Fixing 'zombie' banks is the key to economic recovery

In his Telegraph column, Liam Halligan discusses that it is time to abandon the 'absurd growth versus austerity debate' because the key to economic recovery is fixing the 'zombie' banks.

In making the case for fixing the banks, like your humble blogger, Mr. Halligan shreds a number of myths about the economic and financial reform policies being pursued.

For all the “austerity” rhetoric, we’ve actually seen little overall spending restraint. Public sector net borrowing during the financial year to last month was £65.1bn, almost £3bn higher than the same period last year, according to official data released on Friday.... 

this country will borrow a massive £120bn during the current financial year, with the outstanding stock of government debt set to triple between 2008 and 2015/16.... 

For all that debt must be serviced, with the spiralling interest payments detracting from spending on schools, hospitals, defence and the other public services our country obviously needs.

Ministers claim that financial markets are “rewarding” the UK by demanding only low yields when lending the government money. I so wish that were true. 

For it is only the virtual money-printing that we’ve seen on an unprecedented scale – a grotesque, kleptocratic policy, which is storing up untold future problems – that has prevented a catastrophic creditors’ strike....

Our paltry growth, though, has little to do with “austerity” – as the Office for Budget Responsibility confirmed in a little-noticed report last week. The UK economy is so weak because household consumption is stagnant, in part because real incomes have fallen amid stubbornly high inflation. Growth is low because investment has stalled and exports have continued to disappoint.

There is this horrible circularity in the economic and monetary policies being pursued.  The UK, like the US, is experiencing an explosion in sovereign debt that is being driven by the economic and monetary policies being pursued.

The unprecedented money-printing has kept interest rates low.  This in turn has triggered the Retirement Plan Death Spiral.

When retirement plans, both individual and pension, do not generate the expected earnings on their assets, the earnings shortfall needs to be covered.  Individuals cover it by reducing current consumption.  Companies cover it by diverting funds needed for reinvestment in the real economy.

Covering the earnings shortfall deprives the real economy of the demand it needs to grow.

This lack of demand is then used by the government to justify more quantitative easing and fiscal policies that oscillate between stimulus and austerity in an endless doom loop (see Japan and 2+ lost decades).

Above all, growth is low because bank lending continues to sharply contract, with the UK’s banking sector still denying finance to millions of creditworthy households and firms. 

This is the biggest and most damaging vested interest of all that ministers have failed to take on – namely, our moribund, zombie banks. 

The UK’s political leadership is relying on deeply damaging policies such as “quantitative easing” and the odd half-hearted “scheme” to boost growth. But no amount of QE, and no other “eye-catching initiative” will allow the British economy to get back on track until the banks are restructured and the enormous losses that lurk on unaudited parts of their balance sheets are written-off. 

“I’m the Chancellor in a government that has done more to reform finance and banking than any before it,” George Osborne said at the recent Conservative Party conference, citing the Vickers Commission and the “ringfence” that will be established within the UK’s financial monoliths to separate investment and commercial banking. 

It was the co-mingling of such activities, with bonus-fuelled traders gambling with ordinary punters’ deposits, while enjoying an implicit state guarantee which, more than anything else, caused the financial mess we are in. 

It strikes me that Osborne’s claim to have “reformed” the banks is a long way from the truth. Last week, Paul Volcker, the former Federal Reserve chairman who has fought to introduce a full “Glass-Steagall” separation of investment and commercial banking in the US, a fight he could yet lose, gave his verdict on the UK’s reforms. 

The Vickers ringfence is “full of holes ... that are likely to get bigger over time”, said Volcker. “The concept that different subsidiaries of a single commercial organisation can maintain total independence either in practice or in public perception is difficult to sustain.” 

Oh – and the Vickers measures won’t be binding until 2019, giving our vociferous banking lobby plenty of time to water them down even more.

This is a very important point:  the focus of bank reform has been on complex rules and additional regulatory oversight.  Both have been shown not to work.

Complex rules do not work because the banks use the loopholes in the rules to neuter the rules.  Glass-Steagall was repealed because the banks had found so many ways around it that they had essentially rendered it ineffective.

Regulatory oversight does not work because regulators themselves are prone to industry capture.  This capture can be top down (banks influence politicians) or bottom up (the revolving door).

In addition, there is an overlay of regulators failing in their primary responsibility:  making sure that market participants have access to all the useful, relevant information in an appropriate, timely manner so they can make a fully informed investment decision.

There is a role for regulators assessing the risk of the banks so as to protect the taxpayers through their exposures to the banks through the deposit guarantee.  However, this role does not require the regulators to be the only market participants with access to all the useful, relevant information.

In fact, the regulators could do a much better job of assessing risk, it they let the markets' analytical resources help them by requiring the banks to provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.

This coming Thursday, the Office for National Statistics publishes its preliminary estimate of UK growth between July and September. If these third quarter numbers confirm that Britain is still in recession, and even if they don’t, their publication will mark the start of yet another chapter in the absurd “growth versus austerity” debate. 

That discussion is based on a false dichotomy and is anyway a diversion from the real issue. For the only way genuinely to fix the UK economy is to fix the banks. I’ve said it before and I’ll say it again: there really is no alternative.

Mr. Halligan makes a very important point that applies not only to the discussion of "growth versus austerity", but also to the discussion of financial reform.  To date, it has all been a diversion from the real issue:  fixing the banks.

This is no surprise as it reflects the original choice to pursue the Japanese Model for handling a bank solvency led financial crisis and protecting bank book capital levels and banker bonuses at all costs.

Were the Swedish Model for handling a bank solvency led financial crisis to be pursued, not only would the banks be fixed, the economy growing, social programs protected, but, we would set in place the few necessary financial reforms to reign in both banks and regulators and prevent a future financial crisis.