Tuesday, June 29, 2010

What Exactly Is The National Debt?



The official definition is easy... and misleading

Question - what exactly is the National Debt?

It sounds like a straightforward question and Tyler's Oxford English Dictionary gives a nice straightforward answer - "money owed by State because of loans made to it".

Good. Very clear.

But just out of interest, how does the OED define a loan to the State? "Money contribution from individuals or public bodies to State expenses that is acknowledged as debt".

Hmmm.

So the National Debt comprises contributions to State expenses that are acknowleged as debt. Just as an aardvark comprises an animal acknowledged as an aardvark.

See, when it comes to debt, governments have got this chronic tendency to avoid acknowledging anything as debt if they can possibly acknowledge it as something else instead. Like an aardvark, say.

As regular BOM readers will know, we've blogged the real national debt many times - ie the official government debt plus various aardvark/Enron items like PFI, unfunded public sector pensions, Network Rail, and nuclear decommissioning. These are all items that place on taxpayers a clear contractural commitment to make payments at some future date.

Most recently we estimated this real national debt totalled around £2.25 trillion, over 160% of GDP, and getting on for £100 grand for every household in the land.

That's scary enough, but the bad news is that our real debt is even higher.

That's because of our nationalised banks (highlighted by TomTom in comments on yesterday's post). In case you'd somehow forgotten, we taxpayers own 84% of RBS and 41% of Lloyds. And because that means we are now in a position directly to control what they do (hah), both are now officially categorised as being in the public sector. They have been nationalised, and their liabilities are now ours.

When last sighted (end-2009), those liabilities totalled £2.6 trillion (Lloyds on £1trn and RBS on £1.6trn). That's a stomach lurching 180% of GDP.

Can we really be on the hook for all of that?

Well, there are no formal blanket guarantees, so if the balloon went up, in theory, HMG could still walk away. But in reality, walking away from the liabilities of a bank that was 84% state-owned would nuke HMG's credit standing for decades to come. Ex-Armageddon, walking away is inconceivable. Whatever the small print may say, in reality, we are on the hook.

The only comfort is that these £2.6 trillion of liabilities are backed by £2.6 trillion of assets (actually slightly more, once you take account of the banks' equity capital). So with a very favourable wind, we might not end up losing anything at all.

But the liabilities still have to go on HMG's balance sheet, because these banks are now our responsibility.

And in fairness to the Office for National Statistics they are attempting to do precisely that. In fact, they have been working on it for the last 18 months (see articles here). They long ago included the liabilities of Northern Rock and Bradford and Bingley in the official published figures for government debt (although they continue to publish an alternative debt series excluding them). And they hope soon to include the two big ones.

Why the hold-up? It's because the two banks in question are not keen on having their balance-sheet details paraded around in public, and are arguing commercial confidentiality (to which you might say they should have thought of that before they went bust and came crawling to us for a bail-out).

Anyway, the ONS say they expect the banks' inclusion will increase our official national debt, but "only" by up to £1.5 trillion. That's less than the £2.6 trillion total for the banks' gross liabilities because national debt accounting conventions allow governments to net off holdings of liquid assets, of which Lloyds and RBS have quite a few. Why are governments allowed to net off liquid assets when the banks aren't allowed to do so themselves? Search me - those are just the rules (as devised by government officials).

But on top of these bank liabilities there are some other chunky items we ought to consider.

Like what about state pensions? They're a specific state liability in the sense that most of us have contributed to them through National Insurance - or to put it another way, we've lent money to the government through our working lives against a promise of a state pension in old age. And the coalition's new "triple lock" uprating guarantee makes that promise even more water-tight. So depending on the exact assumptions used, that's another £3-7 trillion of debt to add on.

And what about all those big IT contracts we hear so much about (eg the NHS supercomputer)? Many of them commit us to payments far into the future.

Or what about those big defence procurement contracts (such as tranche 3b of the Eurofighter)? They too contain commitments to substantial future payments.

Or what about all the various financial guaranteees (explicit and implicit) we've given to the UK banks which have not been nationalised? Yes, they're only contingent liabilities, but surely our National Debt stats should not ignore them altogether.

The fact is there is a spectrum of liabilities ranging from sure and certain financial debt such as gilts, through specific contracts for future goods and services such as the supercomputer, to contingent liabilities such as bank guarantees. And what we need more than anything is more information on how that spectrum is made up.

The good news is that post-Gordo it does seem that the ONS are moving towards greater disclosure. They have distinguished the following broad types of debt:

  • Direct liability: a present obligation arising from past events, the settlement of which is expected to result in an outflow of resources - eg gilts
  • Explicit commitment: the government’s responsibility for a future liability based on an existing contractual agreement which does not yet give rise to a present obligation. This is because no exchange has yet taken place, and the obligation, and therefore the liability, normally arises on delivery of the goods or services - eg defence procurement contracts
  • Provision: a liability of uncertain timing or amount, which is recognised in the main accounts since payment is probable and a reasonable estimate of the amount can be made - eg expected losses on the past bank bailouts
  • Contingent liability: an obligation activated by a discrete event that may or may not occur - eg possible losses on future bank bailouts 
  • Implicit liability: a moral or expected obligation on the part of the government that is not mandated by law, but rather based on public expectations, political pressures, or the role of the state as understood by the corresponding societies - eg commitment to pay state pension
They also say:
"ONS has a key role to play in presenting the data necessary for assessment of fiscal burden and risk, and as such needs to understand user requirements beyond the National Accounts boundary. The liabilities in this category which will attract the most attention are; future expenditure under PFI, unfunded pension schemes and government guarantees.

While estimates of these liabilities are disclosed as memorandum items or notes in departmental resource accounts, they are not systematically presented in aggregate (whole of government) form.

ONS should consider its role in presenting a wider range of data on government and public sector liabilities, as is the case in other countries."
So to sum up, here's our updated table of the real national debt including the nationalised banks, but excluding contingent liabilities, all commercial contracts except PFI, and implicit liabilities such as state pensions. In other words, it is a conservative estimate:


So that's just £200 grand per household.

We'd better pray those assets sitting in the vaults of Lloyds and RBS are worth something close to what they claim.

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