Savers lending to the banks

Dear readers…another post on the broken banking system…This time on the Guardian’s ‘Comment is Free’…..Below you will find my version. And at the Guardian, the edited version…..

Public discourse, cheered on by the BBC, amplifies George Osborne’s assertion that the deficit ‘is like a credit card’. That cuts in government spending are needed to reduce the deficit.

If only.

If only government deficits were like our own. To pay down a credit card may require no more than a cut here and a tightening of the belt there. Perhaps we might supplement our income, with a part-time job. But with cuts and additional income, it is possible to regain control, and pay down that card.

Not so for government deficits. They cannot be managed like that.

Believe it or not, the now all-powerful UK Treasury cannot cut the deficit.

Those axe-wielders can only cut government expenditure.

Whether or not the budget deficit comes down, depends entirely on how the rest of the economy reacts. If confidence falls, private investment stalls along with cuts in public investment; if public and private sector unemployment rises, then government tax revenues will fall, welfare payments will rise – and the deficit will soar.

Regardless of cuts in child benefit or defence spending.

That is why the ruthless determination of the Treasury to inflict pain on the poor, on women and children, on the middle classes, quangos and the army, is so poignant to watch.

For it may all be to no avail.

And that is why the debate is not between deficit cutters and so-called deficit deniers.

It is between ‘cutters’ and ‘spenders’ – between spending cuts and fiscal stimulus.

‘Cutters’ believe they can bring down the deficit by slashing government spending. ‘Spenders’ know that cuts cannot do it. Only by the public sector stimulating the private sector, can we reduce the deficit.

But this leads us to the elephant that looms in the hall of public debate, but is widely ignored.

The broken financial system.

The fact is: it is the banks that are broken. Not government.

Think of the economy as a three-legged stool. One leg is public sector investment. The second, private sector investment and activity. The third, the banking system which oils the wheels, so to speak, of the first two.

The banking system exists to serve the real economy – but has been shattered by the theories of neo-liberal economists.

As a result of liberalisation (including the 1971 Competition and Credit Control Act) the system as a whole has been burdened by bad debts and is effectively bankrupted. Banking debts worsen with every personal and corporate bankruptcy, every US home foreclosure (and there were more than 100,000 last month); and with the now inevitable fall in UK house prices.

The consequence is evident everywhere: in the hoarding of cash by bankers; in their failure to lend to the private sector for investment in economic activity. In the way pensioners, savers and taxpayers are lending to the banks – at what for some, are negative rates of interest.

In a truly bizarre twist, the banking system has become a borrowing machine, not a lending machine.

Rather than serving its purpose of lending to the real economy, the banking system is leaching wealth – from taxpayers, savers and entrepreneurs.

According to the Bank of England’s June Financial Stability report, in terms of balance sheets, the UK private sector is repaying more to the banks than the banks are lending. Over the past five quarters net lending was positive only once. The latest quarter showed the highest repayment of lending on record. If repayments by other financial corporations had been included, the position would be much worse.

In other words – pensioners, savers, companies, households and individuals – are lending to the banks.

It’s the economics of the lunatic asylum.

It gets worse. For the banks have chickens coming home to roost – known in the jargon as the ‘funding gap’ or ‘funding cliff’. According to the Bank of England’s Financial Stability Report in June, banks need to refinance or replace around £750 billion to £800 billion of term funding and liquid assets by end 2012. That implies they need to raise over £25 billion every month for the next two and a half years. This is much more than the £12 billion monthly average raised so far.

A banking system burdened by bad debt and liabilities, with a funding cliff looming; a system that is a borrowing machine, not a lending machine – is one based on the economics of the insane. And yet economists – and politicians – have nothing meaningful to say about this failure of economics, and of institutions designed to underpin the real economy.

Instead economists, politicians and Treasury officials engage in a form of displacement activity, fiddling with child benefit and quangos. All the while the private sector, instead of doing the government’s bidding and investing in economic activity, lends to the banks, and, starved of affordable credit, contracts its own activity.

Because of the failure of the banking system, the private sector will not be stepping in to compensate for the Osborne cuts. As a result, expect the budget deficit to rise. Pensioners, depositors and savers will continue lending their precious savings to bankers earning bonuses – in return for derisory rates of interest.

And while this is happening, all eyes are on the innocent mouse that is child benefit.

It’s economic madness.

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12 comments to Savers lending to the banks

  • “Economic madness” has been established to cover what central bankers and their buddies are doing with their ‘noses in the trough’.

    Hence the purpose of the national debt is NOT to be paid off, but to keep ensuring (vested) INTEREST payments.

    The fact that this erodes the value of the currency SUBSTANTIALLY is ‘written off’ under ‘why should we care as long as we get away with it’, it seems…

    Sighingly yours,

    Sabine
    Organiser, Forum for Stable Currencies
    http://forumforstablecurrencies.info

  • larry brownstein

    Ann, Economics of the madhouse it is indeed. And Wednesday will be public observation day. I think I’ll need a strong tranquilizer in order to “calmly” watch the socio-economic system being destroyed. By ignorance and vested interests. The historical examples we have show that austerity not only doesn’t work, it makes the situation worse.

    I was more than a little shaken when I saw Cable’s hands tremble as he sat down after trying to defend the indefensible. His contention that the Lib-Dems are now in the “real world” should be no news to him, yet he presented this as a kind of sudden awakening as if from a deep sleep.

    Unlike Alexander, who is nothing more than a chancer, I don’t want to think that Cable was lying intentionally, as opposed to having convinced himself of the truth of what is, as the evidence indicates, a falsehood.

    And in terms of the mortgage foreclosure scandal in the US, a great deal of fraud is involved, as it was in the securitization bubble itself. And hardly anyone is being prosecuted. This should occasion no surprise, as those at the center are those best situated to protect themselves, especially with the connivance of certain of their “associates”.

    Just as Powell liked to compare Blair with Machiavelli (wrongly in my view), there seems to be something Borgiaesque about what is going on before our very eyes. The question before us is: What is to be done?

  • Joe Smith

    The key points in your comment are ; “There is an elephant in the room. This is the broken financial system. It is the banks that are broken, not government”.

    This message needs to be repeated again and again. One hopes that somehow, in ways we cannot currently predict, this whole ghastly monetarist nightmare will self-implode.

    What does Gordon Brown think of all this? He jetted round the world, and personally and politically broke himself, to help save the world financial system. Yet now the banks are still strutting round, showing no remorse for the mess that have created for all of us.

  • Ann

    Thanks guys – and gal! Good to have you back Larry…have missed your comments and tips. Let’s organise not agonise…..I am talking to a group of economists about setting up a new think tank…to major on macro-economics. If I have to ever again hear a micro-economist – Tim Harford and those chaps at the IFS – comment in an illiterate way on the macro-economy; or if a politician ever again declares that the British economy is ‘like your credit card’ think it would drive me….to do something serious about counter-balancing their misleading, and at times dishonest, interventions in public debate.

  • Brian P. Smith

    I really wish you would do something serious, Ann. I am getting really fed up with all the talk of “having to reduce the deficit” as if there were no other way. They all seem to imply that unless we appease the “bankers” and “investors” we are doomed. What they are really saying is that these people who risk other people’s money by gambling on shares rising or falling are actually the ones who dictate our fiscal policies!

    Why don’t they have the guts to stand up to them and say, “We are going to do what is in the best interests of our economy and if you choose to withdraw your investments, so be it!” Yes, we do need investments, but I actually believe there are people out there who would be only too willing to get involved, to invest in British industry, if only they had the opportunity. People for whom the motive is not making a fast buck, but helping our country, creating jobs, making a difference for others. Not lining their own pockest, which is what the bankers seem to be doing, regardless of the effects on the rest of us!

    [and yes, I am angry!]

    So come on, Ann. Stand up to the system and tell the rest of the country just how they are being fooled. PLEASE!!!

  • Jeffrey Lam

    Hello Ann
    I was wondering what you thought about ecotricity’s move to issue “EcoBonds” (“Invest in Green Energy and cut out the middle man [the bankers]”) to the general public. It seems the King of Shaves did a similar thing last year with their “Shaving Bonds”. It seems that perhaps some companies are “cutting out the middle men” and seeking financing directly from the public.
    If this is a trend that continues, perhaps we may not need the banks as much?

    Regards
    Jeff

  • Ann

    Jeff…I think its wonderfully subversive. However, the worry is this: at what rate of interest? If they are to attract savers…it will have to be high. But for investing in risky ventures it should be low…For me that is the dilemma…in a world in which commercial rates of interest are not regulated, but set by the British Bankers Association effectively….having low repayable rates for green ventures would be vital.

  • Jeffrey Lam

    ecotricity are going to pay 7% interest (7.5% to its customers). So for savers it is far better than any savings account, of course subject to risk. The company implies in recent interviews that this is the rate that it will likely be paying on a bank loan anyway.
    All the above being true, that would mean the savers would reap most of the benefit, while the company pays more-or-less what it would be paying anyway.
    Admittedly, ecotricity could probably achieve even more with a lower rate of interest (and with less risk). I believe that is the point you are making isn’t it?

  • Ann

    Jeff,

    Thanks for this…7.5% is an incredibly high rate of interest, at a time of debt-deflation…It’s surely going to break ecotricity at some point…True that it is probably less than a bank loan, that does not make it repayable. And yes, I making that point..they could be bolder and more innovative, if they were not boxed in by this repayment rate…if they make more than 3% a year, they will be lucky..if they make less, the rate will be a mill around their necks…

  • Alastair McCallion

    I’m no economist & I’ve only just discovered your site, so forgive me if the questions I ask are those you’ve already dealt with elsewhere. I, too, find the foghorned outpourings of IFS & others (you call them micro-economists) frustratingly unhelpful, indeed obfuscatory. But I also have a gut feeling that a purely Keynesian approach to our current crisis cannot be the whole answer. You have explained (to Jonathan Freedland) how banks create new money by lending “out of the ether” as it were, &, as I understand it, your prescription is to get the “three-legged stool” level again by increasing government expenditure (not cutting it), getting the private sector to invest & increase its activity & the banking sector to create the money to (forgive the metaphor mix) get those wheels turning. If that’s a fair summary, at least two questions arise immediately: firstly, how can the banks be persuaded or coerced to do the necessary; secondly, how can the banks be regulated to ensure we, the ordinary punters, do not again have to fill in whatever hole the banks dig?

  • Jeffrey Lam

    Hello again Ann,
    your comments made me go away and look at their accounts in more detail (I had been considering investing in ecotricity’s bonds myself).

    Ecotricity have made their accounts for the last five years available here: http://www.ecotricity.co.uk/ecobonds/financial-performance/our-accounts

    In particular, I was trying to establish a link between the capital expenditure one year and its subsequent increase in revenue the following year. Unfortunately, the five-point plot does not appear linear, but the wonder of spreadsheets allows me to plot a linear trendline nonetheless.

    Anyway, my rudimentary calculations suggest a 45p increase in revenue for every pound of (net) capital expenditure. Using their average operating profit margin over the five years of 13%, that means about 6p of operating profit for every pound of capital expenditure. Estimating their bottom-line net profit is more complicated because it involves tax and interest calculations. (But their net profit averaged 4% of revenue over the last five years, and pointing to 1.8p net profit increase for every pound of capital expenditure)

    A couple of points we didn’t discuss earlier was the size of bond issue relative to the size of the company (though I admit they are probably issuing the bonds because they don’t have that money sitting around), that these bonds are unsecured (though I admit it is not normal to issue or buy bonds on the assumption of default), or that the (private and wholly-owned) company follows a “not-for-dividend” model: re-investing all profits back into building renewable energy, and therefore not having to worry about paying out dividends to shareholders.

    Finally it does appear that they can meet the interest payments of the bonds out of their existing net profits.

    That said, I can see that it certainly would be much, much easier with a lower interest rate.

  • It doesn’t look as if this financial crisis is over by a long shot

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