Streetwise Professor

July 28, 2009

Vladimir Darling

Filed under: Economics,Financial crisis,Politics,Russia — The Professor @ 4:50 pm

No, I haven’t succumbed to the Stockhome Syndrome and begun to love Vladimir Putin.  (And anyways, if that were the case, I would have written “Vladimir, Darling.”)  No, what I mean is that UK Chancellor of the Exchequer Alistair Darling is doing his best Putin imitation, and trying to browbeat banks into lending:

Ministers have warned Britain’s banks to increase the supply of affordable loans to businesses or face the threat of a competition probe if evidence of market failure emerges.

Alistair Darling, chancellor, has ordered ministers to hold a series of one-to-one meetings with bank chiefs through August to establish whether margins and fees have risen excessively on loans to small and medium-sized companies.

The bosses of seven big banks were yesterday told that ministers would leave “no stone unturned” and could present their research to the Office of Fair Trading if there was a suspicion that competition was not working effectively.

“It is very important that each and every bank knows that there is someone looking over their shoulder,” Mr Darling said after the Treasury meeting. “I want to make sure that we have a competitive banking system in this country.”

But Philip Hammond, shadow chief secretary, said Mr Darling was “asleep on the job and the public will take his synthetic anger with a pinch of salt”.

The chancellor’s aides said he did not yet have any evidence of anti-competitive behaviour. To encourage more competition, Mr Darling wants to cut the two years it takes to obtain a banking licence. Paul Myners, City minister, and Shriti Vadera, small business minister, have been charged with going through banks’ lending policies over the next few weeks.

The Treasury claims that in 2007, only 2 per cent of SMEs paid margins on their loans of more than 9 per cent; in 2009 that had risen to almost a third.

Just out of curiosity, what would “evidence of market failure” be, oh Olympian one? And, has there been a substantial decline in competition between 2007 and 2009 that could account for a widening of margins?  Or, is it more likely that the widening in margins reflects a decline in the credit quality of borrowers, and the fact that the banks are likely constrained in their ability to borrow due to their own straitened balance sheets?  And what does “affordable” mean?  Loans that businesses and individuals can afford to take–or ones that banks can afford to make?  Will pressure to lend lead to a decline in the quality of loans, thereby deepening the British banks’ already weak condition?  Is that a reasonable, not to say sane, policy objective of the Chancellor of the Exchequer?

So, the UK is hiding behind the fig leaf of “competition policy” to engage in the same type of pressure tactics that Putin is exerting on Russia’s banks.  Great example to follow there, Alistair.  It will almost certainly do nothing to actually help the British economy.  Instead, it is more likely to put British banks even deeper into a hole, thereby hamstringing growth going forward.

Russia and Britain are not the only ones who are treading on very dangerous ground when it comes to banking policy.  China is concerned that the huge amount of credit it is pumping through its banks is feeding a real estate and stock bubble:

Chinese regulators on Monday ordered banks to ensure unprecedented volumes of new loans are channelled into the real economy and not diverted into equity or real estate markets where officials say fresh asset bubbles are forming.

The new policy requires banks to monitor how their loans are spent and comes amid warnings that banks ignored basic lending standards in the first half of this year as they rushed to extend Rmb7,370bn in new loans, more than twice the amount lent in the same period a year earlier.

Beijing’s concerns are echoed in other countries across the region, most notably South Korea, where the government says it is taking steps to cool a real estate bubble, and Vietnam, where the government has ordered state banks to cap new lending to head off inflation.

The situation in much of Asia is very different from most Western economies, where governments have flooded the financial system with liquidity to encourage unwilling banks to lend more.

. . . .

In statements published last week, Wu Xiaoling, who recently retired as deputy governor of the central bank, warned new lending this year would probably reach as high as Rmb12,000bn, a staggering increase of 40 per cent of the entire stock of outstanding loans in just one year.

She called this sort of growth excessive and said it would lead to bubbles in the property and stock markets.

The flood of new lending also has implications for the quality of bank loans and the country’s overall growth.

“China’s economic recovery is being constructed on the back of a savaged banking system,” said Derek Scissors, a research fellow at the Heritage Foundation in Washington. “Tens of billions – and perhaps hundreds of billions – of dollars of loans will not be repaid.”

He points out that in recent years total loan growth of around 15 per cent has supported gross domestic product growth of higher than 10 per cent but in the first half of this year total loan growth of around 33 per cent supported GDP expansion of only 7 per cent.

“China’s economic policies have shifted from being unsustainable over the very long term to being unsustainable for any more than one year,” Mr Scissors said.

New loans are 40 percent of outstanding loans!  (That is, the flow is 40 percent of the stock.)  That is un-freaking-believable.  And as the wonderfully-named Mr. Scissors said, is un-freaking-sustainable.

Just how does one ensure that loans don’t go into equity or real estate markets?  Lend a money to a company, and it is very difficult to keep it from going where it will.  Like industrial companies can’t buy real estate?  And what’s more, even if there is a way of walling off real estate and equities, why would one believe for a second that loans being made so indiscriminately to the “real economy” are really flowing to high value uses.  It seems like the Chinese banks are lending to anybody with a project and a pulse.  Not only does that raise the risk of a spike in bad loans, but relatedly, it will lead to mal-investment; a distortion in the pattern of investment as well as the level of investment.

In other words, China is setting up itself–and the world–for the mother of all Austrian-style crashes.  Austrian business cycle theory emphasizes how credit expansions lead to distortions in the pattern of investment that are corrected through sharp contractions.  The shovel-the-money-out-the-door theory of loan underwriting will almost certainly distort the allocation of capital, requiring a reckoning when the government cuts back on the stimulus, as it must, if not now, in the coming months.

The banking system in China already had a lot of bad loans.  Indeed, in 2007-2008 I had conjectured that if the world economy were to crash, it would be because of a banking problem in China.  Uhm, right diagnosis (banking crisis), wrong location.  Well, one out of two ain’t bad.  But even though I erred in identifying China as the world’s leading likely source of a systemic shock, that’s not to say that its financial foundation is strong.  Rapid growth in recent years has helped obscure the vulnerabilities in the banking system.  The policy of promiscuous lending will only exacerbate those vulnerabilities.  Thus, China has climbed on the tiger’s back through its aggressive stimulus; how can it climb off, knowing that doing so will increase its bad loan problem?  There’s no immediate answer to that question.

The Russia and Britain and China stories could be supplemented by stories about the way the US in particular has handled its banking problems.  None of these inspire confidence.  Indeed, to me it seems that all of these policies are setting the stage for bigger problems down the road.  The extremely short-run orientation of these policies, which have the whiff of panic about them, carry the very great risk of laying the foundations for future crises, and at the very least, impeding the process of recovery from the current one.

The first rule of holes is that when you’re in one, stop digging.  When it comes to banking problems, politicians around the world are ignoring that lesson, and are making the dirt fly as fast as they can.  And in so doing, they risk burying us all.

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  1. […] Empire entailed a Polka which created a lot of tension between the Russians and the Britishers. Vladimir Darling – 07/28/2009 No, I haven’t succumbed to the Stockhome Syndrome and begun […]

    Pingback by Ладушки.Net » Blog Archive » Posts about Putin as of 29/07/2009 — July 29, 2009 @ 2:09 am

  2. But Professor, if the Chinese economy tanks, who will loan us all the money for refighting the Cold War with Russia (plus all the Hope and Change back home)? I guess we’ll just go on printing more…

    Comment by Vic — July 29, 2009 @ 7:55 am

  3. Vic–close enough. That’s why I think we’re effed. More TIPS are looking better all the time.

    The ProfessorComment by The Professor — July 29, 2009 @ 10:45 am

  4. “Vladimir Darling” is a disgustingly discriminatory title, seeking to tar all Russian men called “Vladimir” with authoritarianism. I can only condemn this transparent racism.

    Comment by Sublime Oblivion — July 29, 2009 @ 10:48 am

  5. For my part I think it’s horrifyingly racist to use the word “Russian” to refer to a race. It’s properly understood as a nationality, with many different races qualifying for the term and the passport that goes with it. Given the pathological racism of maniacs like SUBLIME DURAK, it’s little wonder the people of the Caucasus want out, but quick.

    Comment by La Russophobe — July 29, 2009 @ 12:06 pm

  6. How are things going in Separatistan er Jamestown Kim? Been back to see your colleagues lately? 🙂

    As for the Professor, wouldn’t sweet crude futures be a better bet than TIPS if the Feds are printing money like no tomorrow?

    Comment by Vic — July 29, 2009 @ 1:10 pm

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