Opinion: Radical action need to remedy the economy’s woes

While the Chancellor’s direction of travel in relation to tackling Britain’s economic challenges is improving, his current approach will leave Britain feeling like Sisyphus, labouring hard to push a rock up a hill but never quite feeling secure that it won’t come crashing back down, destroying the hard work already undertaken.

But just as Sisyphus continued to focus on the mechanics of getting the rock up the hill, rather than indulge in any broader experiment to escape his predicament, Osborne toils at the seams of Britain’s economic malaise.

The Chancellor happily wallows in the Bank of England’s myth that giant infusions of credit from Quantitative Easing and the ‘Funding for Lending’ schemes, are any sort of remedy to Britain’s economic woes.

Britain’s businesses and banks in particular, are suffering from a crisis, not of credit , but of confidence. While the Chancellor obsesses on the short term , the actions of those who pull Britain’s economic levers are dictated by long term concerns.

These centre on the fact that Britain’s commercial banks are sitting on huge losses, estimated by the Evening Standard’s Anthony Hilton, at about 20% of their value, on their loan books. The banks are reluctant to foreclose, and the firms involved can just about make the payments now, though they are repaying loans on assets which have declined in value. The problem will come when the Bank Of England start to unwind Quantitative Easing. This will have to be done by selling off the central bank’s holdings of government bonds, which will push up interest rates, meaning those firms and families currently struggling to repay their loans will struggle even further.

In economics this is called the ‘negative feedback loop’, and at the moment Osborne ignores it, and buys into the popular hysteria about the lack of ‘growth’ being the biggest problem. Firms thus don’t want to borrow more, no matter how cheap the Bank of England make credit.

The banks know they face huge write downs on these loans in future, and so won’t be anxious to lend more. Unless this is addressed, Britain’s best hope may be that external forces push economy out of the Sisyphean path which it is currently on.

The Bank of England should stop buying government debt and use these funds to buy some of the bad loans from the commercial banks. This really will free up the banks to lend more, and deliver confidence and a degree of certainty. It also has the advantage that banks will has stronger balance sheets and will be more likely to preserve the current low interest rates to their borrowers.

Politically, it will be portrayed as the government ‘bailing out’ the banks once again, and will mean that the government’s borrowing costs will rise, restricting the Chancellor’s chances of delivering a giveway budget just prior to the next election.

Taking steps this radical, and this unpopular, with potential benefits more likely to be felt by the next government than this one is brave. But without these measures, the UK economy will continue to cough and wheeze to recovery, while all the time exposed to the danger of a second banking crisis, with the capacity too eclipse the first in its impact on the UK economy.

* David Thorpe is a member of the Liberal Democrats in Newham, and works for an economics publication.

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16 Comments

  • mike cobley 11th Dec '12 - 9:54am

    Debts are going to have to be erased, simply because most of them are unrepayable. The toxic derivative swamp still underpinning the banks must be faced and audited, and the banks themselves will have to be radically reshaped. Oh, and then there’s the bond/gilts bubble – what do we do if that bursts?

  • Richard Dean 11th Dec '12 - 10:38am

    It’s good that banks are “reluctant to foreclose”, but they don’t need to if “the firms involved can just about make the payments now”. Presumably the Bank of England has the nouse to realise that it needs to delay QE payback until the economy is in a stronger position where fims won’t be in such a precarious state as they are now?

    It sometimes helps to think of the financial market as composed of unfortunately necsseary, legalized criminals , without any sense of morality or ethics or conscience, out to get rich any which way they can. If I was like that, I’d just love the government to buy up my bad debt. I’d even go and get some more bad debt just to sell it on and make the government even happier!

  • As Richard says :
    “It sometimes helps to think of the financial market as composed of unfortunately necessary, legalized criminals , without any sense of morality or ethics or conscience, out to get rich any which way they can.”
    And a good analysis of our current financial services industry.
    And once the BoE has generously bought up all the garbage that these PRIVATE COMMERCIAL BANKS, have accumulated over the last 20 years, they will be freed up do precisely the same thing again.
    Until then, taking Richards cue, I’m going to see if I can find that old application form, for a 125% mortgage. I mean,… what could possibly go wrong?

  • david thorpe 11th Dec '12 - 1:17pm

    @ richard-the Bof E would like to delay until thingsare better-but the negative feedback loopmeans things wont be better until thgey stop delaying!
    @ john
    they cant do the same again-newcapital requirements and breaking the banks up mean its impossible

  • The broken transmission mechanisms for monetary policy are a real problem, Dave.

    Balancing Moral Hazard against the prospect of two decades of Japan like Zombie banks is a difficult issue.

    I think I would come down on the side of bypassing too big to fail commercial banks at this stage with direct lending into the economy and look at the following:

    1. Application of QE funds to buy commercial and housing bonds directly in the market.
    2. Nationalisation and regional break-up of RBS both to increase competition in the regions and form the core of the business bank that Vince Cable announced at Conference. The acquisition of privately held shares in RBS might be undertaken by a share swap for publically held Lloyds shares.
    3. Utilisation of newly created business bank to acquire good performing loans or discounted underperforming loans from the commercial banks that need to shrink their loan portfolios.

  • @ david thorpe: You say:
    “they cant do the same again-newcapital requirements and breaking the banks up mean its impossible”
    Do you seriously think that the same banking criminals/fraternity, who engineered the Libor scandal, and laundered drug money, without incurring a single prison sentence !?!, are going to flinch at a bit of extra Basel lll scaffolding? I can assure you, there would be much more regulatory ‘meat’, on a (25 years for fraud), prison sentence, than any new, ‘capital requirements’.

  • I agree with the sentiment of John (above) and question the morality of it all as well as the practicality. David says that the Bank of England should buy some of the bad loans from commercial banks. WHY? To bale out the people who foolishly invested in some of these banks who have “toxic” loans? If I have misunderstood, then maybe Mr. Thorpe could make the argument a little clearer…….

  • @ Jon Dunn

    “Do you seriously think that the same banking criminals/fraternity, who engineered the Libor scandal, and laundered drug money, without incurring a single prison sentence ”

    to be fair they are two differnt groups of criminals, just based in the same institutions…

  • Actually the QE should have been distributed by helicopter drop that way it would find it’s way in to the parts of the market that the public chose to put it.

    It would still have a moral hazard problem as it is bailing out citizens.

    Also it would have been inflationary, but those who remember know that that was the origional intension.

  • @Psi
    You are absolutely correct, in that there are levels of banking criminality, that probably range from,
    ‘I was just doing my job’, to ;
    ‘I’m filling my boots with cash,… taking everyone for a fool,,, on my way to a knighthood,… and I frankly, don’t give a s**t….! ‘
    But unless these people see a serious threat to their wellbeing, nothing will change. The latest design of regulation (Basel lll), is interesting, but as far as I can see, toothless.
    Is there anything in Basel lll that says ? :
    “….. If the CEO of Bank of X, should wilfully, infringe the regulations of the said, Basel lll accord, then he will (assuredly), spend the next 25 years in a dual cell as Buba’s ‘gurlfriend’. ”
    Until such time, of the threat of a legally guaranteed incarceration, you can be certain, they WILL, work the system, to make themselves rich, and everyone else, (including our children), tax servitude~inally, poor.
    This madness has to stop.

  • Richard Dean 11th Dec '12 - 11:10pm

    The government’s in trouble because it hasn’t got enough money to pay the bills. Well, it can always print some and pay its way like that.

    But is the economy, yes, the “economy”, really and truly in trouble? Well, the unemployment rate is high, and might even reach the 25% figures in a year or two. But many of the people who have jobs aren’t really doing that badly, they just have a little less of the riches they’re used to don’t they? I know a 90-year old who’s learning Email and Google and PDFs on an Ipad. Even now, people are buying things that we simply wouldn’t have dreamed of a decade or two ago.

    So instead of falling into the financial market gin-fed trap of helicopter illusions, shouldn’t we focus on solving the things that really hurt – like the unemployment rate, particularly youth unemployment? Shouldn’t we be thinking in terms of the distribution of work, rather than of money ,or gin? Well, after Christmas anyway?

  • Richard

    I agree that pain is far from evenly distributed and we are a lot better off than a couple of decades ago. I perhaps wasn’t clear, I am not entirely sure that QE is the right policy, but *if* you are going to print money the more effective use of it is helicopter drop.

    The purpose of QE (as origionally stated) was to raise inflation from where it was predicted to go. the current approach has resulted in a large programme where there has been some higher inflation in recent times but a substantial abount may stilll be set to come.

    A helicopter drop would be more likley to cause the inflation imediately so if you have printed vastly too much you see it and stop. THe current approach has fed in and cause a little but there have been repeated tranches which have been made before the effects of teh earlier ones have been felt.

    My concern is that the system is primed but noone knows how much inflation is waiting in the system. Unwinding QE on this scale if it turns out there is a whole bunch of inflation to come will not be as easy as policy makers pretend.

  • Paul in Twickenham 12th Dec '12 - 7:11am

    “The banks are reluctant to foreclose” – that sounds so nice of the banks, but here in the real world the reason for not foreclosing on a bad loan has nothing to do with altruism and everything to do with not crystallizing a loss that must then appear as a ledger item.

    This sounds like more special pleading and at every level – political, moral, economic and social – it would be a huge mistake. It is surely by now perfectly clear that the current QE exercise has utterly failed and the BoE and the Treasury need to be much more bold and imaginative.

    The BoE’s mandate for QE includes the (as yet unused) option to directly purchase “high quality” bonds directly, and it’s about time that they looked at doing this to directly fund major infrastucture initiatives.

  • Bill le Breton 12th Dec '12 - 9:28am

    For several years I have been campaigning here for NGDP level targeting – to much derision from the so-called Keynsians and the crypto Austrians. I have urged monetary stimulus a l’outrance until that target is reached and expectations entrenched.

    You may all be interested in the speech made over night by the next Governor of the Bank of England,

    “To achieve a better path for the economy over time, a central bank may need to commit credibly to maintaining highly accommodative policy even after the economy and, potentially, inflation picks up.”

    “To ‘tie its hands’, a central bank could publicly announce precise numerical thresholds for inflation and unemployment that must be met before reducing stimulus.”

    Note also that the single target covering both inflation and unemployment is nominal gross domestic product. Which is why he then goes on to add:

    “If yet further stimulus were required, the policy framework itself would likely have to be changed. For example, adopting a nominal GDP level target could in many respects be more powerful than employing thresholds under flexible inflation targeting.”

    This is where the UK is. And, as I have said here for a very long time now, the Liberal Democrats should be campaigning for a new target – NGDP LT set at 5% and a communications campaign directed and changing the expectations of all agents within the UK economy.

    The economic policy is now nearly in place – several years later than necessary – it must be accompanied by a campaigning comms policy to alter expectations and remove the curse of pessimism manacling the political class.

    Again I say, what an opportunity for LIberal Democrats … but I fear by the time we pin our colours to this mast – the ship will be in another harbour and its cargo of credit with it.

    Our economic wizards, Laws, Clegg and Alexander, continue to dither on their position on this. Their timidity and pessimism is the greatest obstacle to the recovery of our economy and the recovery of our political fortunes.

  • david thorpe 13th Dec '12 - 5:48pm

    banks wont foreclsoe yet because many of the assets are worth less than they were bought for-
    @ as for luibor and money lauindering-investigations continue-if you have evidence of criminality do let the police in the relvant jurisdictions know-bankers are doing time for other stuff in the UK.

    as for basel 3 and regaultion-again its a worl in progress lets see how it develops

  • Bill Le Breton,

    “For several years I have been campaigning here for NGDP level targeting “.

    You have even got Stephanie Flanders from the BBC jumping into the debate now A new target for the Bank of England

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