Jeremy Warner: Bankers adopt can't lend, won't lend approach

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The Independent Online

Outlook Mervyn King, the Governor of the Bank of England, suggests that the banks may have to raise even more capital if they are to be persuaded to start lending again, and that if they still prove reluctant then the Government may have to resort to strong-arm tactics to bring them into line, possibly culminating in outright nationalisation.

On one level, the Governor is right to be angry. Vast amounts of taxpayers' money have been made available to the banks, both by way of recapitalisation and financing facilities, in an attempt to get them lending again so that economic growth can resume. Yet perversely, the measures may even be exacerbating the deleveraging process.

Banks would rather hoard cash and reduce their lending so that they can pay off the Government's capital and financing facilities early than use them for the purpose they were intended for, balance-sheet expansion. Bankers hate having been made beholden to the Government and want to free themselves from the restraints on pay and dividends that the Treasury has imposed as soon as possible. The simplest and quickest way of doing this is through balance- sheet reduction. A smaller balance sheet requires less capital.

This mentality has prompted understandable exasperation among ministers and supervisors. Mr King was at pains to stress during an appearance before the Commons Treasury Select Committee yesterday that the new capital ratios were not minimums, but were designed to create a capital buffer that would allow normal lending to be resumed without fear of the damage to capital that would be inflicted by mounting bad debts.

Wish it were that simple. Bankers may have behaved recklessly in lending too much during the boom, but it is not in their nature or self interest to lend already overstretched debtors even more now that the bust has arrived, however much they are commanded to do so.

According to a report commissioned by the Government from the former HBOS chief executive, Sir James Crosby, and published with the pre-Budget report, net new mortgage lending may next year shrink to below zero, a situation quite without precedent even during the last housing market crash of the early 1990s, when the problem was never lack of mortgage finance but rather its cost. Today it is the reverse.

The main reason for this intensification in the mortgage famine is that lenders have approximately £160bn of mortgages to refinance next year, yet beyond the Government, no obvious way of doing so. Nobody is prepared to finance or buy mortgage assets right now. The securitisation markets remain closed.

Sir James suggests the Government guarantees £100bn of mortgage-backed securities as one way out of this downward spiral of decline. Yet Mr King doesn't like this solution at all, as subsidisation of mortgage lending may end up only crowding out small business and other forms of lending. As can readily be seen, there is no magic wand that can be waved to get rid of the deleveraging process.

The deleveraging isn't in any case confined to bankers. Also playing the game are householders as they switch from a borrow-to-consume way of living to a saving-and-spend-nothing mentality. This process may affect economic activity as dramatically as banks' unwillingness to lend. The dangers of a deflationary outcome grow by the day. Policymakers are struggling to avert such a disaster.

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