How to explain the King-Osborne plan to pump more cheap credit into the economy? Robert Peston gave his explanation of last week’s Mansion House speech. Here, our occasional media correspondent, The Skimmer, gives his thoughts on Peston’s thoughts:
Peston: The Bank is saying that, in a business-as-usual way, with no stigma attached and at a cheaper interest rate, it will provide the funds that till now it would only provide through its so-called discount window – which is where banks go to borrow in an embarrassing emergency.
The Skimmer: Every other central bank in the world has been doing this as part of normal operations for five years now – this is part of the core function of a central bank.
Peston: Funnily enough, earlier this week when I interviewed Hector Sants, the outgoing chief executive of the Financial Services Authority, he said the banks were indeed sitting on more cash than they need to do, rather than lending it, because of their fear of impending crisis.
The Skimmer: This would not happen where there was a credible lender of last resort (aka central bank), providing liquidity against sound collateral in recognition of the essential illiquidity/maturity mismatch that is core to commercial banking to offset financial shocks, is the main reason central banks exist.
Peston: This banker said the FSA was being disingenuous. ‘The FSA says in public that we’re sitting on more cash than they are forcing us to hold,’ he said. ‘But in private, the FSA’s people make it almost impossible for us to run down our cash.’ I put this to a Treasury official. He said that the Bank of England’s scheme should persuade both banks and FSA to lighten up: the mere existence of the Bank’s new guarantee that easy money is available to banks should lead to an opening of the lending valve.
The Skimmer: In a banking/economic crisis of this severity, it’s essential that government acts in a coherent fashion. The Treasury should be taking responsibility to ensure that the policies of the FSA and BoE are consistent and that the two institutions are working in tandem. Having one arm of government tighten policy, while the other tries to ease, is simply incompetent.
Peston: All that said, it is the other scheme – with the snappier moniker of “Funding for Lending” – which is far more radical. Because it involves something that the Bank of England and orthodox central banks almost never do – which is to lend money with the express purpose of getting it out into the real economy, rather than just providing the marginal credit that commercial banks need to operate efficiently.
The Skimmer: This is wrong. Monetary policy works only through two routes – price and volume of credit. The central bank determines the cost of credit via regulating the commercial banks’ cost of financing. (eg why your mortgage rate used to move up and down according to Bank of England rate changes). Any activitist monetary policy works on the basis that moving the price and volume of private sector credit is an explicit goal. When money markets go haywire, as they have since 2007, the central bank has to do much more operationally to get mortgage rates to where they want them. Every other central bank globally has been doing this for years now.
Peston: There is no limit on how much the Bank of England would like to lend in this way, but it and the Treasury both talked about how a 5 per cent increase in lending to the real economy, equivalent to £80bn of net new loans, would be useful.
The Skimmer: This is missing the point – the BoE should be offering to fund as high a percentage of bank balance sheets as possible. Reducing existing cost of credit is the most important transmission mechanism.
Peston: The other question which the Bank of England and Treasury were really touchy about is whether the Treasury – or taxpayers – will indemnify the Bank against the risks it is running with the lending scheme. The Treasury thinks an indemnity is not needed, that there is very little danger of the Bank of England incurring any losses. But the Bank of England seemed pretty uptight about all this – and, I understand, the issue of whether taxpayers will guarantee the scheme is not definitively settled.
The Skimmer: This is another sign of the cluelessness of Sir Mervyn King. The BoE is owned 100 per cent by the taxpayer (aka, the Treasury) and has operational autonomy in pursuit of its statutory (and now-routinely-neglected) inflation target. The BoE is already a taxpayer liability, so does not need additional guarantees. This demonstrates again King’s lack of understanding of the place the BoE sits in the political-economy of the UK. This would be like Treasury guaranteeing the Foreign Office. In QE, for example, the Treasury owes money to itself. As Jeremy Warner said of QE: ‘The Treasury is becoming ever more in debt to itself. It’s as strange as that.’
Peston: First, they say creditworthy businesses and households are reluctant to increase their debts in these uncertain times. Second, many of the companies and individuals desperate to borrow are those in some financial difficulties, so the banks don’t actually want to lend to them.
The Skimmer: Households don’t want more credit; they want cheaper cost of funding. UK households are paying off their debts, and will be for a decade – behaving more wisely than the debt-addicted government. This deleveraging won’t hurt growth if it is facilitated by a very low cost of debt service. Businesses need credit for working capital and growth. They need to access debt, but banks have shut down the UK small business sector.
Peston: The big outstanding question for the Treasury, therefore, is whether it is prepared to expose taxpayers to the probability that some businesses and households, who may deserve to be kept afloat, would not be able to repay all of what they owe.
The Skimmer: Taxpayers and indebted households are the same people.
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