On the money

Since 1 April 2004 speculation has grown as to whether councils can use their new prudential borrowing powers to make substantial investment in housing stock. Following tenant rejection of stock transfer in Birmingham and arm’s-length management in Camden, some tenant and local authority representatives have argued that prudential borrowing could support “the fourth way” of local authority ownership and management of housing stock.

The problem is that prudential borrowing will not deliver the substantial investment in renovating council-owned stock that is required for councils to meet the decent homes standard.

The government’s reform of local authority capital finance is, in effect, a relaxation of the previous system of placing local authorities in a strait-jacket of control. Prudential borrowing does not signal that local communities and their representatives are free to make borrowing and investment decisions based on their priorities. Local authorities may have a degree of flexibility about investment decisions, but not to the extent that they could undertake substantial borrowing to invest in dilapidated housing stock.

The previous capital finance regime was introduced to control public sector borrowing. There was a game of cat and mouse between the Treasury and councils in the 1980s: the Treasury brought in measures to control local authority spending and borrowing; inventive council finance departments managed to find loopholes.

This eventually resulted in some councils leasing municipal assets to international banks with a number of them also engaging in sophisticated trading on City money markets. Exasperated, the then Conservative administration brought in strict centrally imposed borrowing limits.

The prudential borrowing system does abolish government control over each local authority’s borrowing. Each council, though, must set itself “an affordable borrowing limit”. This limit must take into account a number of principles, including affordability, prudence and sustainability, value for money, asset management and service objectives.

Investment by councils to meet the decent homes standard cannot be delivered via prudential borrowing

The principles of affordability and prudence and sustainability help to explain why prudential borrowing is not the key to local authorities retaining stock and borrowing to invest in that stock. The affordability principle requires the local authority to determine whether or not it can meet repayments of loans from its income. In the case of housing revenue account investment, income will be restricted to some government grants and what is raised from rents.

The implications for the revenue account in paying off new debt for major investment would be that many local authorities would have to substantially increase rents. This is unlikely to be acceptable either to tenants or to their political representatives.

The prudence and sustainability principle requires a council to take into account all of its responsibilities and likely investment options. In addition, the local authority should only take out loans that it is able to repay in the long term without hampering the level of services it provides to its local community.

If a local authority ignores these principles in order to make major investments in housing, it is likely to face a borrowing cap imposed by central government.

Prudential borrowing may be a flexible friend for local authority chief finance officers; it does not, however, offer a fourth way to those who want councils to retain ownership and management of housing.