered Institute of Housing said a year ago with a report pointing out that HRA reform had failed. It even explains some of the context behind the cost-cutting that led Kensington & Chelsea to scrimp on the renovation of Grenfell Tower. There is a policy question here that ought to be discussed.