Saturday, 19 December 2020

Credit guidance nonsense

Summary.          Credit guidance is the idea (promoted by Positive Money and others) that government should induce banks to lend less to various sectors of the economy which are allegedly unproductive, e.g. property based loans like mortgages, and more to sectors which are allegedly productive, like SMEs and green investments. The first problem there is that banks already lend to SMEs up to the point where the marginal or least viable SME borrower is only just worthwhile. Thus quite how further SME loans can be described as “productive” is a mystery. Second, as regards green investments, there’s nothing wrong with promoting economic activity which cuts CO2 emissions, but the bias towards investment at the expense of more labour intensive forms of activity does not make sense particularly since advocates of credit guidance say they want to maximise job creation. Third if loans for mortgages are constrained, that will cut the number of houses built, which a strange objective, given the housing shortage. Fourth, increased lending for house purchases is largely just a series of book-keeping entries: i.e. it does not involve the consumption of real resources. To that extent, there are no real resources there that can be re-allocated for example to green investments.


Positive Money (PoMo) have recently put much effort into advocating the idea that the Bank of England should do more so called “credit guidance”: in particular, induce private banks to lend more to allegedly “productive” borrowers, e.g. small and medium size firms (SMEs), and less to allegedly unproductive loans, e.g. property related loans, like mortgages.

To quote the relevant PoMo article (I’ve put the quote in green italics):

“For too long the UK economy has been held back by the majority of bank lending going towards property and financial markets rather than the productive investment in the real economy desperately needed to level up regions and boost incomes.

Now more than ever we need concrete action to guide lending towards productive investment to support a sustainable recovery and a fair green transition. Policymakers should look to introduce modern forms of so-called ‘credit guidance’, which were effective in steering lending towards more productive ends for much of the twentieth century.”

Unfortunately there are four big problems there.

First, commercial banks (henceforth just “banks”) are only too happy to lend to ABSOLUTELY ANY borrower who seems credit worthy and viable. It makes no difference whether the borrower is an SME or someone wanting a mortgage or any other sort of borrower. Thus banks WILL ALREADY be lending to SMEs up to the point where the marginal or least viable SME borrower is only just viable, in the view of banks.

Moreover, banks are not even constrained in their lending activities nowadays by a shortage of reserves: unlike prior to the 2007/8 bank crisis. Banks are now AWASH with reserves.

And they’re not constrained by lack of capital either: if banks spot an increase in the number of genuinely viable SME borrowers, or any other type of viable borrower, they’ll have no difficulty acquiring extra capital so as to help fund relevant loans.

So to summarise, PoMo and others want banks to make extra loans to borrowers who appear not be viable. But in that case, how can those borrowers be described as “productive”? It’s all nonsense!

Moreover, if extra loans are to be given to unviable SMEs, banks will want a subsidy for doing that. But PoMo and other authors cited in the above PoMo article don’t seem to be aware of that. Certainly they don’t tell us where any subsidy comes from.


The second problem: matters green.

The idea that banks should be induced to lend to fund investments which cut CO2 emissions sounds wonderful. Environmentally concerned folk with a poor grasp of economics will love that.

Global warming is arguably the most important problem the human race has ever faced, and certainly that problem needs to be solved. But introducing any sort of assistance for loans which fund green investments rather than assistance for non investment type costs (e.g. labour) needed by green projects does not make sense. Moreover, the latter concentration on capital equipment clashes with the claim by PoMo that job creation is an important element of their proposals.  

Put another way, taxes on CO2 emitting activities or materials, like petrol or diesel make sense. And subsidies for generating electricity from wind and solar make sense. But a bias towards capital intensivity where those activities are concerned does not make sense.  

The third problem: less house building.  

The above PoMo article (and the works cited in it) make much of the fact that a large proportion of lending is property based (e.g. mortgages). And that, so the argument goes, means there is loads of money currently devoted to property purchase which COULD BE diverted to allegedly “productive” SMEs and so on.

Well apart from the above mentioned “marginal” problem, there’s another problem there, as follows. What induces house builders to build more houses is (unsurprisingly) house price increases. In fact there’s plenty of evidence that housebuilders are brutally commercial in that respect, i.e. they often obtain land with planning permission but do not build on it immediately. Instead, they wait till house prices in relevant areas have risen to the point where they can be sure that the millions spent erecting a new estate bring them a profit. Can you blame them?

Thus the effect of constraining loans to house buyers would be less house construction: not a brilliant idea, given the housing shortage.

Fourth: book-keeping.

Much of the increased lending that accompanies house price increases does not involve the consumption of real resources. To illustrate, if saver / lenders increase their willingness to lend at lowish rates of interest (which is what has happened over the last twenty years or so), and/or if borrowers increase their willingness to borrow more money to buy more expensive houses, the initial effect (ironically) is not that a significant number of people move into larger or better houses.

Reason is that the stock of houses in the short term is fixed. Thus all that happens is that debts in the form of mortgagers rise, and that increased debt must of course be owed to someone: it’s owed to saver / lenders who find their stock of money has risen. But that’s all nothing more than a glorified series of book-keeping entries.

In contrast to the latter INITIAL effect, there is of course another effect (alluded to above) namely that the increased price of houses induces builders to erect more houses. That DOES INVOLVE the consumption of real resources.
So to summarise, and contrary to the claims of credit guidance advocates, a million Euros or dollars less lending to mortgagors does not mean there is then a million Euros or dollars that can be spent on green projects or loaned to SMEs to enable them buy new machinery.  

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