Council Debt for Dividends

By Eric Crampton 16/07/2013

My colleague Professor Glenn Boyle provided a few rather insightful comments on what’s going on with Council-owned assets in Christchurch. I’ve hoisted them up from the comments section:

The first question to ask is: what are these increased dividends going to be used for? There are two possibilities – greater council spending or lower rates. It’s hard to believe it couldn’t be anything but the former.

That being the case, what really matters is the quality of the intended spending, i.e., is it covering its cost of capital? (which is more than just the cost of the borrowing used to finance the spending) Since we don’t know what the increased spending is going to be on, it’s impossible to say anything definite about this. But the quality of council spending over recent years, and the quality of the ‘analysis’ underpinning it (e.g., the $70m cycleway), means the most plausible assumption is to place 0% probability on these borrowed funds being spent wisely.

There are other interesting undercurrents in all this though. First, by getting CCHL to do the borrowing, the council is avoiding the need to reveal it on its own books, i.e., it’s cunningly ‘hiding’ the extent of its indebtedness. Second, and more importantly, the council is effectively saying it can invest new capital more productively than CCHL. This is intriguing, given that we’re repeatedly told what great investments the CCHL assets are, that they return 15% per annum, and how rates would be so much higher if we didn’t have them. If all this were true, then the best strategy available to the council would be to reinvest the borrowed funds in the CCHL assets to provide for further growth. By implicitly saying it could do better than this, the council clearly doesn’t believe its own spin.

This is hardly surprising. The arguments trotted out to justify the ‘keep-the-CCHL-assets’ line are so transparently flawed that the only plausible explanation for the council’s behaviour is good old fashioned empire building (something that those of us who work at the University of Canterbury are familiar with).

But now the chickens are coming home to roost. As well as the disturbing announcement identified by Eric, this week we’ve also learnt that (i) Red Bus earned basically zero profit in the last financial year and will pay no dividend, and (ii) the council has sold one asset (Jet Engine Facility – what on earth was it doing owning it in the first place?) in order to prop up another loss-making subsidiary (VBase).

It’s like living in an episode of Mad Men (without the fun parts).

Glenn is entirely right. Council drawing funds out of the Council-held firms is inconsistent with Council’s repeated assertions that the rate of return on Council-held firms is very high.

Council should be in the business of providing decent roading infrastructure, working and reliable sewers and waterworks, and a few consumption amenities. They are not the best owners of things like ports. The temptation to tunnel assets out by deferring maintenance and loading the companies up with debt … well, some perils are just too perilous.

0 Responses to “Council Debt for Dividends”

  • Eric, I recommend reading Bruce Jesson’s “Only Their Purpose is Mad: The Money Men Take Over New Zealand”. I think it will show that there is another way of running local body owned enterprises that does not mean throwing our hard won investments and gains to the private world of wolves.

    Some of Chch owned enterprises may not make a profit. This year or the next. When people move into Chch again and it becomes a city again then we can talk of what they should do. Selling the family silver is an option when one is really on the bones of ones arse. It may demonstrate a parlous state. But when it is sanctioned by ideologues it smells of “lets look after my mates” when the price will certainly be way too low to sell it and only redeem a modest and very temporary cash flow.

    In the recent bailout competition I suspect that private may be ahead of public when it comes to who has got the mostest.

  • If Council wants to own special purpose vehicles for delivering particular services on a not-for-profit basis, that is ENTIRELY DIFFERENT from Council claiming that they own the things because they earn a great return and that selling them would be getting rid of big dividend-paying assets!!

    Note that Bruce Jesson is also the one who, in railing against the 80s reform, gave Canterbury Economics its name: he blamed the reforms on the Gnomes of Canterbury. We wear the name with pride.