A lifelong friend in a senior position at a major UK bank confirmed to me privately that last week’s news that banks were approving 4 out of every 5 loan applications from small businesses was nonsense.
Fortunately our Government has not been so easily duped.
The Daily Telegraph reports today that Vince Cable is considering plans to force banks to lend. It publishes this direct quotation from the Business Secretary:
What we would question is whether banks should be paying out dividends and bonuses when that money could be used to … support small business lending.
The original fuzzy thinking behind the bailout was to protect depositors and prevent a system meltdown and economic chaos. In late 2008 Kaletsky wrote passionately in praise of the bailout, claiming it was the only way to stave off the then threat of mass unemployment and civil unrest.
Even those in favour of the bailout recognise that economic chaos now looms starkly on the horizon given the seizure in both the interbank funding market and in turn the trickle of bank loans finding their way to borrowers. The Government bailout team either didn’t consider this risk at the time or were incapable of designing a bailout contract that would ensure that future loans were made. Therefore Mr. Cable has no choice but to act, or else the very economic chaos that triggered the bailout will ensue anyway.
Doubters of my conclusion that Cable should be praised may question how banks can declare such sizeable profits without making loans. The answer to this is that there are still massive quantities of debt available for purchase at below par prices in the capital markets. Why lend money out in the real economy in an accounting environment where the most you can recognise as a profit in your books, if the borrower performs optimally, is about 2% of the amount loaned every year?
If the alternative is to purchase a bombed out “alphabet soup” structure at say 60 pence in the pound then the annual profit can be enhanced by marking up the price (and adding this unrealised gain to your annual profit statement) since all the other banks are doing the same thing. The annual profit line is also greater since central bank funding comes at the “official” rate that is much lower than the interbank market rate.
In early 2009 the ECB and Bank of England invited banks to fund alphabet soup purchases from a separate pot of taxpayers money called the “Discount Window”. The Discount Window is not part of any market at all, so the banks were delighted to accept all such funding offers. Given the scale of this activity prices of such assets have risen gradually and steadily and so another bubble is inflating but the nature of the accounting regime (the ease with which a profit can be recorded without a transaction occurring) hides this bubble from the eyes of scrutineers.
And so our banks have been very active in the last 18 months, not in the real economy but in the world of alphabet soup bonds.
Therefore I conclude that Cable is brave and correct to design measures that force banks to lend or else banks will continue to operate as state backed hedge funds rather than drivers of the real economy.
But on the other hand, what about moral hazard? The notion of forcing banks to lend has been widely mooted in the press and usually dismissed on three grounds:
- How can the Government ever hold banks to account if loans which we taxpayers have forced banks to make go bad?
- Forced loans is a concept blatantly at odds with the official position that the government does not control banks, we taxpayers are merely substantial shareholders;
- Bankers are skilled market operators and therefore we cannot interfere with their compensation contracts. The more we define their role the more difficult it will be to maintain that senior bankers are not just highly paid civil servants.
All three points are entirely correct and prove that the idea of forcing banks to lend is ridiculous.
And so we have established that Cable’s plans to force banks to lend to small businesses are both commendable and ridiculous in equal measure.
This conclusion says more about the wisdom of bailing out the UK banks than any rant ever could.