As George Osborne has made some announcements about a possible credit easing policy in the UK I thought that I would take you in a trip on Doctor Who’s TARDIS when an oddly similar policy was announced by the previous Chancellor of the Exchequer Alistair Darling back in February 2010.
This was explained in a letter from the Chancellor of the Exchequer Alistair Darling to the Chairman of the Treasury Select Committee John McFall. This can be found on http://www.hm-treasury.gov.uk/d/chx_letter_040210.pdf
What does it mean?
This letter authorises the Bank of England to spend up to £50 billion on asset purchases. However these will now be private sector assets as opposed to the public sector ones that the Bank of England’s QE programme mostly ended up purchasing. It will buy commercial paper,corporate bonds and secured commercial bonds. It will be financed by the issue of Treasury Bills. So just to make it clear whilst the Bank of England will no longer buy government bonds it will continue to buy corporate bonds.
Differences from previous policy
1. It will be paid for by the issue of Treasury Bills and not the Bank of England creating money.
2. It will purchase private sector assets as described above.
Implications of such a policy
Actually on a first reading this policy looks preferable to the Quantitative Easing policy which had previously been pursued. This is more in line with the way the US Federal Reserve has operated and as I wrote yesterday it has had more success than we have had with unconventional monetary operations so far. So hopefully companies will find it easier and cheaper to finance long-term borrowings. This does seem to have been the American experience. Also borrowing the money and not simply creating it is a better more transparent system as I never liked the idea of circulating money between the Bank of England and the Treasury.We should have done more of this and less of QE. If we had our economy would be in better shape now.For the curious the average rate paid on 3 month Treasury Bills in January was 0.49% according to the Bank of England.
The only drawback is that some of these private-sector markets are quite small in the UK so it may take a while to spend the money and have an impact. So far the Bank of England has only spent some £479 million on Commercial Paper and £1,484 million on Corporate Bonds. It bought £2.11 million yesterday so at that rate it would take quite some time to spend £50 billion!
Why was this not announced at 12.00pm yesterday?
I am sure there will be plenty of speculation about why this was released on the HM Treasury website in the evening and not with the Bank of England’s announcement. It certainly is not good policy procedure in my view and smacks of political opportunism and possible disagreements between the Chancellor and the Treasury. However it on first reading looks a better policy that QE even if it may prove harder to spend. I will leave analysing possible rows and disputes to the political press.
One last thought. There was not much left of the concept of Bank of England independence and this puts another nail in its coffin.
Having had time to think a little more about this policy it still looks a good idea to me. One flaw that does come to mind is the adage for banks ” be careful of borrowing short and loaning long”. In principle this can apply to nations too and in borrowing on a rolling 3 month timescale and loaning to bonds which have much longer lifespans e.g 5 years,10 years this is exactly what we are doing.
Moving forwards to the 3rd of October
Chancellor George Osborne announced this at the Conservative Party Conference.
Everyone knows Britain’s small firms are struggling to get credit and banks are weak.
So as part of my determination to get the economy moving I have set the Treasury to work on ways to inject money directly into parts of the economy that need it such as small businesses.
It’s known as credit easing.
It’s another form of monetary activism.
So there you have it an announcement with little detail. However back on the 14th of September I discussed this matter in my analysis of a speech by Monetary Policy Committee member Adam Posen which had this section as one of his main points.
More cooperation between the Bank and HM Government to promote investment and credit to small and medium business should be the beneficial next step
So as you can see the matter had been in the ether so to speak,although the lack of detail may mean that the policy was made up something on the hoof as a response to pressure to “do something” about a weakening economy.
How much of a change is this?
In theory as you can see above the plan and its objective is pretty indistinguishable from that of his predecessor as Chancellor. I will leave the political turf war as to who thought of it first etc. to them! However since February 2010 the Bank of England has used this facility very little. For example it last bought some commercial paper in mid-August 2010 and as it only bought £120 million on that date you can see that it had little enthusiasm for the task. On its balance sheet right now it has a total of £1.088 billion of Corporate Bonds,no Commercial Paper and £25 million of Secured Commercial Paper.
In other words the Bank of England has shown no enthusiasm for this policy at all. no wonder some authority for this will go to the UK Treasury going forwards!
What has also changed since February 2010?
This is a more awkward one for supporters of such a policy as one of the reasons for the move back in February 2010 was that interest-rate on many corporate bonds had risen. Since then the situation has improved considerably and many corporates can issue on much better terms. They often trade in relation to UK government bond yields and if we look we can see that out ten year bond yield was 3.9% when Alistair Darling made his statement but 2.33% when George Osborne made his. So there had been a substantial change for the better.
So here the policy is confused. I heard the Conservative Party Chairman Francis Maude say on radio five live that this policy would help small businesses. Unfortunately the minimum size for a corporate bond excludes them! Do keep up Francis!
However reading between the runes let me give a suggestion which is that we need a corporate bond market for smaller companies than is available now. If the government wishes to encourage this then I support this wholeheartedly as it gives them an alternative source of finance. Perhaps there could be joint loans and some securitisation but a lot of care is needed here as problems in this area helped cause the credit crunch! However it will never be viable for the smallest. So Francis Maude’s suggestion needs to create a market first….
Problems with such a policy
1. We can see that there is a theoretical problem that the larger and maybe some middle-size corporates are doing okay and maybe quite well out of the current system. They account for the bulk of the £180 billion or so of UK Corporate Bonds.
2. For the smaller companies which are likely to need more help we need to create market first and for this to be viable it needs government help at least initially. But then the government must step away due to the moral hazards in its involvement with the risk that the programme withers on the vine. Also this will take some time and is unlikely to be of much help for a year or two.
3. Since I analysed the February 2010 proposals much more evidence has emerged on bad debts at quasi-governmental institutions and central bank programmes and I am afraid that the evidence is bad. A loan organisation like this would have similarities with Fannie Mae and Freddie Mac the US mortgage companies and they have had real problems in this regard. The Bank of England has had real problems with loan securitisations- which lest we forget is part of this proposal- and called one group of them “phantom securities” i.e it felt the woll had been pulled over its eyes. I believe this is one of the reasons it has rushed to end the Special Liquidity Scheme which tightened credit conditions for the banks.
4. There is the implication in the programme that civil servants will be involved in the loan/securitisation process and here we hit the danger of them attempting to “pick winners”. They have little skills in this regard (politician’s have even less usually..) and in genral pick losers. Older readers will remember the shocking record of the National Enterprise Board in this regard and the admittedly beautifull but commercial failure that was Concorde.
5. In these times there is enormous pressure for green industry and this combines most of the problems above. Politician’s will love to take the credit for such initiatives and as they are professionally gullible many will turn up to take the money and create an enormous moral hazard. In the United States real problems have emerged with such programmes where a sloar panel manufacturer called Solyndra has recently collapsed after recieving Federal loans.
Ironically Adam Posen highlighted the biggest danger to his own proposal in his speech.
First, as we know, a lot of what was termed ‘investment’ during the boom years was misallocated wasted capital.
In essence “misallocated wasted capital” is the danger going forwards for his suggested policy.
Two utter fantasises expressed in support of this policy
This phrase seems to forget that we are supposed to have an independent central bank. I do not think it is independent any more as I think that Quantitative Easing crossed the rubicon with fiscal policy. If the government agrees with this as they are now implying they should scrap the Monetary Policy Committee which they have just defined as a QUANGO without use!
It is neutral with regards to fiscal policy
The illogic displayed here is to claim that because there are assets against the borrowing it does not really count. Unfortunately for this argument you could exclude capital investment on such a basis and maybe on better grounds. Which is odd as they are cutting that as a way of reducing our fiscal deficit….
So frankly it is rubbish even on their own terms.
Did the accelerated withdrawal of the Special Liquidity Scheme cause the problems this hopes to fix?
I put this question in becaus elest we forget government schemes give with one hand and take away with another. The speeded up withdrawal of the SLS is at least a partial cause of the lack of bank lending. I pointed out the dangers of this on this website back in December 2010 here http://www.mindfulmoney.co.uk/2732/economic-impact/the-bank-of-england-will-make-it-harder-to-get-a-mortgage-in-2011.html.
I was thinking then more of mortgage finance than loans to small buisnesses but the withdrawal of up to £185 billion seems to have had an impact in a lot of areas and frankly with the withdrawal of that amount of money it is no surprise.
I want to approve of the plan above because I think that some help for our smaller businesses is needed. However there are loads of pitfulls and the journey from February 2010 to now has highlighted then. Accordingly I am less of a fan than I was and I fear the money will be driven into the wrong areas.
I remain convinced that the best route is to reform our banks and get them back to proper banking rather than being zombies in some banking remake of the Night of the Living Dead! Here are my thoughts in this area from last week. http://www.mindfulmoney.co.uk/wp/shaun-richards/a-plan-for-reforming-the-uk-economy-start-with-the-banks-right-now/