Today I wish to open by looking at a planned move by the UK government which will exploit the difference between appearance and reality to the disadvantage of taxpayers and to the advantage of politicians. It concerns the fact that the pension fund of the Royal Mail (the UK nationalised postal service) will be taken over by the UK government. Ironically it is not the takeover itself that is the problem because due to the way the pension scheme had been guaranteed the UK taxpayer was always on the hook for any deficit in the scheme.
What is the state of play?
Bloomberg has reported that the Royal Mail pension scheme has £28 billion of assets and liabilities of £37.5 billion. On this basis the UK taxpayer is about to be aware that they are acquiring an expected loss of £9.5 billion. So let me present you with national scandal number one and as David Byrne put it.
How did I get here?
UK taxpayers will rightly wonder what trustees and indeed government ministers were doing in the past to let this happen. These schemes are supposed to fund themselves and yet those responsible for stewardship have failed and yet as ever apparently no-one amongst the well paid ranks of people who are supposed to represent their interests are apparently responsible!
There is a further problem with this situation as we can reasonably value the assets but valuing future liabilities is a problem. Royal Mail pensioners will be receiving their pensions over the succeeding years and decades and frankly it is impossible to predict exactly how much they will cost. For example, the Institute of Economic Affairs has estimated that the future liabilities will be some £10 billion higher raising the deficit for UK taxpayers to nearly £20 billion.
Yet another problem for Quantitative Easing
As the Bank of England ploughs ahead with its Quantitative Easing programme with another £1.5 billion today of UK Gilts (government bonds) maturing between 2027 and 2060 we see that today it is acting in an area which affects pension funds. If it reduces interest -rates at the longer end of the Gilt market then it makes annuities more expensive and raises future costs for pension funds. If you read articles about the effect of QE on pension funds this is usually what is meant.
However there are other problems. If you believe that extraordinary monetary policies like QE have boosted share prices and asset values,which I do, then the Royal Mail asset value has been artificially affected too. Not easy now is it?
Even worse there is an element of pensions geekery where the future liabilities of such funds are calculated according to a AA Corporate Bond interest rate which will have been affected by QE too. Of course there is the additional problem that the credibility of using ratings to value debt has been given an enormous downwards knock by events in the credit crunch era.
The deeper problem UK public-sector accounting
Whilst we are not exactly sure of the size of the Royal Mail pension fund deficit we are sure that there is one. However due to the system of UK public-sector accounting when it comes onto the official books it charges into a phone booth and comes out dressed as Superman. This is because the assets of £28 billion are counted but the higher future liabilities are ignored! So whilst the UK taxpayer is receiving expected future losses the UK public-sector accounts show an improvement of £28 billion in our national debt. Even in thse times of numerical and actual inflation this is a tidy sum although the rub is that it is a tidy sum based on financial alchemy.
Comment
So what we are seeing here is a perversion of the role of a balance sheet where you count assets but ignore (future) liabilities. The supposed justification for this is that the pension liabilities could be defaulted on, which in itself is very weak as you could use that rationale for virtually any liability.
The danger for taxpayers and in particular future taxpayers is that the “boost” to the national debt numbers arising from this will lead to more public-sector spending which our politicians of every hue tend to like. Then at a later date we will see “an entirely unpredictable surprise for which no-one is to blame” when the pensions have to be paid. Actually more likely the numbers will be hidden in fiscal statistics which disappoint.
We see a situation that now has an additional layer of complication as we could do with a fiscal boost especially one which is “free”. But we have two problems with this . Firstly it is not free and secondly politicians have a dreadful record in wasting money. Let me give you an example of this.
Aircraft Carriers with no aircraft
The UK contracted under the last UK government to purchase two new aircraft carriers the Queen Elizabeth and the Prince of Wales. To those who follow such matters amber lights were already flashing as the UK abandoned full scale aircraft carriers as too expensive in the 1970s and went for smaller flexible ones which flew Harriers. How come they were no longer too expensive for the UK?
These carriers were supposed to cost £3.9 billion but as is the way of things the latest estimate is now much higher at £6.2 billion. In the new straightened times we are unable to afford aircraft for them. So to my mind they pose a serious problem not only for our military but for economics. Building them adds to Gross Domestic Product but what if they turn out to be the equivalent of digging a hole and filling it in to employ someone? Yes work has been done but my point is that it is not productive work.
We did actually have some aircraft that could have flown off the carriers as the UK Harrier force did so regularly but we scrapped them. In the clowning that has gone on here we probably scrapped our most effective aircraft as for example it was the plane we first sent to Afghanistan where due to the thin air I gather the Tornadoes we kept struggle to get off the ground so much that one did not manage it.
So the portents for us spending the “boost” wisely are not good.
The Irish National Pension Reserve Fund
The danger of having assets sitting on a public balance sheet have been shown by the Irish NPRF. The story starts well as back in April 2001 money began to be put aside for future pension liabilities and so far so good. However as Ireland’s banks hit trouble Irish Ministers changed the law so that they could direct the NPRF to invest in them and hopefully kick this particular can down the road. Take a look at the results from the latest update.
Since 2009 the Fund has invested €20.7 billion in preference shares and ordinary shares in the two banks (Bank of Ireland and Allied Irish Bank),
At 31 December 2011 the total value of the National Pensions Reserve Fund was €14.5 billion, comprising the Discretionary Portfolio of €5.4 billion and the Directed Portfolio currently held at €9.1 billion.
It is the Directed Portfolio (which means what it says…) that is to be compared and if we allow for dividends paid the money invested has nearly been halved.
There are two fundamental problems here which start with politicians being usually useless investors and end with the issue them being in charge. People with short-term priorities like politicians are exactly the wrong group to plan long-term investments.
Credit Easing looks like a damp squib
Last autumn the UK government made various grand pronouncements about its plans for Credit Easing. As I wrote at the time it was a confused policy which ministers such as Francis Maude and Justine Greening seemed to queue up to demonstrate that they did not understand it. It has now resurfaced but the £20 billion will only reduce interest-rates for small businesses by a claimed 1%. Yet let us do some number crunching.
The UK can borrow for five years at 1.22%
Add 1% in a generous allowance for costs
So with a cost of 2.22% we see that loans to small and medium sixed businesses were available at 3.22% or 2.22% plus 1%!? I hope you get my point that something is wrong here.
I would like to make it clear that I hope that the scheme works but as it stands quite a few matters do not seem to add up to me.
High Speed Two
For foreign readers HS2 refers to a new planned railway line which initially will go from London to Birmingham and then maybe onto Leeds and Manchester. Let us take a look at the plan which rather ominously was given by Justine Greening who along with not understanding credit easing thinks that electric cars are immune to rises in the price of fuel!
The capital cost at 2011 prices of building the complete Y network is £32.7 billion
So here we have problem number one. How much will it actually cost as public-sector schemes of this sort invariably overrun? For example the London Olympics has gone from £3.6 billion to £11 billion with nobody apparently responsible.
To counter claims that this is a lot of money to get to Birmingham train station just under half an hour more quickly we were told this.
At present values, it will generate benefits of up to £47 billion and fare revenues of up to £34 billion over a 60-year period.
Frankly this looks like meaningless gobbledygook to me. Fantasy dressed up as accountancy. For a start how do we know that in 50 years time we will not have superseded trains?
Conclusion
The clash between the long-term needs of a nation and the invariably short-term wants and needs of politicians has been exposed and expanded by the credit crunch era. In times of economic growth the problem is often swept up in the growth itself. But now we need to plan more carefully and I will be interested in readers thoughts as to what we should do. We cannot go on as we are.
So any forecasts tomorrow should be taken with much more than a pinch of salt.
