From June 5th 2012)
There is a significant divergence between the way the mainstream present the UK’s Debt to GDP ratio and the approach taken by ‘alternative media’ economists and writers in the blogosphere.
It very much depends on what you include and what you don’t.
Back in early 2011 the Office for National Statistics (ONS) included this under-reported gem as a header for its 25th January public finances news release:
‘For the first time data for Royal Bank of Scotland and Lloyds Banking Group have been fully incorporated into the public sector finances. This has impacted considerably on the measure of public sector net debt that includes the effects of the financial interventions. It has not materially affected the measures excluding temporary effects of the financial interventions, that are used by HM Treasury for the purpose of fiscal policy and are the measures that are forecast by the Office for Budget Responsibility.’
Further into the release we find out that at the end of December 2010:
Net debt excluding the temporary effects of financial interventions was £889.1 billion,equivalent to 59.3 per cent of gross domestic product (£2322.7 billion, equivalent to 154.9% including interventions)
The measures excluding the temporary effects of the financial interventions are used by the Office for Budget Responsibility to forecast the public finances and by HM Treasury for the purposes of fiscal policy.
For the record let’s bring the numbers through to the end of 2011. They are slightly less obvious in this January 2012 release but are still there to be seen:
Public sector net debt at the end of December 2011 was £1003.9 billion (64.2 per cent of GDP). This compares to £883.0 billion (59.4 per cent of GDP) at the end of December 2010;
Public sector net debt at the end of December 2011 was £2329.9 billion (149.1 per cent of GDP). This compares to £2257.0 billion (151.8 per cent of GDP) as at the end of December 2010.
And a link to the ONS media release:
http://www.ons.gov.uk/ons/dcp171778_253584.pdf
So the ’64.2%’ ratio is our officially recognised year end rate, not the ‘149.1%’ which happens to include the liabilities of our semi-nationalised banking system.
It is ‘temporary’ of course, however long that may be.
My concern lies in what happens if we have a system-wide crisis with Europe acting as a catalyst. Will those banking liabilities crystallise? After all, although not included in the headline debt ratio by bringing them on to the national balance sheet the UK is effectively announcing to the world that it is standing behind them. How could the UK not be held to account in the panic of a crisis?
And of course what other ‘off balance sheet’ derivatives are also lurking in the banking undergrowth? Are there additional unknown contingent liabilities?
But our nationalised banks have assets. The £1.3 trillion is not reported because the assets of these banks exceed their debt. Indeed, there is a net book gain so there is nothing to worry about.
Enter IAS39, ‘mark to market’ and our global property problem.
Over on the asset side of our balance sheet we have lots and lots of loans and complex derivative securities predominantly secured by some form of property or financial asset. Alas, in many cases the underlying value of that security has tanked since the bursting of the property bubble.
But for the support of the regulatory authorities on both sides of the Atlantic in 2008 and 2009 we would already be in something of a pickle. Without labouring the point the U.S. authorities relaxed the ‘mark to market’ rules at the height of the credit crisis. In other words if the systemic drop in value threatened the system, get rid of the rule that required assets to be based at market value. I’ll leave Wiki to explain the background on this little wheeze:
I mention this because within the profile of our local banks U.S. investments are not exactly under-represented.
IAS 39 is an international accounting standard that sets the basic framework for the recognition and measurement of financial instruments:
http://www.ifrs.org/NR/rdonlyres/BCE30C2D-F85E-42B7-ADB6-E91B50F13B39/0/IAS39.pdf
It is a technical document so I will get to what I find the most interesting element, the paragraph on the measurement of financial assets. On the face of it the document seems to make a lot of sense but the problem of course has been current market conditions. During 2008 and 2009 the banks carried too many assets as ‘available for sale’ which would have involved making them down to a ‘fair value’. The quantities involved were so great that they would have threatened the integrity of the entire system.
So, as in the U.S., a way was found to take these assets out of that category. They would be ‘held to maturity’. Some elaborate and very creative balance sheet manipulation took place, SPV’s, ‘Special Purpose Vehicles’, were created to hold ‘bad’ assets which could be held to term. Tainted and overvalued assets could be shifted and legitimately held at book value without impacting future profitability. No significant write-downs were necessary; the banking system survived and bonuses continued to be paid.
Our £1.3 trillion or so of banking assets are ‘backed’ by an asset portfolio which on the face of it should not cause concern. But what proportion of these assets are held at book value and how much of it truly represents underlying market values?
What happens when the sovereign debt problem does become a systemic issue?
Which number should we be looking at?