The Parable of the Unforgiving Banks?

In the news today, the banks the UK government have been bailing out and providing emergency loans to are reportedly being less than helpful when small businesses approach them for loans, and the UK Chancellor and the Business Secretary are unhappy about it. An odd thought popped into my head that this sounds rather like an old parable playing out in real life (though I can't really imagine the UK government changing its mind about rescuing the banks). But I can just imagine Alistair Darling thinking "Maybe I should ask the Archbishop of Canterbury to pop round to RBS and have a word".

Credit cycle

George Osborne made a speech at Harvard about changing the way we control the economy.  For the last decade or two, the UK and US have tried to control the boom-bust cycle by using one lever (interest rates) to try to control one variable (retail inflation).  When retail inflation goes up, the governments raise interest rates to bring it back down again.  But, Osborne says, there has been a second, hitherto ignored cycle: house prices ("asset inflation") and credit.  House prices and consumer debt has risen while inflation has remained low, and now the credit crunch is in a sense a credit-led-bust rather than an inflation-led-bust.  Osborne suggests trying to control this new credit cycle by controlling how much money banks are allowed to lend as a ratio of their assets.

Osborne seems to have missed a more general point: the credit cycle is partly an artificial problem.  It is precisely because the government (actually the Monetary Policy Committee) frequently changes interest rates that we get credit booms and busts.  The mortgages that are in trouble in the UK got into trouble because of six consecutive interest rate rises.  And the rush for credit was caused by so many interest rate reductions in the years beforehand.  If interest rates were generally constant, it would take a lot of the speculation out of the property market, and house prices would have a chance to settle at a level and growth rate that is determined much more by supply and demand.  Constant interest rates would remove the "fear of missing the boat" that when interest rates are lowered and house prices skyrocket, a house that is nearly affordable today will be far too expensive tomorrow.  And they'd remove the terror of negative equity from house price crashes when rates rise.  It is those sentiments that drive the booms and crashes in the property market.

It also strikes me that for controlling retail demand (in order to control retail inflation), interest rates are a very inefficient and inequitable lever to pull.  They disproportionately affect the people with the biggest mortgage-to-salary ratios (ie, first time buyers), and have fairly little effect on almost everybody else.  Renters don't see rent rises until six months to a year later, and those who have had mortgages for a long time have a much bigger cushion because inflation and career growth have raised their salaries compared to their repayments.

Surely rather than having a massive effect on just a few people, the lever to pull to control retail demand would be one that effects every consumer, not just homeowners with large mortgages?  Perhaps sales tax (VAT) or by varying part of income tax (which could be reflected in the PAYE system very quickly allowing short-term changes)?

Just a thought

Northern Rock nationalised – what an opportunity

The government is going to nationalise Northern Rock, but the opposition think this is a "disaster" and takes us "back to the policies of the 1970s".  

I think it's a fabulous move, and a very capitalist one.  The difference between the 1970s and now is that in the 1970s, the government felt it needed to own industries as a whole and there was no private competition.  In the 1980s, the government changed plan and backed off industry entirely, relying just on regulation and competition.  I think now there's an opportunity to realise that governments can do something slightly more than just regulation: they can get their feet wet in the market and be competition.

What would this do for the everyday citizen?  It's a very effective way of ensuring consumer minimum standards in an industry – much faster than regulation, and potentially more effective.

For example in Australia there is a problem with bank fees – not just for overdrafts, but just for accessing your money.  And these bank fees, as always, hit lower income earners hardest.  The Australian government would have a hard time pushing through regulations to outlaw bank fees – there would be law suits for judicial review complaining loudly that it's "not a viable commercial model".  But what if the Australian government still owned a bank (it used to own the Commonwealth Bank), and told it not to charge bank fees?  The private sector, just to compete for customers, would have to drop their bank fees too.  And by running a profit-making non-fee-charging bank, the government would prove that it is a commercially viable model.

Competition can be more effective than regulation, but if the public wants to drive the industry in its direction, then the public sector has to get its feet wet.

And now that Northern Rock has had to be nationalised, I hope the UK government will realise just how useful it could be to them.