Why £20 Billion is not enough

By Rachel Reeves

In my Fabian Review article “Why £20bn is not enough” and at Saturday’s Fabian conference session “Fairness in a Recession” I argued that although government action to date was welcome, more would be needed to pull us out of this recession. Specifically, measures to get banks lending again, greater use of government spending, support for the mortgage market and quantitative easing.

So, I welcome today’s intervention to support lending. Action was urgently needed to help support businesses and families who can’t access credit and so will help keep people in work and in their homes.

Recapitalisation in October gave banks the capital they needed to shore up their balance sheets – and it was hoped it would boost bank lending. But the global economic situation has worsened since then. Banks are so worried about their bad loans that they are not willing or able to lend, fearing the capital they have as a share of their (risk-weighted) assets will fall to unacceptable levels and the markets will lose all confidence in them. So, banks are hoarding the cash they got from government instead of lending, even to good customers.

The government is clearly frustrated with the banks. One reason the October bailout hasn’t increased bank lending as needed was because of the banks’ reluctance to face up to their losses. We need banks to be honest about the extent of their exposure to bad loans. Without this it is difficult for the government to know how much it needs to do to get us out of the crisis, which was caused by banks taking on unacceptable risks in the first place

The new scheme basically says, we will guarantee new, high quality, business including mortgages and corporate debt, so it won’t add to your loan position. So, it has a real chance of re-starting bank lending which is critical for economic recovery – enabling businesses and families to access credit again. But banks will have to pay for the insurance, so it is not a blank cheque – the banks have an incentive to check all new borrowing.

Moreover, today’s announcement includes extra time for state-owned Northern Rock to pay back government loans so it focuses on lending to customers – consistent with government priorities. And, the rescue package for Royal Bank of Scotland includes a commitment by that bank to lend an additional £6bn in return for its bail out (taxpayers will now own almost 70% of RBS). Other banks may still follow the nationalisation route in the days and weeks ahead as shares take a further battering – right now RBS shares are down 60% and Lloyds 30%.

Also welcome in today’s package is the £50bn for the Bank of England to buy up assets directly from (non-financial) firms – for example corporate bonds. So, some firms will now by-pass the retail banks and borrow straight from the centre. This is another step towards quantitative easing which would mean the Bank of England creating a new line its own balance sheet to directly purchase government and corporate bonds. As argued previously (see here, for example) quantitative easing will bring down interest rates on a wider range of assets over longer time horizons and will directly provide cash to businesses and government. The Bank of England will no doubt start using this facility before long as interest rates head to zero and risks of deflation increase.

Today’s actions, like October’s bailout and November’s PBR would have been unimaginable at any other time since we came to power in 1997. But, the government is right to be radical and to constantly revise the policy approach – no one knows what it will take to get us out of this global crisis, the risks are that we do too little. We can’t afford to leave any stone unturned to provide real hope for now and to begin putting down the building blocks for the future.