Councillors at the casino? The differentiated landscape of local council financial strategies in England

The local council financial crisis in England has reached a critical point. From a rarity in the experiences of the London Boroughs of Hackney and Hillingdon in the early 2000s, a slew of Section 114 notices – the legally required statement that the council cannot balance its budget between expenditure and income for the next financial year – have been issued across the country. Their number has reached twelve since 2018, including more than one at some local councils, and many more political leaders are going public with their financial warnings. Local councils in financial stress range across different types and sizes across England, from Birmingham to Woking, Northumberland to Thurrock. Such situations have pushed local council finance onto the international front pages in a dramatic fashion.

Financial innovations have become part of the repertoire for local councils struggling to close funding gaps, including borrowing to invest in commercial property portfolios, income strip leases, and interest rate swaps for debt management. Indeed, Birmingham City Council is reported to be considering further financial engineering as a way out of their fiscal fix by securitising its nearly £1bn of equal pay claims, borrowing against them and paying them back over time.

Such new and untried financial strategies and practices connect to characterisations of ‘councillors at the casino’ running risks with local taxpayers’ money and taking a local public service gamble, jeopardising essential service provision.

These depictions summoned up images of local councillors returning to the casino for the first time since the financial hit on the banks and legal precedent of the Hammersmith and Fulham swaps affair that effectively closed the UK local public sector market to financial innovations from the late 1990s.

Looking beyond the specific local councils hitting the current headlines, my new book, Financialization and Local Statecraft, examines what has been happening across the wider landscape of local government in England since 2010.

The UK government reduced expenditure and introduced local financial self-sufficiency in pursuing austerity after the 2008 crash, forcing local councils to find savings and new income sources to close funding gaps.

Based on research between 2019-22 including over 50 interviews with national and local politicians and officials and commercial finance executives, the research finds local councils have had to engage in more active and integrated financial and risk management strategies since 2010 amidst austerity, centralisation, and heightened risk.

Rather than a wholesale shift to ‘councillors at the casino’ and wild-eyed gambling with local service provision, a differentiated landscape exists of limited engagements with financial innovations and risk taking. Vanguard, intermediate, and long tail approaches are being followed by local councils. Risks have been generated by strategies and practices in both municipal as well as commercial finance.

Taking interest and investment income per capita at the end of the 2010s as an indicator of the risk appetite and commercialisation of local councils to invest to generate new revenue streams shows that across the five different types of council there is a handful following vanguard approaches, especially smaller unitaries and districts. A further intermediate group is active but less engaged, while most councils have much more limited or non-existent activities.

Figure 1: Local government interest and investment income by local government type, 2019-20

In terms of political leadership, NOC and Labour-led councils are in the vanguard and joined by Conservative, Independent and Liberal Democrats in a mix of local councils following intermediate and long tail approaches. Peaks of the vanguard are evident across this differentiated landscape, with intermediate uplands and councils across much of England following the long tail.

Figure 2: Local government interest and investment income by location, 2019-20

Across the diverse population of over 300 local councils in England, this differentiation is explained by local combinations of key dimensions shaping local strategies:

• Local council types and sizes;
• Capacities and capabilities;
• Risk appetite;
• Openness to commercial finance;
• And economic and financial conditions.

Following over a decade of austerity, including the pandemic and its one-off infusion of additional financial resources, local councils have continued to deal with unprecedented financial situations in trying to balance their budgets in differentiated ways following vanguard, intermediate, and long-tail approaches.

Local council affairs and priorities have become dominated by their financial condition, in varying ways rewiring and rescaling their objectives, incentives, autonomies, and accountabilities.

Where financial innovations have been introduced, local council deliberations often now involve the claims of external financial institutions and commercial interests such as bond holders and other investors and partners.

But in summer 2023 local councils’ extended coping strategies are running out of road. As risks have multiplied since 2010, they have been displaced and relocated to local councils, reducing margins for error and increasing the possibility of failure. An already fragile system has become less resilient and able to withstand and bounce back from shocks. The LGIU reports that the vast majority of senior council figures lack confidence in the sustainability of local council finances.

Intensifying and expanding fiscal stresses and risks are manifest in the continued concern expressed about impending or potential S114 notices amongst a growing number of local councils. The current scale and magnitude are different from the usual annual cycle of council budget reviews and scrutiny for forthcoming financial years.

More councils are talking publicly about S114s with multiple causes, often with both national and local factors compounding each council’s financial plight. Each case of failure is explained by local manifestations of the dysfunctional structure of the system and locally particular issues relating to political leadership and/or management.

Financial meltdowns at vanguard councils have attracted the most headlines as eye-catching and incongruous cases of local councils engaging in commercial activities and investments, such as high levels of UK sovereign-backed borrowing relative to their balance sheets.

However, fiscal stress is now even reaching councils historically considered as well-run and relatively cautious, including those following long tail approaches that had not participated in riskier financial strategies and schemes through a sheer lack of funding to meet their statutory service provision demands. Local councils face the systemic problems of unfunded mandates: legal responsibilities without appropriate levels of matching funding to deliver them. Inverting the international principle, finance does not follow function in local government in England.

While it has been a worry since the mid-2010s of the austerity decade, the current moment is a critical turning point for local council sustainability, resilience, and local public service provision as the cumulative impacts of prolonged fiscal pressure bite ever deeper.

To close continued funding gaps into the next financial year and cope with inflation, increased interest rates, and rising local service demands, local council strategies include further rounds of asset disposal, reducing and/or refinancing capital programmes, reserve use, spending moratoria, and vacancy controls and voluntary redundancies.

Local council leadership and management have been forced to explore the boundaries of what constitutes statutory service provision in certain areas as many are pushed into retrenchment around delivering pared down versions of essential local services, often for the most vulnerable people locally.

National government continues to explain financially failing local councils largely in terms of bad decisions, poor culture, and weak governance and leadership. While there is consensus that the local council funding system is broken and needs long overdue fixing, the role of systemic dysfunctions in council financial failure is ignored by national government in favour of accounts that emphasise particular local difficulties. Political capital has been sought by criticising local leadership. For example, Conservative Secretary of State responsible for local government Michael Gove bemoaned the Labour leadership’s ‘woeful mismanagement’ for Birmingham City Council’s plight that has ‘harmed the city’.

Given national policy choices have generated and intensified such adverse financial conditions. However, it might be asked whether it is national rather than local government that has taken the local public services gamble since 2010.

Indeed, the UK’s national Office for Budget Responsibility notes the ‘de facto insolvencies’ of local councils are resulting from national fiscal management. International credit rating agency Moody’s has warned of more council financial failures in the short term.

Since 2010, national government has effectively taken the chance that local councils could continue to provide essential local public services while simultaneously reducing expenditure and generating new sources of income.

Contradictory agendas have been in play. National government reduced funding for local governments in England, introduced local financial self-sufficiency, and encouraged innovation and risk-taking as well as retained centralised control and (eventually) inhibited behaviours, mostly amongst the vanguard, deemed too risky and speculative.

Rather than engage in any thoroughgoing but politically difficult reform such as ‘fair’ funding reviews or business rates and council tax revaluations, national government holds the line that it is not prepared to bail-out failing councils as a result of what is deemed their local mismanagement. Avoiding what economists call the moral hazard of creating incentives that encourage others to take imprudent risks and borrow beyond their means to service and repay.

The Chief Executive of CIPFA, Rob Whiteman, even worries that financial management failure may become normalised across the sector as some councils see an S114 notice as more attractive and now politically and reputationally acceptable than making local cuts, using up reserves or raising local taxes if many other councils are doing the same and DLUHC’s capacity to intervene becomes stretched. Further, Whiteman argues that the Treasury and DLUHC may let a council effectively go bankrupt and renege on its financial arrangements – including defaulting on its debts and other commercial obligations – as a lesson to others if issuing a S114 notice becomes a stock response to the current period of fiscal stress.

Financial failure is addressed by national government commissioners independently to assess the local council’s plight. Such interventions are often followed by financial sticking plasters to stabilise the situation in the short-term, including capitalisation directions and other flexibilities such as temporary council tax increases. High levels of borrowing, even from HM Treasury’s Debt Management Office’s Public Works Loan Board, present a thornier challenge but ultimately will require refinancing and reprofiling. Any new deals on the balance of funding between national and local levels, revaluations of local residential property tax, multi-year settlements, or new tax instruments remain distant.

With reduced strategic and operational finance function capacity resulting from over a decade of austerity, local councils are left trying various tactics. Following strengthened national prudential borrowing rules. Bolstering internal control and risk management, especially in copying vanguard approaches. Hoping the restoration of local audit and its backlog eventually gets resolved by implementing the Redmond Review recommendations. And believing that the Department for Levelling Up, Housing and Communities’ tightening of the best value framework and warning notices, plus the new Office for Local Government, will enhance the preparedness and resilience of the system.

Fixing the dysfunctional funding system requires thoroughgoing and structural change. As the LGIU Local Democracy Research Centre has demonstrated, learning from and adapting international practice can play a vital role, including assigning constitutionally protected roles, responsibilities and funding for local government, introducing appropriate equalisation and redistribution mechanisms between more prosperous and disadvantaged places, and building stronger national government support and trust in local councils to govern rather than just deliver nationally mandated services with insufficient funding.

Closing the accountability gap, each local council has the potential to go further in improving the disclosure and transparency of financial strategies and arrangements rather than hiding behind exemptions and commercial confidentialities.

Longer term and systemic changes are multiple. Reinvigorating formalised and structured systems and practices of accountability and scrutiny. Enhancing the financial literacy of councillors and officers to support greater oversight, scrutiny and accountability. Strengthening internal audit, controls, and monitoring. As local councils have become more complex financial entities in their connection of municipal and commercial finance in attempts to balance their budgets, councillor, executive, and wider public financial literacy and expert knowledge are even more important.

As the UK government refuses to bail-out struggling councils or even lets one or more effectively go bankrupt, costs ultimately fall back onto local residents through reduced services, asset sales, increased local taxes, and fraying local infrastructures. Local people’s faith in their local council will be undermined and diminished as a result.

Amidst populist discontent and distrust of the ability of politicians and public institutions to make people’s lives better, vanguard financial strategies risk local residents and taxpayers becoming further disengaged from their local councillors and councils with worrying implications for local democracy.

Yet this is not simple, story of gung-ho elected local politicians and appointed officers across England staking local taxpayers’ money in the casinos of international finance and imperilling local public service provision.

To avoid continued fiscal stress, financial failure, and the spectre of unfunded mandates to provide services, local councils have to continually ask national government what local government is for and how it can be funded. Only then can pressure be maintained for much-needed and long-overdue change to the currently broken system.