Monday, December 14, 2015

LOBOs: Putting up and not shutting up

At the Newham Full Council meeting last Monday, the Cabinet member for Finance, Lester Hudson, responded to the arguments that myself and Cllr Whitworth put forward here and here about the exposure Newham has to LOBO loans.

Cllr Hudson said that the Council had saved £64 million in reduced interest rates because it had redeemed old expensive debt and taken out "cheaper" new LOBO debt to replace it. He believes that this amounts now to £64 million of savings and this is a fact and has been checked by PwC (auditors). He invited us to check this.

He also explained that we were criticising the choice of LOBO loans with the benefit of "20/20" hindsight. The real test should be what a "Reasonable person" looking at financial forecasts at the time would have expected interest rates to be. At the time the Bank of England was predicting interest rates (in the short term) to rise. No one anticipated the fall in interest rates that has since taken place. In terms of financial modelling, you should look at previous recessions and there has been nothing comparable has happened in previous recessions except for 1929-1935. The key issue is that they took out fixed rate loans based on reasonable forecasts at the time. If he had a time machine and could have anticipated the collapse in interest rates we would have made different decisions. If we could dig out a different economic forecast he would listen to our argument so he challenged us to "Put Up or Shut Up".

Unfortunately neither myself or Cllr Whitworth was able to respond to his points so I thought I would take up his challenge and say what I would have said if I had the chance.

The key issue about the £64 million savings (I will as invited be contacting PwC for them to confirm this calculation) is not that we "paid off" early some expensive loans and took out newer "cheaper" loans but that instead of taking out the safer and transparent loans from the Government (called PWLB) we took out inherently risky derivative based loans (called LOBOs) from British and Foreign Banks? Also why did we put all our eggs in one basket and take out all "fixed rate" (not that LOBOs have turned out to be "fixed") loans instead of a prudent mixture of floating and fixed loans?

Why did we take out loans for up to 70 years that did not protect us against falling interest rates but allows the Banks to raise rates if the market rate rises?

With regard to the argument about "hindsight". The Bank of England and other forecasters report "market expectations" and not "predictions". All forecasts are educated guesses to a greater or less degree. No one really knows what interest rates will be in the future. The real "reasonable person test" is "what will happen if it all goes wrong" and interest rates do not go the way we think.

Robert Carver an ex Hedge fund manager and derivatives trader who used to work for Barclay's points out "Seventy years ago it was 1945. Who then could have predicted that (bank base) rates would go from 2%, to 17% in the late 1970's, then back down to 0.5%?!"

He also reminds us of Robert Citron, treasurer of Orange Country California on making a prediction that interest rates wouldn't rise. A few months later Orange County was bankrupt after losing $1.6 billion on interest rate derivatives). "I am one of the largest investors in America. I know these things."

I will also respond to the comments made by the Mayor at the meeting.

Hat tip Nick Dunbar and Joel Benjamin.
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