Why are student loans in the news?
Last week a bill regarding student loans quietly passed through its final reading in the House of Commons. It allows the Government to raise £6bn by taking a chunk of the student loan book and selling it off to private banks. This loan book – which represents the income stream derived from graduates paying interest on money borrowed from the Government to finance college courses – is currently worth £18bn.
Why are they doing this now?
The Treasury needs cash. It looks likely that Alistair Darling will overshoot his own forecast for public sector borrowing of £38bn for the year to 5 April 2008 and £38bn was already £4bn higher than Gordon Brown predicted in March 2007. So this latest disposal is part of a “£36bn drive to plug gaps in the public finances”, says The Times.
Government departments are under pressure to identify “surplus” assets, such as the student loan book, that can be sold off. Aside from the obvious boost to Government coffers, the Treasury under New Labour has long argued that selling public assets to the private sector not only results in them being managed more efficiently, but also increases the stability of public finances: in this case, by reducing taxpayer exposure to any defaults on student loans.
How will the student loan sale work?
Oddly, in much the same way as the rather discredited “structured investment vehicle” arrangements favoured by the investment banks for the sale of similar, but higher risk, mortgage receivables. The idea, says MP John McDonnell in The Guardian, is that the Government will sell slices, or “tranches”, of student debt to a separate “special purpose vehicle” (SPV) for cash. The SPV will raise the cash by creating and selling bonds secured on the pool of student loans. This technique is handy, if a little long winded, as it enables the Government not only to raise the cash but also to keep the bonds issued by the SPV “off balance sheet”, a phrase which translates as “out of the public borrowing figures”.
Is this a new idea?
Far from it. The policy of privatising state assets started under the Conservatives back in 1992. However, most of the 700 government projects that rely on private-sector involvement now are the work of Gordon Brown, who suffers, says McDonnell, from an “obsessive commitment to the private sector”. Private firms have been involved in projects ranging from building motorways and schools to dealing with Northern Rock. This has helped New Labour meet its self imposed “Golden Rule” – that borrowing cannot exceed 40% of GDP – since “maintenance” payments to contractors involved in, say, building hospitals under contracts that can stretch over 20 or 30 years, are treated as day-to-day expenditure rather than borrowing.
Isn’t involving the private sector good?
Often it’s not. The record for previous “public/private partnership” (PPP) schemes and their close relations, the “private finance initiatives” (PFI) is mixed. For simple projects with predictable risk and reward trade offs, such as roads and prisons, they can, as the FT notes, help to get infrastructure built on time and to budget. But big “question marks” hang over assets such as schools and hospitals, where changes to both the technology and specified service levels have lead to significant delays on many projects.
Criticisms have also been heaped on Brown’s “adamantine insistence” that private bidders be offered the ongoing London Underground refurbishment project via the PFI, despite many of the risks being “unquantifiable” – the harder risks are to price, the greater the likelihood the Government ends up overpaying horribly.
But there must be savings to the taxpayer?
If only. The chairman of the public accounts committee describes the profits made by private firms under PPP and PFI, at the taxpayer’s expense, as “the unacceptable face of capitalism”. These profits arise because, desperate to get liabilities off public accounts, the Treasury has developed a habit of awarding contracts skewed spectacularly in the private sector’s favour. Take the last sale of a £2bn chunk of the student loan book in 1998-1999. According to the then higher education minister, the cost was “25% to 30% above the cost of keeping the loans in the public sector”.
How will banks profit now?
A bank could buy the bonds issued by the Government’s SPV, which will be sold too cheaply to reflect largely non-existent default risks, then cash them in for a profit on maturity. Or it could subscribe for the bonds and resell them to another bank for a higher price and immediate profit.
Just how big are ‘off balance sheet’ liabilities?
Pretty soon we should all know. As chancellor, Gordon Brown – who spent this week lecturing bankers on their “lack of openness” – foisted a commitment on his successor Alistair Darling finally to come clean and disclose “off balance sheet” liabilities under the “whole of Government accounts” project in 2008/2009. How this will work is unclear, but one thing’s for sure – the impact will be dramatic. Bedlam Asset Management estimates that the total cost of PFIs by 2014 will be equal to the entire £122bn of income tax collected in 2004.
Far worse is the potential size of the Government’s public sector pension obligation – this could add a liability of anywhere from £600bn to £1trn. However, even that number is blown out of the water by the size of the guaranteed state pension obligation – Motley Fool’s Wat Tyler puts that figure at anywhere between a further £2.5bn and three trillion.