In the City Hall drinking game, every time Councillor Doug Ford gets up and starts a speech with the words “folks, let me tell you how it works in the private sector…” you have to chug. Which is why there is so much drunkenness around the Bay and Queen area.
A lot of Ford opponents most loudly object to this rhetorical crutch on the grounds that you cannot and should not run government like a business, since they are two different types of enterprises with two very different goals. (Short version: for most government enterprises, the smart business move would be to shut them down, since they will never be profitable, since the very reason they exist is to deliver services that are not profitable to deliver.) But when we get hung up on that point of principle, we also let slip another major observation, which is that Doug Ford appears to be completely financially illiterate.
I’m serious: for a guy who talks so much about how da bidnessmen run thangs, he appears to be completely unfamiliar with the basics of business and even household finance. For example, on the Ford Brothers’ Weekly Radio Shoutananny this weekend, Doug Ford said this, in reference to the city’s ordering $700 million worth of streetcars through debt financing:
I don’t think the average person… they wouldn’t do it. Do you go out and purchase a house, purchase a business, purchase a big capital piece of equipment for your business, and not have the money?
Well, Doug, thanks for asking. (Remember! There’s no such thing as a stupid question. But if there were, this would be one of them.) I want to take this slowly:
Oddly enough, the average person, when they buy a house, doesn’t “have the money.” The average detached house in Toronto costs $800,000. That’s as much as the average family in Toronto earns after tax in 11 years. If the average family looking to buy a home was paying rent and buying food and—let’s say through some act of heroic parsimony—still putting away 25 per cent of their income towards their house fund, then they would be able to afford a house in just 49 short years! But the problem is that, for many families, by that time, the children will be preparing for their own retirement and the parents will be thinking about moving into retirement homes. Forty-nine years in the future turns out to be a really inconvenient time for most families to take possession of a house.
Which is why the private sector has developed these things called mortgages, which allow you to buy a house and pay for it while you live in it. Virtually everyone who buys a house in Canada uses this method of financing their purchase—it is, yes, a “debt,” and it makes sense to incur it because it allows you to use your future earnings to afford something you need now. You’ll find, actually, that not only do average people rack up this kind of debt, but many businesses that need to buy buildings do, too.
There’s an accounting principle here that says if you are going to use something for 25 years, you can spread the cost of buying and maintaining it over those 25 years. Most of us use debt to do that sort of spreading.
But wait! There’s more!
What about, as Doug asks, when you buy a business? Well, let’s see. Earlier this month, when Hertz Rent-a-Car wanted to buy its rival Dollar Thrifty, did the company open a big vault of cash to pay the old owners? It did not. It borrowed $1.2 billion to make the purchase. And, after that, its stock price went up, because investors thought it looked like a smart move. How did Walton Street Capital buy the Marriott Hotel in Prague for 130 million Euros? It borrowed the money from a bank. How is Richard Schulze, the founder of Best Buy, trying to arrange to buy back the company? “Schulze has said he plans to fund any deal through a combination of private-equity financing, reinvestment of his own equity worth over US$1.6 billion under such a deal, and debt financing with the help of Credit Suisse.” (Emphasis mine.) And look, someone else is borrowing $23 billion to buy Sprint!
See, borrowing money is often how you finance the purchase of a business. Because borrowing money is usually a lot cheaper and gives you more control than assembling a group of equity investors. And it’s much quicker than waiting until your piggy bank is full enough to pay for the buyout.
Now, what about capital equipment for your business?
Let’s discuss a car, say, as a capital expenditure for a business. A factory, machinery, computers—those might be other capital expenses. But since Doug Ford’s example was a fleet of streetcars, we’ll stay with transportation. So let’s say your business wanted to buy a new Cadillac Escalade for one of its executives to use. You could present it to the executive as a “gift” from the other executives, but the business is going to pay for it because, clearly, it’s a capital expense for the business. Would you go to the car dealership with a big suitcase full of money? I suppose you could.
But in the real world, how do they do it? Oh, here’s an example Doug Ford should be able to relate to: “According to Ministry of Transportation records, [Rob] Ford’s new 2012 Caddy is registered to Deco Labels—the Ford family company—and is being leased from GM Financial Canada Leasing Ltd.” A car lease is a type of borrowing—a type of debt—in which you get someone else (e.g., GM Financial) to pay for the car for you and you pay them back in small instalments, with interest, to use it for a period of time. Then, at the end of that time, you can either buy it from them to keep or give it back. (Incidentally, not everyone thinks leasing is a smart way to borrow for a car. “Leasing is absolutely the highest cost of borrowing in the market place. Hands down, no exceptions,” Dennis DesRosiers told the Globe.)
But yeah, businesses—such as Deco Labels—do incur debt to buy capital equipment.
So how does the private sector measure responsible debt?
The important question for the average person and business is not whether you “have the money” sitting around in a bank account somewhere to pay for something. The question is whether you can afford to service the cost of the debt you take on to buy it. That is, can you make the repayments? One yardstick for figuring out if debt is a problem is looking at how much debt you have compared to how much your income is. In Canada, the “average person” Doug Ford is so fond of talking about has $1 of debt for every 63 cents in income they have. Rogers, the Canadian communications giant, has long-term debt of about $10.79 billion and annual income from its businesses of about $12.47 billion. The City of Toronto has a net debt of $4.4 billion, and has annual income in taxes, user fees, and transfers from other governments of more than $11 billion. (By way of further comparison, the US government’s debt is over $12 trillion on annual revenue of about $2 trillion.)
But what about the cost of servicing the debt? Experts suggest a household should not pay more than about 40 to 44 per cent of its gross annual income in debt payments. If you reach that limit, no one’s going to give you a mortgage or issue you a new credit card. But if you pay, say, 30 per cent of your income to service your debt, you’re doing okay by that reckoning. That average Canadian family we keep talking about is spending 18.6 per cent of its income on debt service.
Now, since the City of Toronto’s net debt isn’t even 40 per cent of its gross annual income, clearly the payments are substantially lower than that threshold. The chart on page five of this city budget overview shows that the city pays about 4.5 per cent of its operating spending on debt charges. As a percentage of gross revenue, it actually works out to about 2.3 per cent.
But since the City of Toronto doesn’t have a lot of discretion about how it spends most of its income, it’s more useful to look at our debt payments as a percentage of our tax revenue—the city’s “disposable income.” The City has passed a rule stating that debt-service charges can never amount to more than 15 per cent of the city’s property taxes collected—an artificially low ceiling imposed in the name of fiscal responsibility. Last year, we paid $263.6 million in interest charges on our debt—which works out to about 11 per cent of our tax revenue (see page 7 here).
(Bonus points: you may have heard that the City of Toronto is in danger of becoming “Greece.” The country that gave us civilization has a debt that equals roughly 162 per cent of its GDP—not 162 per cent of its tax revenue, but 162 per cent of the country’s total annual economic output. Toronto’s debt is about 3 per cent of GDP. Greece’s interest payments as a percentage of revenue were about 12.9 per cent in 2010. Toronto’s last year were, as noted, 2.3 per cent.)
Which is part of why we have a top-tier credit rating (AA1 from Moody’s, AA from the other agencies), and had that credit rating all through the David Miller years, too. As private-sector debt expert Moody’s says, “Toronto’s rating relative to other Canadian municipalities reflects a low debt burden….” This excellent credit rating means it is really really cheap for us to borrow money—which is another reason it often makes sense, from a business perspective, to borrow, but that’s another story.
Anyhow. You may have reasons to think that it would be nice if Toronto’s debt was lower. But the way they do things in the private sector, and the way average people do things, cannot really be among those reasons.
PHOTO: COLIN MCCONNELL/TORONTO STAR