UK Guardian: Policy response to financial crisis wrong

In a column by its editors discussing why the Funding for Lending Scheme has failed, the Guardian exposes why the entire policy response to the financial crisis has been wrong since the very beginning of the crisis.

The problem with the government's funding for lending scheme – and indeed its entire strategy for growth – can best be expressed in an old cliche: you can lead a horse to water, but you cannot make it drink. 

With its policy of monetary activism, the coalition has concentrated on laying on the H2O of credit.

Please re-read the highlighted text as the justification used by each of the western governments and Japan for bailing out its banks was to preserve their ability to extend credit.

Regular readers know that this justification was built on a number of false assumptions.

One false assumption was that banks had to have capacity on their balance sheets if they were to be able to extend the credit that the real economy needs for growth.  Your humble blogger has documented why this is assumption is wrong.  The simple fact is that lending and funding for loans are completely separate as for at least the last 4 decades banks have had the alternative of selling the loans that it originates to buyers like insurance companies and pension funds.

The Guardian editorial focuses on a different false assumption.  It focuses on the assumption that there is a great unmet need for credit in the presence of an economy facing a major shortfall in demand.

Ministers have exhorted banks to lend, the Treasury has signed up to the Merlin agreement with financiers – as well as encouraging the provision of £375bn of quantitative easing and the £80bn scheme of funding for lending. 

These wheezes have cost hundreds of billions of pounds and taken up months of policymakers' time – and the net result has been sorely disappointing....

They have been good for banker bonuses though as they have enhanced bank profitability.

Faced with a major shortfall in domestic demand, he has depressed demand still further by laying out the biggest programme of spending cuts ever seen in peacetime Britain. 

And to spur growth, he has relied instead on trying to offer as much credit as possible. Put another way, an unthirsty horse has been offered gallons of surplus water.

Please re-read the highlighted text as it nicely summarizes why the response to the financial crisis has not worked to date (even when there was some stimulus as in the US).

Going by reports this week, Mr Osborne will next week announce yet more policies to boost lending to small and medium-sized businesses; perhaps by more closely targeting the funding for lending scheme administered by the Bank of England. 

This could once be chalked up as foolishness, but now it surely goes beyond that – it is wilful, damaging blindness on the chancellor's part....

Willful, damaging blindness about the ineffectiveness of the policy responses to the financial crisis that began on August 9, 2007 are not limited to the UK's chancellor.  This extends across countries and central banks.

As a group, they choose to implement the Japanese Model that Japan deployed for handling its bank solvency led financial crisis.  As a group, they apparently believed they would get a different result than  a Japan-style economic slump.

As a group, they are unwilling to admit that their experience parallels the Japanese experience and they have pushed their economies into a Japan-style economic slump.  A result predicted by your humble blogger.

One of the reasons that your humble blogger has advocated for adopting the Swedish Model for handling a bank solvency led financial crisis is that it avoids the Japan-style economic slump.  It does this by requiring the banks to recognize upfront all the losses on the excess debt in the financial system.

As a result, the burden of servicing the excess debt is not placed on the real economy where it would divert capital needed for growth and reinvestment.

But it must surely be evident by now that the main problem is not the lack of loans available to firms; it is that businesses do not see the growing markets or buoyant economy that would justify them spending and borrowing to invest.

The chief executives and managing directors can hardly be blamed for this: as Tuesday's industrial production figures and bleak forecasts from the National Institute of Economic and Social Research indicate, the economy is still stuck in the doldrums. 

While this remains the case, the government's focus on credit is misplaced.

The Guardian editors have eloquently summarized the current state of the global economy and why the policy response to the bank solvency led financial crisis was and still is wrong.