Sunday, October 05, 2008

Brown's choices: City, Banks, or Homes?

Germany gives 100% guarantees on banks deposits.

So – decision made. All European countries will almost certainly have to follow suit. To retreat from that position would cause marked dissatisfaction in Germany, Greece and Ireland, and weaken public confidence in the security of the money system.

So Europe’s governments are going to have to guarantee bank deposits. Which does not leave governments with much money to give to the City of London, should it suddenly discover itself short of funds - “difictiveliquidsquidity” as it is known in the difficult to memorise technical jargon of the financial marketeers.

Gordon and his darling are both intoning a mantra:

“We will do whatever it takes to maintain economic stability, to protect people and banks”.

I personally read that as a promise to do a £multi-billion City bailout if necessary.

It seems to me that he can either guarantee the people’s bank deposits, or he buy up the toxic debt the City. He cannot do both. Surely not?

So he has a choice. I think it is best to leave the City to market forces, and guarantee the banks.

Meanwhile, back at the Bank of England…a different, but related, choice is building up with increasingly loud calls from the Federation of Small Businesses, and assorted academics, for interest rates to be lowered, in order to get the real economy to pull out of recession.

If interest rates are low, it is easier to afford loans, so money flows out into the real economy, activity builds up. But there is a risk of inflation if money exceeds the amount of goods and services created. The problem is – banks are in any case reluctant to lend, especially at low interest rates.

The Bank of England wants to inhibit inflation, so wants interest rates kept high, which means more bank profits, which would puff a little money into the gaping hole of dodgy debt in the swirling depths of the financial system.

Brown and Darling are between a rock and a hard place. That is the problem with only having interest rates as a means of controlling bank lending – it does not work in conditions of stagflation, which is where we are in all probability headed.

Lending should have been controlled also with tighter capital requirements , which control the amount of money have to back the loans they hand out. These controls were cast away in the name of the free market. Result: banks are undercapitalised.

For Governments to guarantee all bank deposits is brave but potentially expensive. Brave promise, kept with difficulty. Better call than trying to save the City, in my opinion.

It seems to me that since the fall in asset value of the loans that banks lent out on houses is one of the major triggers for the slow-motion financial disintegration that we are experiencing, then the Government should pass a Right to Rent bill, which would see to it that home-owners who cannot repay their mortgages can convert to an affordable rent. By taking over the mortgage, the government is renationalising the housing stock, investing in housing, which makes good sense in green economic terms. As with all economic interventions, the ramifications will have to be studied, and unintended consequences guarded against. In the end, buying up the houses seems common sense.

The principle here is – direct state money at the real economy, where money does an honest days’s work. You can make a lasting difference here, Darling. Trying to bail out the City is like p*ssing into the wind.

No comments: