Placing Borrowing at the Heart of the System

A few days after the Autumn Statement, Martin McQuillan considers the Osborne plan to expand student numbers based on questionable finances that the IFS have labelled 'economic nonsense' and have slowly started to unravel. This short-termist policy may have big implications in years to come as BIS will have to make up any further shortfall in the HE budget - a budget already under extreme pressure. With so many risks ahead, the HE sector needs to take a long and detailed look at this scheme.

Charles Ponzi was a financial engineer and conman.  He gave his name to a particular kind of fraud.  On the basis of the difference in value between reply coupons for international mail issued in one country and their equivalence as stamps in another, he promised investors dramatic returns.  In fact he took money from investors to pay out a dividend to a select few, making the scheme look legitimate, while pocketing the rest of the money to fund a lavish lifestyle.  The original Ponzi scheme was not small in scale.  He got away with it for two years and at its height in 1920 Ponzi was taking (in today’s terms) $4.5million of new investment per month.  When it collapsed the Hanover Trust Bank of Boston went with it.

On the face of it George Osborne’s announcement in his Autumn budget statement that the government would fund the expansion of higher education through the sale of the pre-2010 student loan book looks to have little in common with Charles Ponzi.  The student loan book is considered a government asset, just like Marble Arch or the 4G spectrum.  It can be sold to raise capital to fund short-term spending.

However, in the case of the loan book sale, the spend will be to borrow more money to fund bigger student loans. This future borrowing is, for the moment, unlimited.  It is not clear from the Chancellor’s statement whether he intends that this process of selling off student loans, to fund future borrowing, to pay for universities, is to go on ad infinitum.  It will pay for an increase in student numbers in the immediate future but over time its costs grow dramatically.

All the evidence suggests that the new loans will have a greater rate of non-repayment than the pre-2010 variety.  The taxpayer might ask whether systematic borrowing to fund the sale, at a loss, of subprime loans to profit-making private companies, looks less like mainstream accounting or more like the taxpayer as the victim of Ponzi-like chicanery?  It is borrowing in the taxpayer’s name to sell off future tax intake to the private sector.  It is a situation that like any borrowing bubble is bound to lead to a crash.

Against all expectations George Osborne’s Autumn statement announced that the cap on student numbers in England would be abolished from 2015-16.  As an interim measure an additional 30,000 places would be made available for the next academic year 2014-15.  The initial numbers would be available for universities; private providers would be able to access the unlimited market from 2015.  This expansion, costed at £700million per year, would be funded by the estimated £12billion sale of income-contingent repayment loans taken out between 2003 and 2010, before the Coalition’s reforms.

As yet there is little detail on this proposed sale and recent statements cast doubt on whether it will or can finance expansion.  However, in a report written in 2010 by Rothschild’s bank, advising the government on such a potential move, it was proposed that in order to make a sale attractive to private finance a certain degree of profit would have to guaranteed either by a ‘synthetic hedge’ (effectively a government subsidy to investors) or raising the interest rates on repayments.

These pre-2010 loans are protected by law; only a government can change the terms of repayment.  If the Treasury feels confident enough to price the sale of this tranche of the loan book at £12bn then it might be assumed that they have already crunched the numbers on this and decided on their strategy: private subsidy or higher terms, its either bad news for the much put upon taxpayer or for graduates (who are of course also taxpayers).

The so-called ‘student number control’ was introduced by Gordon Brown in 2007 to repair the over-spend at the time on a generous student support package.  For the Coalition it became the primary mechanism for reigning in the underestimated cost of their reforms.  Conventional wisdom says that uncontrolled student expansion is unaffordable, while a true market in student choice is not possible as long as there is a cap on demand by limiting student numbers.

Recently, the Russell Group had started to turn up the volume on a campaign to introduce variable fees for different types of institution, suggesting that the true cost of an ‘elite’ education was £16,000 per year.  Most in the sector recognise that the value of the present fee of £9,000, set in 2010, will have declined in real terms by around 12.5% by the end of this parliament.

Hopes for the readjustment of fee levels looked to be a forlorn hope when on 23 November The Guardian reported that the cost of post-2010 loans had blown the budget of the Department of Business, Innovation and Skills.  The Treasury had lost patience with the level of impairment that had to be set aside to cover the cost of the non-repayment of loans (now running at 40%) and BIS were looking at ways to cut their budget in year by £570million and a further £860million after the election.  The science budget and student maintenance packages were said to be at threat.  It is in this context that George Osborne’s announcement appears as something of a bombshell.

It would seem that Osborne has decided that it is more important to secure the ideological legacy of the Coalition’s reforms by creating an unlimited market funded by borrowing than by balancing the BIS budget.  However, with UCAS reporting that university applications are currently 4% down on this time last year, it is not entirely clear that the demand exists for increased higher education provision at £9,000 per year.

Recruitment trends since 2010 have demonstrated that, despite government hopes, there is little incentive for the best universities (with a balanced portfolio of research and postgraduate students) to expand their undergraduate operation.  Student numbers have already been shifting between universities as the reforms make it easier for applicants to change institutions once A-Level results are known.  Despite this many institutions have not been able to meet their student number controls for the 2013 intake.  In this context a further 30,000 places followed by years of unlimited expansion looks either disingenuous or a heroic assumption.

However, the noteworthy thing here is that the ‘alternative providers’, partly responsible for the present budget woes at BIS, will have access to a market without a student number cap from 2015.  It is surely not an accident that within weeks of David Willetts writing to private providers such as the London School of Business and Finance to instruct them to stop all recruitment, that George Osborne has produced this Ponzi-shaped rabbit from the Treasury’s fiscal hat.

We can expect numbers at private colleges, funded by the public loan book, to explode in such a scenario, raising questions about the quality, relevance and rates of repayments related to such courses.  Willetts can claim this as a great investment in higher education, aiming at participation rates that even Tony Blair could not achieve.  However, this is surely the wrong way to fund the educational infrastructure of a knowledge economy.

The Russell Group has argued that it is spending money on the wrong thing: privileging an expansion of places over the quality of provision.  On the one hand, we might read their response as ‘if the sector is to be flooded with loose, unsustainable money, where is our share?’  On the other hand, they have a point.  An increase in the science budget, whose cash settlement has also been declining in real terms, would do more for innovation, growth rates, and GDP than guaranteeing the profits of Pearson.

This is not so much expansion on the cheap as expansion on the never never.  As a post-election promise the Conservatives and Liberal Democrats might never have to deliver on it, but the announcement has the political virtue of challenging Labour commitments on public spending and the regulation of private providers.

In this sense, the statement was pure Osborne: all tactics and no long-term strategy.  Universities should not simply accept this gift horse without conducting a full dental examination.  As the recent kurfuffle at BIS demonstrated when fiscal and political reality finally catch up with present student finance arrangements it will be universities that will have to pay the price with painful and immediate readjustments to cover the shortfall.

Charles Ponzi was not without his critics.  He successfully sued investigative journalists for libel and was given a clean bill of health by regulators from the Commonwealth of Massachusetts.  George Osborne has given universities what they have wanted for some time, the abolition of the student number cap.  He plans to achieve it by pumping up a giant debt bubble, putting borrowing at the heart of the system, and kicking the can down the road for the inevitable day when the Vice Chancellors of tomorrow will be left to carry it.

12 responses to “Placing Borrowing at the Heart of the System

  1. This post makes some good points but the overall mode of it is strange to me. Many people in the higher education sector seem to have accepted a defeatist mode of engagement with policy which assumes that ultimately everything that happens will be ‘bad for higher education’. There seems to me at least a possibility (I’d put it more strongly than that usually, so it’s a rhetorical move in this context to say only ‘a possibility’) that taking off the cap will have some positive benefits:

    – young people who weren’t able to get into university last year would be able to go
    – young people who were put off by the intense competition for places might be persuaded to apply
    – more older people – say, mid-20s and upwards – who don’t have a degree – or have a degree and fall into one of the ELQ exemptions – might think of applying
    – universities that are teaching-intensive might expand, creating more opportunities for new university teachers
    – universities able to offer additional places within their existing facilities might decide to offer them at lower fees than what they charge at the moment

    Some of these things are good things, right? By any measure of why we value higher education and the university as an institution?

    The adverse points on the student loans book sale are important but we should treat the student loans sale as an aside, a rhetorical flourish by the Chancellor (to be honest, every BIS and HMT Minister since 2008 – when the legislation making a sale possible was passed – has promised a sale in a similar rhetorical flourish and it’s never happened). The HMT scorecard – the policy decisions table – published alongside the Autumn Statement records the additional costs of the student places, and the unit cost is more than just the maintenance loans, so it seems to me that the costs are accounted for.

    Is it just possible that we should enjoy the confidence that the government is showing in the higher education sector and think more positively about how we use the additional student places to deliver the very best education that the sector can?

    The impact of the big HEFCE funding cuts – and higher tuition fees – I know is still there (and I was complicit in making those changes happen, fair enough) but since then every fiscal event has included new funding for science and research and now this measure to increase student places, despite the ‘more means worse’ lobby, despite massive public spending cuts elsewhere.

    Like I say, just a possibility to reflect on, no more than that.

  2. This was very helpful, thanks. It is hard not to end up believing (or, rather, worrying) that this whole scheme is of a piece with things like railway privitisation (which have ended up seeking large sums of tax revenue being passed over to for-profit companies).

  3. The scorecard only runs to 2015/16. Both the IFS and OBR complained about the lack of detail beyond that, given the commitments to have an additional 180 000 students by 2018/19.

    The 290m for 15/16 only represents grant as far as I can see (to cover 90 000 extra students – 30k in y2, 60k in y1) , since as usual RAB is sidelined from the scorecard as ‘non-cash’ with no impact on the deficit.

    Osborne repeated yesterday that net sale proceeds will be used to cover the cash outlay on maintenance grants and loans. It’s hard to read that as a rhetorical flourish, especially as it was originally set alongside a claim to bring down PSND with the surplus proceeds.

    Bottom line: we don’t have sufficient detail and what we do have is flawed.

    Opponents of a loan sale are not the enemies of aspiration. This was a hamfisted attempt to stifle dissent there.

  4. £290m over 90,000 students is £3,222 per student. That’s much more than the maintenance grant (max is around £2,900 and only around 40% get that, from memory). My guess is that the figure includes the annual non-cash element which is part of DEL. But agree that we don’t have sufficient detail. Stifling dissent? Hardly, I’m an opponent of the loan sale too.

  5. I don’t mean you stifling dissent, I meant the politics of the announcement.

    The figure does look a bit odd – but ‘full cost’ per student inc RAB is somewhere around 6k (as per Willetts’s slides at the LSE Robbins event). So again it’s all unclear.

    I read this all the other way – HMT want the sale to go ahead and the ‘human capital’ line has been co-opted in support. If you believe in the growth to come, then you don’t sell assets indexed to graduate earnings.

  6. The £6k per year will I think include the ‘lifetime cost’ of the loans. The £3,222 presumably includes the non-cash cost in BIS DEL in 2015-16 which is just the year 1 (and year 2, for the earlier cohort) cost of the loans.

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