The government’s two-faced policy over banks

With the announcement of a bank loaning scheme, it does indeed appear that government policy is decided on a flip of a coin

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Heads or tails?
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Simon Miller
On 15 June 2012 09:22

Georgie boy and Merv the swerve donned their glad rags last night and went to the Mansion House to announce a £110bn gamble to save the UK economy, demonstrating a resemblance to the Batman villain Two-Face who decides his actions on the flip of a coin.

And it seems that is how this government acts. Firstly by regulating banks into restricting credit then suddenly announcing cheap financing for loans.

Banks were burnt by over-extending credit in the heady days of the previous decades, granted, and have retrenched, but there is another important factor that demonstrates this flip of the coin by the government.

Scared by the opprobrium poured onto banks, politicians and regulators got nervous. In the Basel III agreement, they decided that banks needed a capital adequacy of 7 percent. So far, so good and given a sensible timeline for banks to grow the capital organically.

However, with the Independent Commission on Banking proposals, our fiscal geniuses in the UK went one better and increased the capital adequacy to 10 percent.

Now what do you think a bank is going to do? Faced with the ongoing turmoil in Europe, a slowing global and national economy, and regulatory demand on their money, they shut up shop.

So the Bank of England decided to launch quantitative easing (QE) -- printing money in the guise of putting money back into the system when in reality inflating the debt problems away and keeping the sovereign bond yield low.

And the banks saw the extra money and shored up their finances.

As the soon-to-be uber-regulator of the banks again, you have to wonder why the BoE didn’t point out the contradiction between regulatory demand on money and putting money into the system? You cannot have it both ways.

So they’ve come up with a version of the Special Liquidity Scheme in the form of dishing out money in return for a “loan” of bank assets such as their mortgage books.

It is an admittance that QE didn’t work, but there is no admission from Merv and certainly not from Georgie-boy. In fact if this round of cheap credit doesn’t work, Merv hinted at further QE - what was that Einstein quote about repeating the same experiment in the hope of a different result?

In fact it doesn’t take a genius to see the Janian quality of the government in action last night.

What has been the biggest sound bite regarding the UK? Debt. How much privately and publicly we have in debt.

Indeed, Georgie said as much last night: “The common theme is an underlying problem of excessive debt – banking debt, government debt and private sector debt.

“And the common challenge is how to manage the difficult process of balance sheet repair and deleveraging in a way that creates the conditions for sustainable growth and new jobs.”

So what is the solution they have flipped on? Granted companies need credit flows to survive. Sometimes you need cash to keep going when waiting bills to be paid. But in the same instance the government want to get more people on the mortgage trail.

What would happen? OK, the theory goes that the more property sold, the more money gets pumped into the economy through new white goods etc, but there is also another issue. The more people out there wanting a house, the higher the demand, the higher the house price. The reason why, at least in London, that house prices have held up pretty well is that although there are less buyers, there are less houses on the market. Supply and demand.

Does this two-face government want to kickstart the bubble again?

The two-faced attitude of the government also shows in its white paper on banking reform.

Don’t get me wrong, there is no reason why a taxpayer should assist a troubled bank, but there is also a question of whether a bad bank should survive anyway. I think there has been a false dichotomy been sold over this ‘too big to fail’ stance taken by governments and regulators alike.

It has never been a too big to fail problem. Other banks could have easily taken on RBS’s mortgage and deposit books and run them. The problem has been one of too cowardly to allow the fail. I know, i know, I keep banging on about this but to force haircuts on bondholders is just wrong.

A bondholder lends money to a bank at a rate commensurate to the risk of a default. The bondholder accepts this and takes the money on his punt. If a bank looks likely to default then either the bondholder negotiates a repayment schedule or takes a haircut. At the extreme, he takes it to international arbitration. What a regulated bail-in will do is drive up the rates banks pay, lessening the amount of cash in the system.

In addition, $3.5trn of short-term fund refinancing is coming up over the next two years for international banks - in the case of Europe, why would a potential bondholder take the risk? How does this square with the desire to increase credit and liquidity in the market place?

The fundamental problem at the moment is that the government is trying to send out one signal: we know the banks were wrong and we will punish them. Meanwhile it knows that banks are needed to kickstart the economy and, hopefully, increase receipts so it can genuinely start cutting the nation’s bills.

However, all this flipping of the coin, just doesn’t flipping work.

Instead of all this tinkering, George, address the fundamentals of this “uniquely British problem”.

Money is too cheap, bills and taxes are too high and there is too much paperwork for businesses. Release us from the burdens you impose and I suspect you will find that banks will lend in increasing confidence without your flip-flopping.

Simon Miller is the Editor of Financial Risks Today. He tweets at @simontm71

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