Dec 09 2008
Banks to lend to government
In the UK the government are revealing how they think they can borrow £157 billion this year, followed by another high borrowing year next year. They will tap into three sources of demand for government paper.
The banks will need to be substantial buyers, as the authorities are currently consulting on proposals to “significantly” tighten liquidity standards for banks. That means they will have to lend more to the government through the gilt market.
The pension funds will need to be buyers. Market declines in the value of many assets will create more large black holes in their funds. As company contributions are increased to make up for the losses the regulators and actuaries will direct the money to a considerable extent into gilts. Some pension funds will unfortunately end up in trouble where the sponsoring company has gone bankrupt. These are likely to be put into government bonds to a greater extent, directly or indirectly.
There will also be some volunteer buyers, concerned about the risks of other investments and taking note of the large buying demand from the first two sources. Many investment managers who held large positions in equities during the 2008 collapse are now increasing their government bond holdings.
The trouble with this approach by the regulatory authorities is that it makes increasing bank lending and getting things moving again in the real economy that much more difficult. Compare these two regulatory statements:
“We continue to expect Basle II to result in a reduction in our regulatory capital requirement compared with Basle I” (Northern Rock Accounts published in 2007)
“Firms will be obliged to hold sizeable buffers, and we would expect a marked increase compared with holdings under the predecessor regimes” (FSA December 2008)
In the heady days of 2007 before the August tightening of the money markets, many banks like Northern were lending large sums, and were concluding that they could either lend even more or return some capital to shareholders under the future regime. The Rock Directors in Spring 2007 were happily discussing how to handle their regulatory windfall of being told they needed less capital for their volume of business. Today banks are told that they need to hold a lot more in liquid government bonds, lending to the government at low rates of interest, to have a buffer against bad news.
The FSA itself says that its new policy will entail a substantial revenue loss for the banks. Capital that could have been employed lending to companies and individuals at higher interest rates will be lent to the government at low rates. The FSA says of bank turnover
“diminution in revenues – this diminution could be in the order of £1-5 billion (or even higher if the spread between the yields on government bonds and other debt widens).
This change to banking capital is a fundamental one and will mean less lending and therefore a slower economy. The Regulators no longer like much reliance on wholesale market funding, where banks borrowed through the money markets. Instead Regulators wish banks to rely more heavily on deposit taking from the High Street and the web. Paradoxically it was the High Street deposits which pulled Northern Rock down, for it was only when that run became apparent that action had to be taken. Aware of this the Regulator says a bank needs more cash and government bonds as a buffer. That means lower bank profits, which in turn means the banks have less capacity to lend to others. Gaining deposits will also require the banks to offer a lot more than 2% to draw in the funds.
The round trip of money between banks and government which I have described before should be seen in this context. If we take the example of the money lent to 3 of the banks as Preference capital by the government at 12%, we can see what this does to banks profits and therefore to their future balance sheets. The money effectively has to be lent back to the government at around 4%, leaving the banks with a loss of around 8% each year, or £1100 million of losses between them. Far from strengthening the banks, this adds to their problems.
If the government is serious about wanting an early recovery it needs to revisit the banking problem. Its current strategy of bolting the banking stable long after the horses have gone is not going to get us back to sensible economic trotting let alone to the races. It has now designed a regulatory system for both pensions and banks which will provide a substantial supply of lending to the government, but which will make it more difficult to kick start the productive economy again with the right amount of new lending to business and equity investment. The sad truth is we need more profitable banks if we are to get the economy moving at a sensible pace. Given the way some are fanning the dislike of banks and bankers, few are going to like this uncomfortable truth even though as shareholders we are all now part owners with a stake in their profits and losses.
John Redwood has been the Member of Parliament for Wokingham since 1987. First attending Kent College, Canterbury, he graduated from Magdalen College...
So for us simple souls, if I read this right, the government master-plan is to
1. Borrow more from the banks
2. Insist the banks maintain a higher reserve against lending
And having themselves taken some of the cash they could loan, and further made other lending more difficult by insisting on higher reserves, the banks then have to “lend more” Hmmm….. Again a tiny flaw in the logic seems apparent.
Doesn’t this incidentally give the lie to the whole concept of the Keynesian fiscal stimulus as there will be no aggregate increase in cash in the economy, it will just be seized by the government and spent less well by bureaucrats on special interests.
Reply
John,
You miss out the ultimate solution to the Governments debt problem and its called “quantatative easing” aka printing money to buy outstanding debt.
Its only a small step between using the printed money to buy existing debt to buying new debt to give the Government the ability to “create” demand or even lend directly to housebuyers through their new banks.
This is a socialists dream!!!!
Reply: Please see earlier post which describes this
Reply
Look, none of what you say is rocket science. The logic is irrefuteable. Many other commentators are pointing out the same contradictions. And given that there are clever blokes in Government and the Civil Service this must be evident to the Government.
So the question begs itself, why are they contuing to pursue this flawed policy?
Reply
jean baker Reply:
December 9th, 2008 at 12:06 pm
For increased labour unionist control and pofiteering ……
Reply
Not an Economist Reply:
December 9th, 2008 at 4:00 pm
Because they disagre with it.
For one, I was reading Samual Brittain’s website the other day and he seems to be in agreement with much of what the govt is doing. And he is a well respected political/economic commentator.
Also, look to America. The same profiligacy in monetary matters is evident there. Firstly in the behaviour of Greenspan as Fed Chairman for most of the last 10 years and now Bernanke who thinks all of America’s woes can be cured by monetary inflation.
Secondly, I guess there are elements within this govt who genuinely think that a society in which the state had increased control over the economy would be a better place. And because they don’t understand what has happened to bring this crisis upon us, they would argue that the crisis is essentially one of market failure and has therefore strengthened their position. (I don’t include Samuel Brittain in this camp though).
Thirdly - hubris. And its about time they had their fall.
But the issue that intrigues me more is why the electorate seem to be falling for it all. An opinion poll I heard about this morning puts the Tory lead at around 4% - despite all that is happening. If anything proves that Turkeys don’t vote for Christmas this has to be it. Indeed in this instance they seem to be wrapping themselves in the bacofoil and stepping into the oven all on their own accord.
Reply
1. The EU imposed Basel I and Basel II. I am not myself sure what part the EU played in introducing the FSA either. I suspect rather more than meets the eye.
2. Mr Cameron’s speech this morning on government borrowing and on cutting back the State was excellent and it addressed this very problem. If the State wasn’t so greedy, then the government’s borrowing from the banks would much less severe. He also told us how very dangerous borrowing by the State actually is. That, he said, is why a general election is now urgent.
Reply
Why not just let all the banks go bust. The government set up their own and then ‘privatise’ them? Worked for the railways, shipyards, telephone, roads etc. Free money! Have money for having money! Genius.
Reply
For everyone to understand this all we need is just one newspaper headline saying:
Government lends to banks at 12%
Expects banks to buy bonds at 4%
Lend to mortgage holders at 2%
This is not possible and you don’t need a degree in economics to see that. Can’t you get the Mail to publish this.
Reply
I may be wrong, but it seems to me, taking an overview, all this borrowing of money by the State and then spending of money by the State represents a further extension of the State into our private lives.
The State is borrowing private money, paying it back with tax and spending that borrowed money.
Why not just *not* borrow the money and let people invest it however they want? that money would all be invested - it does not require the State to borrow it for this to happen.
By choosing to be the agent which consumes that part of the finite amount of lending, the State is superceeding our private, individual choices - those of the lenders and of those who would have borrowed but now cannot - and pays for doing so by taxing us! which further restricts out freedom to do as we please.
Almost all State action, one way or another, consumes to one degree or another, from the supply of *choice*. There is a finite supply of choice. Choices can be taken by us, individually - which is freedom - or those choices can, by one mechanism or another, be taken from us and be made by the State. That is not freedom.
Reply
Government lending to banks at 12% with banks then lending to others at 4% or so is not quite as daft as it sounds. This is because (if I’ve got this right) the private banking system can effectively print money, i.e. lend several times its reserves and capital base. I.e. private banks will lend about ten times what government originally lent to banks, which after expenses, might leave banks with a profit.
Reply