If you had $151,000 in the bank earning 0.25 per cent interest, would you borrow $67,000 at five per cent to add a new room to your house?
Of course not. Yet the Yukon government is doing essentially that, except in millions instead of thousands.
The cabinet has asked Yukon Hospital Corporation to build hospitals in Dawson and Watson Lake, plus a medical residence in Whitehorse, for an estimated $67 million.
Instead of dipping into the government’s cash surplus (about $151 million as of last April), the government plan is for the hospital to borrow the money from a bank.
Sometimes people around town complain that the Yukon government is not up to date on the latest business practices from Outside. But not in this case.
The government is in fact copying the big banks in New York, circa 2007, when many of them borrowed billions “off balance sheet” in structured investment vehicles and so on.
We all know how that turned out.
There are a lot of reasons why this might be a terrible idea for the Yukon.
First of all, it could cost us millions and millions of dollars. We don’t know how much, since the government is keeping the details secret. But here’s a rough guess.
For the $67 million in question, let’s say the government is earning 0.25 per cent in the bank now.
The government won’t say what interest rate the hospital will likely be paying, but here are a few reference points.
Prime was 2.25 per cent last week and many quality commercial borrowers Outside are currently paying one per cent, or more, above that. One of the commercial real estate lenders in Whitehorse is offering one-year money at 5.35 per cent and five-year terms at 7.2 per cent. Locking in for 15 years, the likely term of the loan, the interest rate would be 8.5 per cent.
If the government borrowed at 8.5 per cent, or an 8.25 per cent “spread” over its bank account rate, the loan would cost us all about $5.5 million extra per year.
And if the government paid it off slowly over 15 years, the total extra interest cost could be in excess of $30 million.
But the government has claimed that they are getting a good rate, at least compared to regular commercial borrowers.
This is probably true, since the loan is guaranteed by you, the taxpayer.
It is practically risk-free for the bank (which is nice, if you’re a bank). So the more appropriate comparison is a provincial borrowing rate.
Ontario’s 15-year debt is yielding around 4.5 per cent. Let’s be optimistic and say the Hospital Corporation could borrow on a shorter term at a better rate, say 1.5 per cent over prime, or 3.75 per cent.
That would have an annual cost of about $2.5 million, or more than $15 million over the life of the loan. Of course, borrowing at a shorter term exposes the Hospital Corporation to interest rate risk.
If inflation goes up, as some economists fear, and rates are eight per cent in five years, that will be expensive.
Either the Yukon government will have to cough up extra millions, or the hospital will have to slash costs somehow.
Another reason this could be a bad idea is “mandate creep.”
The Whitehorse General Hospital is a well-run outfit, especially compared to many other hospitals this columnist has suffered in.
Getting them to run three other construction projects, negotiate real estate deals with the banks, and run hospitals in Dawson and Watson Lake risks distracting their management team.
Of course, we can’t blame the hospital managers for all this. They are acting on direction from the government and their board. One hopes, at the very least, that the board insisted on iron-clad protection from the government against cost overruns and interest-rate risk.
Another reason to worry about this deal is that it may combine the worst aspects of government construction projects and privatized efforts.
Since it appears to be a plain old bank loan, the risk of cost overruns remains with the hospital or government, but with market interest rates.
This is unlike the new Fort St. John Hospital, where private money is involved, but the risk of cost overruns also sits in the private sector.
Moreover, citizens worried about the Fort St. John hospital deal can also go online to Partnerships BC and obtain a “fairness opinion” from an independent adviser. Your government is not offering this.
So why is the government doing all this?
One can only speculate, but one possibility is that the Yukon government is running out of money, but needs to keep the spending hose going until the next election in about two years.
From the $151 million in the Yukon’s bank account last April, we have to subtract $36 million frozen in asset-backed commercial paper.
Then this year’s cash deficit of $29 million and some portion (say 50 per cent) of the Yukon’s $71-million share of the Mayo B dam project.
If we assume cabinet keeps up the vote-winning deficit spending (say $25 million per year) for two years up to the next election, that gets us to somewhere around $0 in the bank in 2011.
And that assumes our transfer payment formula isn’t affected by recession in the South, and that the government avoids expensive wage increases for government unions.
What this means for the Yukon after 2011 is no more cash in the bank, plus tens of millions in long-term loans to pay off on the hospitals.
Either the government will have to cut the public service and do fewer projects, or keep on borrowing until the future is fully mortgaged.
Maybe this scenario is too pessimistic. Or maybe it’s not pessimistic enough.
In the Yukon, we don’t have an independent budget officer like they do in Washington and Ottawa, to give an unbiased report on our finances.
We should probably get one, before this cabinet’s off-balance-sheet legerdemain ends up costing us millions.
Keith Halliday is a Yukon economist and author of the Aurore of the Yukon series of historical children’s adventure novels. His latest book, Game On Yukon!, was just launched .