Credit easing – expect more fruitless searches for sponges in the Aegean Sea

The UK government recently announced a “credit easing” plan.  According to a junior minister the rationale is:

  1. Small businesses (SMEs) are unable to borrow funds from either the main banks or in the shadow banking markets;
  2. The UK needs SMEs to thrive in order to drive the economy;
  3. The Treasury/ Bank of England can raise funds or make guarantees to such businesses, and will do so, in order to fix this problem.

By way of further support, the US precedent has been cited.  Yet it has been widely reported that a $528 million loan to a green energy company called Solyndra, guaranteed by US taxpayers, has been written off.  It may be less than half of a basis point of the $14 trillion US national debt, but it’s still a lot of money to mere mortals. That company would never have procured the loan but for the US Government’s guarantee.

For Einstein, a hallmark of insanity was the repetition of a failed action in the hope of a different result.  Of the various ill-conceived UK government interventions in the banking system, all of which have failed to stimulate the economy, the three worst are probably:

  1. setting the price of credit (interest rates) to zero.  The mistaken thinking was that this should make it cheaper to borrow.  Sadly, the policy has had the obvious ancillary effect of maximising the prices of all fixed assets, such as properties and business rents;
  2. pouring cash into failed banks via QE in the hope that this would be lent to “deserving businesses”;
  3. nationalising the insolvent RBS and supporting others, yet turning a blind eye to the banks’ loss-making business models which, masked by the EU’s IFRS accounting regime, allow managers to pay themselves bonuses out of losses using the QE cash.

As the CEO of brokers Tullett Prebon, Terry Smith said “If you thought the banks were bad at lending, wait until …the government tries it”.[1]

Why are Mr Smith and so many others worried that any UK ‘credit easing’ will be a disaster for the taxpayer and fail to channel funding to meritorious borrowers?  The answer is that money donated is likely to be less effectively deployed than money lent in search of a profit.  Allow me an example from personal experience.

Many moons ago I showed up for the first day of my three year course at Warwick University.  I immediately embraced campus life and looked forward to the comfort of my taxpayer-funded accommodation, the conviviality of fellow students, and to relaxing in campus cafes and bars.

Within a few days I heard about one of the University’s main benefactors, Lord Rootes.  This generous philanthropist had done a great deal for Warwick.  He had donated the funding for a block of luxury student apartments on campus.  I soon realised that there was an effective lottery every year for one of these snappy penthouse pads, and one year I passed the official building just as the names of the lucky winners were being posted on a notice board.  One or two had been queuing in anticipation, and their whoops of joy that morning surpassed the delirium later expressed by some on my own course who were awarded top-rated degrees.

Lord Rootes also established a research fund.  Any Warwick student could apply for a grant to undertake interesting and valuable research during the summer vacation break with a view to making the world a better place.

Call me naïve, or a man of limited horizons, but I never seriously thought of applying.  A few ideas flitted across my mind, but I would have felt awful had I won some funding and failed to come up with powerful research that might have helped cure cancer or free innocent prisoners on the death rows of jails located in banana republics.

But not my friend Jim.  Unlike me, Jim was a cool dude, tanned and swarthy.  He was always invited to the best parties.  He did not appear to study very hard, he coasted easily through his course.  On one sunny Spring morning I learned that Jim had won that summer’s award.  It seemed an astronomical amount, perhaps £10,000 in today’s money.  The foundation’s trustees had been bowled over by his proposal to research sponge formations in the Aegean Sea.

When campus reconvened the following October, there was Jim, even more tanned.  He had spent the summer Greek island hopping, swimming and scuba diving.  He produced a one-line report for the disappointed trustees: “There are no sponges in the Aegean Sea”.

You may seek to distinguish the Rootes trustees’ business model (donations) from the UK’s putative credit easing model (a lending business), but the scepticism of Mr Smith and others reflects concerns that career civil servants will simply not be motivated by an entrepreneurial lender’s zeal to earn a return on funds lent.

If the UK’s credit easing plans materialise, expect taxpayer funds to flow into new businesses aimed at commercially exploiting sponges in the Aegean Sea.


[1] Oct 4 Wall Street Journal p 8