Browns Banks Bankrupt Britain

Professor Michael Benfield Explains

About 18 months ago I upset HBF[1] colleagues in South Wales by ‘having a go’ at the Welsh Agent for the Bank of England. He was telling our quarterly MD’s dinner meeting of ‘the Bank’s’ view and likely progress of the UK economy. My response was that ‘the Bank’s’ continuing focus on attempting to control inflation were misguided, ill timed and - if it did not use all its power and influence to cause the Government to take immediate action to re-open the mortgage tap - within 6 months UK house-building would be closing down[2].

Having grown up on the tools and not afraid to call a spade a ‘bloody shovel’, my terminology was a little more strident, hence my chastisement. However, the ‘Agent’ was sufficiently courageous to visit me a couple of weeks later and – as he put it – “let me give him both barrels”.

At the business meeting before dinner, HBF executive chairman, Stuart Basely, had asked for ideas on how what was then only a mortgage-lending crisis, reflecting concerns in the wake of the US sub-prime fiasco, could be addressed. Simply expressed I suggested that, with mortgages generally granted over a 20 – 25 year period and since over such long-term house prices have always risen, Government merely needed to guarantee the value of residential mortgage security against loss over the 20 – 25 year life of the mortgage. I added that under these circumstances this would not cost government, taxpayers, or mortgage lenders a penny.

My view then was that such ‘comfort’ could restore UK confidence in housing and protect the industry. This was true because conditions in the UK and US residential markets were completely different. They had oversupply, massive sub-prime lending, and falling house prices. We had chronic shortage, mainly sound (if questionable) lending, and (until then) rising prices.

Whether or not my simplistic take on affairs ever got through to the Bank of England, or Cabinet ministers I will probably never know, although a couple of weeks ago Stuart did indicate that he had ‘sort of’ used them.

What I and everyone else now knows is that, wedded to his policies and conviction that he could ‘save Britain’, Prime Minister Brown, Chancellor Darling, the Bank of England, our UK Bank’s, mortgage lenders and others in positions of trust and responsibility, have singularly failed to understand the crisis, let alone do anything even half sensible about it.

Take for instance Darling’s half-baked one-year 2½% VAT reduction. Reputedly that has, or will, cost UK taxpayers £12.5 billion. Now if instead he had granted a one-year VAT holiday on home extensions and improvements, this would have kick started pent up demand, encouraged thousands of homeowners and residential landlords to bring forward improvement projects, and secured more jobs in, for example, soft furnishings and white goods. Even if this had, say, doubled the historical 240,000 p.a. or so such projects to 480,000 for a year then, assuming a high average spend of £50,000 each, the one-year loss of VAT on the £24 billion output would only have been £4.2 billion. If he had really wanted to give away £12.5 billion then another £8.3 billion would have remained in the coffers for other initiatives.

Now what could we have done with that?

In mid February I wrote to ‘The Times’, subsequently copying in BBC’s Robert Peston and others, linking the £1 billion that RBS was proposing to give in bonuses with the Lloyd’s TSB decision to advance a maximum of 80% of valuation on new mortgages. I pointed out that with an average first time buyer home costing around £150,000, this put the 20% ‘deposit’ now required at £30,000. Since this is out of reach for many first time buyers, I suggested making up to £25,000 available to them on the basis of £5,000 for every £1,000 they provided. In this way that same £1 billion could help buy (and sell) some 1.2 million first time homes – or at least 5 years new house building output if this were totally given over to such homes.

Darling, too, could have used £1 billion of his remaining £8.3 billion VAT giveaway for the same purpose. Actually ‘giving’ it free, gratis and for nothing to first time home buyers would have helped restart the house building industry and (re)create up to around 400,000 jobs.

It struck me then, and still does today, that free “Deposits for the needy” has a better promotional ring about it for banks and Government than free ‘Bonuses for the greedy’.

That would still have left £7.3 billion available from the one-year VAT give-away. Some of this could have been carried forward for another 2 or 3 years to protect the housing recovery and provide many urgently needed ‘affordable homes’. For instance, £1 billion would have fully fund almost 17,000 homes at Governments £60k target price. Upping the figure to, say, £3.3 billion would have provided around 55,000 affordable homes, solved the housing crisis and still left £4 billion for other programs.

There is, for example, an urgent need to fund the costs of meeting Government demands for higher-level ‘Code for Sustainable Homes’ housing. While there is still much uncertainty about how much extra these will cost, if £5,000 were needed for a Code-4 house, then £1 billion would fully pay for this upgrade in 200,000 houses. Thus, in the run up to the 2016 zero-carbon target, Government could have used this £4 billion to help secure total annual new housing output at this higher Code level for 4 years without price resistant buyers, or cost pressured house-builders, having to find a penny.

Of course 100% funding in this way would not have done much to differentiate desirable, higher specification new homes from less desirable existing (much of it old) stock in the housing market. It might have made more sense, say, to give higher Code level homes a reduction in council tax. If 10% were allowed for Code-3, 15% for Code-4, 20% for Code-5, and 50% for the much more costly and difficult to achieve Code-6, overall perhaps a £500 average reduction in council tax levied on new homes may have resulted. That is enough to make homebuyers recognise the value of buying into higher Code specifications. Assuming an increase in output to 200,000 new homes p.a., this would have cost £100 million in the first year, £200m in the second, £300m in the third and so on, such that £1 billion would have funded this for 8 years.

So what could have been done with the £3 billion now left from the Darling VAT give-away?

Well, I suggested, consider using the old Government Small Firms Loan Guarantee scheme (now the Enterprise Finance Guarantee scheme[3]). This used to guarantee repayments of up to £250,000, now more given recent changes, although the banks claim they still have no ‘clear policy’ on this. Just £1 billion is the equivalent of 4,000 x £250,000 such loans. However, many small firms would welcome just £100,000, which means up to 10,000 small firms could have been ‘saved’ from insolvency if £1 billion of the VAT give-away, or bank bonuses, went to them rather than retailers who have clawed back the reduction, the few consumers who might have benefited from this, or bank employees, many of whom are currently engaged in forcing thousands of small and medium sized firms to close down.

With such firms typically employing 20 to 50 people - say 30 on average – this means 30 x 10,000, or 300,000 jobs could have been protected for what, in the scheme of things, is a relative pittance. Indeed, this would have facilitated a huge recovery in much of the (house) building sector. And it would only have cost £1 billion IF all of the 10,000 firms so supported subsequently went bust, which is most unlikely. To the contrary they would have been more likely to increase the Government’s tax take as well as removing the need to pay out billions in unemployment pay. Equally important is that via these small employers this money would have found its way directly into the pockets and purses of workers who, as is generally the case, would have spent it on a wide range of ‘goods’, or even savings, so supporting other industries, innovation, education and other ‘good causes’.

In addition to this, the other £2 billion could have been directly allocated to SME’s in other industries. While car making is not my first choice (we don’t immediately need more cars, but we do need many more houses), it could have been used to support latent ‘green’ enterprises, most of whom could make a contribution to the sustainable housing targets.

Yet, despite Government rhetoric that banks and mortgage lenders should be lending, they are still not doing so. Yes, when asked they will say that funds are available subject to ‘sound banking principles’. But this seems to be mere code for ‘we need to restructure and recapitalise our own balance sheets first’.

So what are the results of observing these ‘sound banking principles’?

Well, apart from reducing available mortgages from 110% and 120% (which was clearly barmy) to 80% (which is equally barmy in current circumstances), there is the further barmy brief to property valuers requiring them to ‘down-value’ homes for which mortgages are currently being sought.

An actual example of this is of a new block of flats in which each flat was offered for sale at a sizeably reduced price of £138,000. To secure a sale the developer accepted £130,000 for one of these from a cash purchaser. A week later the next but one flat was ‘sold’ but then down-valued for mortgage purposes to £115,000. A month later another flat was down-valued to £100,000. That is 27.5% less than the already reduced asking price and 23% less than a cash buyer had paid 5 weeks earlier.

By all accounts this is not unusual. It is happening all over the UK. Even worse is that it is happening with the Government’s new ‘Home-Buy Direct’ scheme[4], with some mortgage lenders stating that they will only advance 80% or 90% of the 70% of valuation that they have agreed with Government to provide (the other 30% coming from the house builder & buyer).

The further barmy feature of this is that such ‘down-valuing’ is actually undermining the value of the bank / mortgage lenders base of residential property mortgage assets.

In similar fashion, where these ‘barmy banks’ have foreclosed on house-builders and put them out of business, they now find themselves having to get other house-builders in to complete the works. This means the banks are taking on the tasks of developers themselves, with all that this implies in terms of promotion, arranging sales, mortgages, etc. not to mention the increased costs to the uninitiated.

And this barmy behaviour isn’t just with housing development. It is happening across all sectors of industry and commerce. As banks fail to make funds available on ‘sound banking principles’, so they put firms out of business and amass bankrupt stocks and (non)-working assets that nobody now either wants or can find the money to buy.

The knock on effect of this to those firms who are still operating is equally damaging. Besides undermining the bank’s own (foreclosed and mortgage security) assets, this reduces the asset values of such firms and gives the ‘barmy banks’ further reason to reduce the facilities that they were until a couple of years ago so keen to press onto these ‘clients’. Unable to operate with reduced support many such firms are themselves now trapped in the same downward spiral of asset values, facing reduced bank support, and heading toward insolvency.

It seems that neither banks nor Government understand the fundamental principle that the intrinsic value of industrial assets only exists in use, i.e. when they are working. Closing down a firm and putting them out of use - perhaps permanently – loses that value. It also has the consequential knock on effect of down valuing all other assets that remain working, since more of the same assets are now available in the market at little or no cost.

Actual examples of this are of an in-use production line that had been refinanced in spring 2008 for £500k being sold for £38k at the end of the year, and of a press with used value 3 months earlier of £22k being picked up for £1,500 together with a near complete dismantled duplicate for ‘spares’. In the later case the equipment is being prepared for shipment to Poland to establish a competing plant. As may be obvious to readers, but apparently not Government or banks, this has a devastating effect on the market for new plant and equipment, as well as speeding up the export of what remains of UK manufacturing industry.

In many cases it is already too late to avoid this. To stop it getting worse it is essential to Keep Britain Working. And to do this industry and commerce MUST be provided with ORDERS.

Cutting bank rate to 0.5%, printing money via ‘quantitative easing’, buying-in ‘toxic debts’, and all the other fancy financial engineering tricks that are being spawned as run off from banker greed and primarily to keep the banks afloat, won’t immediately create these.

It is NOW, IMMEDIATELY, not tomorrow, or in three or more month’s time, that they are needed. Government, Politicians, Civil Servants, City Institutions, et al seem to have little understanding of the urgent time scales operating at the industrial and commercial ‘coal face’.

So, to facilitate these orders, lines of credit, bank loans, mortgages and so on MUST be made available so that the people who do the work – Britain’s Wealth Creators – are thrown the life-lines that will enable them to survive. A 0.5% bank rate is not much use to them when, in order to swell their profits and re-capitalise their balance sheets, the bankers are all playing in the LIBOR pool and linking their ‘re-negotiated’ loans to this at 5, 6, 7 or more percent. Nor will ‘sound banking principles’ comfort the tens of thousands of firms who will close, or the hundreds of thousands who will lose their jobs, if they do not get this without further delay.

The really important point here is that it is now too late to worry about ‘sound banking principles’ when making loans to business. The banks themselves did not worry too much about this as they fuelled their own greed engine. And they are not doing so now as they ‘Trash and Cash’ firms that were sound, profitable and progressive just 12 or 18 months ago. It is not a ‘sound banking principle’ to encourage someone into debt one day, then snatch away their loan ‘umbrella’ the next. Yet this is what the banks are doing. Even worse, they are reneging on loan agreements, demanding that borrowers provide more security, and tearing up their own written commitments to erstwhile borrowers who cannot do so.

It no longer matters whether a borrower has sufficient security for the loan required. Whatever they offer today will be worth less tomorrow unless the banks stop undermining asset values. And the only way they can do that is to open the money floodgates to enable realistic business and development plans to be implemented and facilitate the flow of ORDERS.

And it is pointless denying otherwise sound firms the funds they need to stay in business on the grounds that their order books are not sufficiently strong (if indeed they exist) when it is Government, banks and other institutions that are causing there to be no orders.

Location, location, location in property must become lend, Lend, LEND in banking. Money must be made available to established businesses, business people, and homebuyers with almost abandon.

Yes, precautions must be taken to avoid fraud and such like, but insistence on the provision of ‘sound’ business plans and ‘adequate’ security has become shear nonsense. In today’s climate neither mean anything anymore. People who have run perfectly sound firms for years are not suddenly going to become reckless and loose the banks money. Bankers are perfectly capable of doing that for themselves. Historically something like 6 out of 10 new businesses fail in the first year of operation. Another 2 go out of business within 3 years. But those that remain generally stay active, provide employment, and supply valued goods and services for a very long time.

Give such established businesses the money NOW. Don’t wait, pontificate, demand business plans that can have no true basis or relevance in the present economic climate - and in any event are out of date the day after they are written. Forget demanding ‘security cover’ that will be inadequate in a month or so’s time. Government can, should, and indeed MUST take the shackles off its Enterprise Finance Guarantee scheme, underwrite 100% of loans to firms established for more than 3 years, not 75% as presently prescribed. They MUST DIRECT THE BANKS TO MAKE THESE FUNDS AVAILABLE TO INDUSTRY NOW. Not tomorrow, or in a few weeks or months time after some ‘committee’ or other has ponsed around ‘considering’ the issues. Britain does not have time to wait any longer. Action, not words, must be the order of the day.

Yes, there will be some failures, but these will be far less than what is about to happen if ‘Lord Mandelson’ does not instruct his tight arsed banks to free up the economy immediately.

Indeed, he should go further. He should seek an act of Parliament pegging all banking salaries and other rewards to those of the Civil Service, for in truth it is only the service value they provide that the nation has any use for. Furthermore this should be retrospective to the start of this millennium. The year 2000 is a good place to impose such a regime. Forget crocodile tears for the poor lowly run of the mill banking staff. They too have had their snouts in the trough of bonuses and share options, none of which would have materialised had the banks been run along the lines of ‘sound banking principles’.

In 2003 UK banks collectively paid out £5 billion in bonuses. By 2007 this had risen to £15 billion[5]. Cumulatively over the period this may total around £40 billion. This is not dissimilar to the bale outs they initially received from UK Government. Had they exercised ‘sound banking principles’ during this time then they would have had the funds in reserve to avoid passing the cost of this support to UK taxpayers.

Why did Government not make it a condition of such bale out that they all repay these bonuses? After all that is effectively what the banks are doing when they demand early repayments and more security from their ‘clients’.

Few if any bankers or politicians have ever, as my late father-in-law used to say, “Created the value of a blade of grass’, at least not in those capacities. True, banks have a utility value. They facilitate the transfer of money between transacting parties. And that is important in our society, which exists and prospers by transacting with one another. Yet while a complex society needs people to create, police and enforce the rules by which we transact, it is now clear that our careerist politicians, many of whom have climbed on a similar greedy gravy train to our now despised bankers, have singularly failed to do this either before or after the ‘crunch’..

Why, for instance, was it not made a condition of bank bale-outs that all past, present and future ‘bonuses’ be stopped? Or their activities split up into clearing (circulation), savings and loan, and ‘merchant’ activities? Come to think of it, why were they not all nationalised, perhaps a large number closed (most were – and are – ‘bust’ anyway) and these splits implemented before subsequent re-privatisation?

I could go on, but the weak political response that we have been given so far, i.e. ‘that it is necessary not to lose banking experience, expertise and ‘talent’.’ is just pathetic. Who the hell needs the kind of experience, expertise and ‘talent’ that got us all into this mess in the first place? And retaining it is certainly NOT doing anything to protect or restore the industries who do produce value and on whose efforts all our futures depend. All I see happening is bankers protecting their own jobs at the expense of previously sound businesses.

No. It seems that Barmy Brown’s over-long stint as Chancellor of the Exchequer made him far too familiar with, and party to, the parasitic institutions that live off the backs of those who do the real work. Read Geraint Anderson’s recent kiss and tell book, Cityboy, to understand just how corrupt ‘The City’[6] really is.

So, as events unfold what is the state of play today?

At the HBF Policy Conference on Tuesday 17th March, Michael Coogan, Director General of the Council for Mortgage Lenders, revealed that net lending in 2009 is likely to be negative £25bn. That is to say, more money will be repaid than lent out this year; clear evidence of both barmy mortgage policies and the impotence of Government rhetoric.

Not much to encourage new orders here.

At the same conference Stewart Basely referred to “… the strangling impact of the lack of mortgage availability.” He was being house building industry specific, but along with house building most of Britain’s SME’s are being strangled to death.

In fact, in February gross mortgage lending declined to an estimated £9.9bn, down 15% from £11.7bn in January and 60% from February 2008, according to new data from the Council of Mortgage Lenders. This is the lowest monthly lending figure since February 2001.

February is typically the weakest month for mortgage completions. And although this is a larger decline than the 3-4% usually experienced between January and February, it is in-line with the CML’s forecast of £145bn gross mortgage lending in 2009. That’s about a quarter of peak loan levels and maybe a fifth of what is required to meet Government’s 240,000 annual new home output requirements. In itself this is increasing due to the downturn in new housing starts and now stands at circa 252,000 p.a. .

According to Coogan, "Retail savings are now the predominant source of funding for mortgages. But banks and building societies have seen savings ebb away to National Savings and Investments, which has a negative impact on their ability to lend”.

In his view, "This is yet another example of fractured policy. There are now fewer active lenders in the market, but the government wants them to lend more. At the same time, the government's own savings institution is sucking away the funds that would enable them to do so. Until funding improves, the capacity of lenders to lend will remain constrained."

Barmy behaviour indeed.

Meanwhile, in apparent accord, FSA Chair Lord Turner’s review of global banking stresses, amongst other things, the importance of “… a system-wide "macro-prudential" approach rather than focussing solely on specific firms.”

Back at the Bank of England, concern over meeting Government inflation targets is still the order of the day. The minutes of the Monetary Policy Committee meeting of 4th and 5th March reveal that it regards the current extremely low level of Bank Rate as providing “a substantial stimulus to the economy”. It also felt that any “further reduction could have some adverse impacts on the economy, given its effects on the profits that banks and building societies were able to make through the spread between their deposit and lending rates.”

Talk about protecting your own. What planet are they living on? Don’t they realise that there will be no house-building or other industry from which to make profits if they do not address the real problems faced by SME’s in all sectors before worrying about bank and building society profits? The real problem for industry and commerce is securing ORDERS. There are still plenty of people wanting to place orders. They are just being prevented or discouraged from doing so by, in Stuart Baseley’s terms, the stranglehold placed upon them by bankers and their ilk.

Which takes me back to my ‘go’ at their Agent 18 months ago.

The fact is that, over the long term inflation causes most things to double at least every 10 years or so. This takes account of the highs and lows of interest rates, economic downturns, and so on. Although, from memory, in the mid ‘70’s Government statistics were showing this doubling to occur every 7¼ years, 10 years is a fairly easy and reasonable rule-if-thumb figure to work with. Try it for yourself. In the Midlands 40 years ago an average wage was around £1,500 p.a. and a 3 bed semi cost maybe £3,500. Today the same job pays £25 -£30,000, or around 4½ ‘doublings’, while a semi costs nearer £200k, or 5½ ‘doublings’. If you check back over what salaries and housing costs were for your own occupation and home you’ll find this approximation holds fairly true. How many politicians, bankers, pension or insurance companies have ever dared to make this clear to you?

However, now, and almost in covert recognition of this, by the virtual printing of money via ‘quantitative easing’ both Government and the Bank of England are laying the seeds of rampant inflation within the not far distant future.

Hence my complaint that since, like all countries, the UK economy is subject to uncontrollable international forces, the Bank of England should stop wasting its time and effort trying to play God with inflation, put in hand strategies to support SME’s, the backbone of our economy – many of whom are in the house-building sector - and tell the Government to do likewise.

Coogan’s ‘fractured policy’ exposes the fault-line in Governmental and Institutional thinking. While we need banking’s monetary mechanisms to service transactions, in themselves they do not ‘add the value of a blade of grass’ to the national economy. While the analogies are now rather dated the majority of those employed in our huge financial army would be of more use ‘ carrying teaspoonfuls of coal from Newcastle to Battersea Power Station’. Whatever wealth they may fool themselves and Government that they create, in reality this depends on Britain’s thousands of really small firms to support their macro markets.

What should they do?

Well, even though my rant about bank bonuses and the useless VAT give-away is historical, all the measures outlined, including long term mortgage value guarantees, could be put in place – and become immediately effective - tomorrow. For a mere fraction of what has been blown on the banks and motor industry the UK could be put back to work creating useful, much needed homes, property improvements, and a spread of other construction and other goodies. Furthermore, all of the measures suggested would create what British business urgently needs – almost instant ORDERS!

Humungous bank bailouts have not provided these. Nor have the ‘bonuses for failure’ that these many hundreds of billions of pounds have facilitated. If anything they have made matters worse by perpetuating the banker’s self-delusion of their own importance. Assuming a ‘top-down’ approach to be the route to salvation, these actions have approached the crisis from the wrong end. Apart from the need to protect individual savings It would not matter much if a number of banks were let go to the wall. On the other hand loosing our vital business roots would be catastrophic, for it is the ‘trickle-up’ that these provide which will renew our economy.

And there you have it. While Barmy Brown bounces around the international stage pretending he has the ‘credit crunch cure all’ rather than ‘minding the shop’, his Barmy Banks, uncontrolled by a Bank of England suffering from enforced myopia, are busy Bankrupting Britain. Failing immediate action I fear that at least half of UK SME’s will be out of, or closed for, business by October this year. The greater tragedy is that most of them will never re-open.

Professor Michael Benfield PhD

1 April 2009

[1] HBF – Home Builders Federation

[2] It was.

[3] From January 14th 2009 until March 2010, the £1bn Enterprise Finance Guarantee (EFG) Scheme is supposed to support up to £1.3bn of new 10 yr bank lending to ‘viable’ SMEs with an annual turnover up to £25m for loans from £1,000 to £1m. However, without orders previously ‘viable’ companies are being reclassified by banks as too risky, thereby enabling them to refuse to lend.

[4] Over £400m of Government money has been allocated for HomeBuy Direct, 79% of which has gone to HBF members. HBF initially proposed the scheme to Government and then worked with the HCA to develop it to be workable for both the industry and customers.

[5] Recent BBC TV programme

[6] Geraint Anderson, Cityboy, 2008-9, Headline Publishing Group, London