The Government’s recent announcement that Public Works Loan Board interest rates were being increased by one per cent with immediate effect was only surprising in terms of the size of the increase and that it was taking no other action to curb what it regards as risky commercial property investment by local authorities.

The Government stated frequently that it would take action to address its concerns about the scale of local authority borrowing and undue commercial risk. Now it has.

Unfortunately, the prudent, those that have neither borrowed excessively nor undertaken significant high risk commercial property investments will suffer the same fate as those who have. Higher interests rates will be funded by the council tax payer.

The Government will be lobbied to reverse its policy, but there are strong arguments that borrowing from the PWLB has been too easy and oversight of borrowing lax. In three years’ time, on current plans, one district council will have debt in excess of £2.1bn on current service expenditure of less than £100m; financially it should be treated as a moderately sized real estate company with a small local authority attached. Market discipline would either have prevented the risky investments undertaken by some or forced that investment into commercial vehicles that isolate the council tax payer from the risk. The public interest case for greater scrutiny of borrowing is overwhelming.

Given the consensus that alternatives to the PWLB are the way forward, councils must now navigate the array of borrowing options and structures offered to them by banks, investment funds, intermediaries and increasingly, each other. It is clear that many sharks smell blood in the water and they are beginning to circle. Much of the advice and guidance those sharks offer will be questionable, the products unsuitable and interest rates offered excessive.

These problems have arguably persisted for many years. Some councils belatedly discovered that the LOBOs they had taken out were not stepped rate loans they could repay without penalty if rates went up, but derivative products with high exit costs. The situation is ripe for an epidemic of similar problems.

Local authorities are accustomed to treating the PWLB Certainty Rate as the benchmark, but this now risks the insidious problem of structurally high interest rates. PWLB rates have never been a market rate, but an arbitrary rate set by government. Nothing illustrates this better than the overnight 1% hike in the PWLB margin; within recent memory the margin was as low as 0.15%. Any rate an investor ties to PWLB margins is equally arbitrary. Some commentators have suggested that investors would be 'very interested' in local authority debt at 1.5% over the Gilt, which is undoubtedly true, but leaves one wondering if a council’s finance director should also offer the investor his or her shirt off their back.

UK Local authorities offer some of the best credit risk available to any investor. None have defaulted on any debt since the City of London was created in 1067, whereas even the UK government technically defaulted in 1932. Debts of local authorities are secured on all their revenue, nearly all of which is either government grant or statutory taxation, presenting markedly lower risk than any company. The PWLB is the lender of last resort – for those in doubt, search Hansard – enabling any local authority to refinance a maturing loan and repay a creditor even if the capital markets are closed to them. UK local authorities are tightly controlled by their respective governments and cannot borrow for revenue purposes. Crucially, should problems begin to manifest themselves, as Northamptonshire has recently proved, intervention prevents insolvency. Taken together, most UK local authorities would receive a very high credit rating.

Elsewhere, good credit ratings translate into a comparatively small difference – 'spread' – to government debt. US municipalities with credit ratings similar to that of Lancashire County Council, one of the UK local authorities that is rated, typically borrow at a 0.5% spread to US government debt; 0.2%t better than equivalent US corporates. Even TfL bonds, which are illiquid and thus market interest rates are higher than they should be, were pricing at 0.8 to 0.9% over UK Gilts in early October. An increase is inevitable given the new PWLB margin, but there is no justification for rates greater than 1.2% over Gilts and even 1 per cent offers double the margin of a US equivalent.

Many experts say 'the Sterling market is different' to justify large spreads, but this excuses what is often little more than greed or lazy management. Local authorities need to be brave and hold out for lower rates than currently mooted: ultimately, if investors want long dated bonds and loans with low credit risk, they will give ground.

Christian Wall is director at PFM Advisors UK