Funding for lending is working – house price sales have hit a two and a half year high. Funding for lending is not working – banks are not lending to business. Maybe the problem is that interest rates just don’t cut the mustard and we need to apply a lot more imagination to fixing the economy.
In 2008 Nobel Laureate Edmund Phelps said: “A fundamental issue that regulatory discussions must confront, however, is what function society needs the banking industry to perform. Increasingly over the past two decades, the banks have tried to make money with mortgages, residential and commercial. As this has proved difficult, the banks will either have to shrink their supply of credit to the economy as a whole or else redirect some of their credit to the business sector.”
He continued: “Unfortunately, the banks for the most part appear to have lost the expertise to make business loans and investments, which they once had in the fabulous years of investment banks such as Deutsche Bank and J.P. Morgan.” See: Edmund S. Phelps: What Has Gone Wrong up until Now
Five years on, and it is as if we have gone nowhere. According to the latest survey published this morning from the Royal institution of Chartered Surveyors, the number of houses sold in February reached their highest level in two and half years. You don’t need to look far for an explanation – funding for lending is working.
Yet the lead story on today’s ‘FT’ tells the other side. Funding for lending is to be ‘put on steroids’ said the pink-un, as the government looks at ways to stimulate lending to businesses.
In other words, those words uttered by Phelps in 2008 are just as apt today. Banks are willing, or at least more willing, to fund mortgages, but still reluctant to provide funding for business. How can an economy sustain rising house sales at a time when business is haemorrhaging?
Drill down and the problem becomes more difficult to explain. Big business has cash. It doesn’t need to borrow, and it can fund its own investment, it just isn’t doing so. Smaller businesses do not have sufficient access to funding, but in times such as these lending to smaller businesses is notoriously risky, so why should banks provide such risky finance?
On the one hand, we call for the state owned banks to do more to help the economy, but if a bank owned by us taxpayers started losing money because it had made a series of loans to businesses that then failed, the first ones to scream out in fury would be us tax payers.
Banks can’t afford to have more than a tiny percentage of their loans go bad. The mathematics of bank lending means there is very little room for bad debt. Near zero interest rates may not be helping, because there is insufficient margin in it for the banks. They dare not provide risky loans to business.
Yet extrapolate such risk averseness out across the economy, and we take the risk that growth may stumble along at near zero for years, and government borrowing will never fall to more prudent levels, unless there is some kind of debt write-off.
That’s the thing about risk. Low risk on a micro scale is high risk on a macro scale. And indeed vice versa; after all, the crisis of 2008 was primarily caused because banks had reduced micro risk, via the process of securitisation of mortgages, but in the process created systemic risk.
The government can fret about lending to business all it likes, but bank lending does not and never will hold the solution. We can cut interest rates to minus 10,000 per cent, but it won’t create an economic miracle, because lenders will never provide finance to business at less than zero per cent.
No, the only solution is for the government to find a way to persuade the markets to provide more investment into business in exchange for shares in profits. Until QE is used to directly promote investment into smaller businesses, rather than naively hope it will somehow get business lending up, the economy will continue to limp along bottom.
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