Britain needs to do more to get its banks lending again, says the Organisation for Economic Cooperation and Development (OECD).
Despite the nationalisations and the recapitalisations and the interest rate cuts, they just aren’t pumping enough money into the economy yet.
There’s just one problem. Where’s the money going to come from?
Banks aren’t lending enough
The OECD has warned Britain that it needs to get its banks lending again, or face a fresh slump. “It is essential that the supply of new lending is not held back any longer by banks with insufficient capital to meet losses associated with past lending.”
The OECD’s concerns are well-founded. Net mortgage lending in May rose by just £324m. That’s the smallest monthly increase on record (the data begins in 1993), and was about a third of April’s rise, much lower than the City had expected. Meanwhile, approvals for new loans were little changed month-on-month, at 43,414, although that was up 10% on the year.
Worse still, lending to businesses is still falling, declining by 0.1% in May, after a 0.3% fall in April. As Chris Dillow recently pointed out in Investors Chronicle, lending to businesses is one of the most critical elements to the economy’s long-term health. A paper by researchers associated with Tilburg University suggests that bank lending to households has no significant impact on long-term growth, but that increased lending to firms is associated with increased long-term GPD growth. As Dillow puts it: “There might be votes in stimulating mortgage lending… but this is not the source of long-lasting economic performance.”
Those pesky banks. We give them our money and support and fund their bonuses (whether we like it or not), yet they won’t lend to us. However, it’s not as simple as all that. As David Wighton points out in The Times, “analysts at KBC Peel Hunt estimate that UK banks are already advancing 85% of the volume they lent from their own balance sheets at the peak of the markets.”
Hold on. If banks are lending at almost the same levels as last year, then what’s the problem? The key point to note here is, “from their own balance sheets.”
The trouble is, much of the money that inflated the housing bubble and the credit bubble in general wasn’t sitting on banks’ balance sheets. It was hiding off balance sheet, with the money provided by the wholesale markets. It seems a long time ago now, but what brought the likes of Northern Rock down was its reliance on borrowing money in the wholesale markets to write mortgages which were then parcelled up and sold on to investors. But that source of lending has pretty much dried up.
Enjoying this article? Sign up for our free daily email, Money Morning, to receive intelligent investment advice every weekday. Sign up to Money Morning.
Where’s the money going to come from?
So where’s the money going to come from? The answer to this question in recent years has largely been – the government (or as we prefer to describe it, the taxpayer).
But the government doesn’t have any money either. Britain’s budget deficit will hit 14% of GDP by 2010/11, reckons the OECD. To put that into perspective, about 3% is generally seen as being on the edge of the comfort zone. The trouble is that foreign investors are noticing this worrying fact. In the three months from March through May, foreigners sold a record £22bn worth of gilts (UK government debt). Who did they sell it to? Well, the Bank of England of course, through its quantitative easing programme whereby it has pledged to buy £125bn of gilts in total.
But the Bank’s current batch of QE is set to come to an end fairly soon. And if the Bank stops acting as the buyer of last resort, then interest rates might be forced higher to attract foreign investors, “without whom the funding arithmetic looks impossible to meet”, Michael Saunders of Citigroup tells The Times.
The other solution of course, would be for the government to announce “more explicit” spending cuts, as the OECD puts it, and also tax increases. Yet, Gordon Brown is having none of it. His latest re-launch consists of some insipid catchphrase about ‘building Britain’, and lots of incoherent policies, and no idea at all of how it’s all going to be paid for. Indeed, Labour’s whole strategy right now seems to involve positioning itself so that it can attack “Tory spending cuts” come the next election. And they don’t seem to care if they ruin the country in the meantime.
Why the recession is nowhere near over
It’s hard to see how banks can be forced to lend more against this backdrop – particularly as they are still waiting for the worst of their dodgy debt problems to reveal themselves. And that suggests that the recession will go on for longer than the optimists hope, and the ‘recovery’ won’t be a “V-shape”, but more of a long period of stagnation.
As we’ve mentioned before, this is one of the reasons that for the long term, investors should be looking to emerging markets, rather than those in the developed world, particularly the UK and US. You can read more about this in my colleague Cris Sholto Heaton’s free weekly MoneyWeek Asia email – read the latest issue: Why Asia doesn’t need exports to grow.
Our recommended article for today
Three defensive stocks to buy now
As the stock market rally falters, it’s time to get re-acquainted with the world of inflation-beating defensives, says Theo Casey. Here, he picks three stocks to hide behind.