“I want you to know it was I who discovered your secret -. R.A.B.”

This post represents my personal opinions, and not those of current or former employers, projects, or programmes I am or have been responsible for. This post is available under a CC-BY license.
When a politician slips in to the dry, impenetrable terms of governmental accounting regulations, you know that he’s (and it is usually a guy, sorry chaps) trying to get something past you. Such was my reaction when I glanced over David Willetts’ article in the Times Higher a few weeks back. Specifically, this bit:

“This is just part of the Exchequer’s continuing support for higher education. This Exchequer subsidy for loans is known as the Resource Accounting and Budgeting (RAB) charge – a forecast of the amount of money that will not be repaid – and it is going to be at the core of university financing for many years.

I expect that, in the future, as the data accrue [sic], the policy debate will be about the RAB charge for individual institutions”

So what does it mean?

If you’re like me the first thing you did was to google “resource accounting and budgeting” and struggle to find a definition. The phrase in quotes is pretty unique to UK government and most of the “introduction to RAB” stuff (like this) implies you already have a serious understanding of accountancy. 

Likierman (1988, Public Money and Management [needs shibboleth]) suggests that:

“Resource accounting is a set of accruals accounting techniques for reporting on the expenditure of central government and a framework for analysing expenditure by departmental aims and objectives, relating those to outputs wherever possible. Resource budgeting is planning and controlling public expenditure on a resource accounting basis”

(If that prompted the question “what is accrual?”, Wikipedia is there for you. But I bet you can tell me all about post-structualism…)

So, fundamentally, RAB takes into account the expenditure and related income over the total life of an investment, and is a superb way of thinking about the “total cost of ownership” of something like a loan. A RAB charge would be incurred where the total expenditure is less than total income – so when Willetts says that the RAB charge of the new student loan system will be 30%, he’s suggesting that 30% of loans will not be paid back – even taking into account the extra 3% above the rate of inflation that students will be paying post 2012 and the sneaky way that interest begins to accrue before they even graduate.

Why 30% – well, quite frankly, why not? It’s just a figure he’s pulled out of the air. Sure, there’s probably complex actuarial calculations behind it, but it’s possible to do those calculations in an almost infinite number of ways. HEPI worked out that at a RAB charge of anything over 47% meant that the government ends up losing money long term, and that merely by decreasing the estimate of ongoing annual salary growth from an almost laughable 4.7% to a still optimistic 3.5% (core salary growth in the UK was 2.1% in March 2011) the RAB would be pushed over that figure.

At this point you’re thinking “Yeah, we know, the new funding model makes bad financial sense for the government, the Followers of The Apocalypse have told us this again, and again, and again … but what’s new?”

Look at the last line of my quote. RAB charges for individual institutions. Rather than pulling a figure out of the air for the whole sector, in future Willetts wants to be pulling a figure out of the air for individual institutions. So the University of Poppleton might have a RAB charge of 40%, Christminster University may have a RAB charge of 10%, the University of Bums on Seats might have 70% – all based on historical graduate first destination salary data (both incomplete and affected by numerous variables), some very dodgy work that the QAA will hopefully not have to do, and the alignment of the planets in the constellation of Capricorn. 

This is scary, market-skewing and idiotic in itself – you may wonder why anyone would want to do something like that. But take a step back. Insurable risk against the non-payment of expected dividends from anticipated income. This is hedgeable. Not content with establishing a market in higher education, the government wants to start playing with derivatives.

Remember that come the new funding model universities are essentially private, and thus the government is no longer obliged to treat them equally. Instead it attempts to treat students equally (except of course where Mummy and Daddy are so rich that they don’t need a loan). So if you run, say, an Arts College the government would be less inclined to want to lend to your students as they would see them as riskier. But they can’t be seen to be ignoring arts tuition, so they open up the risk of funding such students to the private sector.

Enter a hedge fund manager. Sure, he’ll fund a risky loan, because he can insure against it (and because the government is involved so he’s unlikely to lose out). In fact, he could load the insurance so he could bet against the repayment of the loan – and would then have a financial interest in students failing to repay their loans. You can write the rest of this dystopian novel at your leisure…

Seriously, there are scary implications to calculating investment risk on an institutional basis. That Willetts floated this idea in the middle of a dense and eminently skippable paragraph about government budgetary regulation suggests that there is something distinctly “off” about it. Hopefully we won’t be dissecting it within the forthcoming White Paper.

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