Fiddling with loans while Rome burns

Darling’s attack on banks for failing to make credit available shows he still has no big ideas for overcoming the recession.

Rob Lyons
Columnist

28th July 2009

The UK chancellor of the exchequer, Alastair Darling, has been talking tough. He wants to crack some bankers’ heads together. Having saved many of Britain’s biggest banks from collapse last year, the UK government then clearly expected them to make credit readily available to businesses at reasonable rates. But the figures suggest the banks are charging more, with stricter lending criteria, than before.

Stephen Alambritis of the Federation of Small Businesses, writing in the Independent, demanded that ‘banks must reduce their charges to reasonable levels’ (1). David Frost, director general of the British Chambers of Commerce, said: ‘It will be business that drives the UK out of recession, but that can only happen if the banks are prepared to play their part. I am still hearing too many stories of small businesses being unable to access appropriate financing.’ (2)

So Darling called in banking leaders for talks yesterday. He told the BBC: ‘We need to get to the bottom of what is happening with individual banks, to see if loans are being made available and to check that [banks] are not charging more than is justified.’ (3)

The problem, however, is that government policy is somewhat schizophrenic. On one hand, the banks are still in intensive care. Banks like Northern Rock, the Royal Bank of Scotland and Lloyds are either partially or completely owned by the government. In order to get their liabilities off the books as quickly as possible and establish future banking on a sounder footing, the government is keen for them to bolster their balance sheets. On this basis, the banks need to reduce their liabilities at all costs. So they have either been reducing borrowing facilities for businesses or charging more to factor in the potential risk of the borrower going broke.

But, on the other hand, the government is also mindful of the fact that if credit dries up for any length of time, the recession will get much worse. Some businesses, for example, are very seasonal. Many retailers lose money for most of the year only to make bumper profits at Christmas. How do they finance themselves in the meantime if credit is either very expensive or unavailable? The result could be that perfectly viable businesses go to the wall because they can’t get the working capital they need.

This contradiction of interests between banks trying to restore their balance sheets on one hand, and businesses (and wannabe homeowners) trying to get finance on the other hand, is what the ‘credit crunch’ is all about. The trick will be to get debt back to manageable levels without provoking a full-blown depression, while also providing for a more secure banking system in the future.

This is precisely the problem identified by Lord Turner in his government-commissioned report on the future of the banking system, published in March this year. ‘The quality and quantity of overall capital in the global banking system should be increased, resulting in minimum regulatory requirements significantly above existing Basel rules’, Turner proposed, swiftly adding that ‘the transition to future rules should be carefully phased given the importance of maintaining bank lending in the current macroeconomic climate’.

There are a few black clouds on the horizon, however. For one thing, the much-vaunted ‘green shoots of recovery’ have failed to appear, as yet. Rather than stagnating over the past three months, as many economists had believed, the latest official figures show that the economy shrank by a further 0.8 per cent in the three months from April to June. If those figures are roughly correct (and every set of figures has to be taken with a bigger-than-usual pinch of salt at present), banks will have to charge even more for lending to cover the risk of bad debts – which is precisely what they appear to have been doing.

Secondly, a few more skeletons seem to be emerging from the bank’s closets. For example, it was reported yesterday in The Times (London) that Britain’s banks are only now facing up to the task of refinancing £300billion worth of commercial property loans. The estate agency Savills suggests that half of these loans will need to be renegotiated in the next two to three years, but argues that the market is currently only capable of absorbing about £20billion worth per year (4).

Fundamentally, the British economy has been living off debt, both public and private, for years now. The ability of the UK economy to produce new value and to take a cut of value being produced elsewhere is no longer sufficient to manage this mountain of debt. Larger companies are able to issue new shares or corporate bonds – in other words, borrow directly from the markets. How long firms will find buyers for their shares and bonds is open to question, but one way or another, clearing and refinancing those debts will not be a quick or painless process.

But small businesses are reliant on the banks, which have become much more conservative in their lending policies. It’s not that the banks don’t want to lend at all (banks like Royal Bank of Scotland and Lloyds need to lend a certain amount as part of an asset protection scheme agreed with the government); it’s just that they want to lend to companies who are sure bets to pay the money back, and at much higher profit margins than would have applied in the past. If this impasse cannot be resolved, some profitable businesses may go to the wall simply due to short-term cashflow problems.

For the UK economy to be revived long-term, a major restructuring must take place. But without any clear idea of what a new economy might look like or how it will be achieved, we could very well end up with a brutal process of businesses going to the wall and jobs being lost. While capitalism has always thrived on what the economist Joseph Schumpeter called ‘creative destruction’, some of this may be destruction, plain and simple. The government will endeavour to mitigate the worst of the damage that this will involve, but there needs to be a more fundamental shift towards an economy built on greater productive activity, not merely consumption based on debt or inflated property prices.

Sadly, Darling’s latest turn seems to be missing the point. His bank-berating sideshow yesterday seemed to be less about taking practical action and more about being seen to be doing something. The basic contradiction between bank solvency and business credit will remain for some time, even if Darling can provide some further, small-scale, emergency relief.

The real problem is that Darling hasn’t got any broader vision of how the economy might be rebuilt (and nor, does it seem, do the other political parties). A year after the crisis hit and he’s still fire fighting. There is little evidence that the government is doing any more than wishing that the whole problem would go away and we could return to the world as it existed 12 months ago. But there is no prospect of a return to the faux boom that ended a year ago. Ultimately, the length and depth of this recession will depend to what extent the world can be convinced that Britain’s got a plan for the future.

Rob Lyons is deputy editor of spiked.

Previously on spiked

Rob Lyons argued that the government seemed more interested in saving its own skin than the economy. He also argued the government seemed more than happy to witch-hunt bankers. Rob Killick looked at what’s in store for the British economy. Frank Furedi explained why the state won’t be the saviour of the economy. He also said we need a public debate about the economy. Phil Mullan explained that the recession was indicative of a deeper crisis. Or read more at spiked issue Economy.