Posen’s Radical Call
I’ve noted before that I have a lot of time for MPC member Adam Posen, in particular his views of the likely path of consumption. Which are turning out to be rather accurate.
As an expert of the Japanese lost decades (and often missed off plural is important here!) it is perhaps unsurprising that he worries more than other MPC members about how an economy recovers from a balance sheet recession.
This week he made a superb speech, which I’d highly recommend.
Posen not only retiterates his call for more QE (on which my own views are a bit more nuanced) but also sets out a truly radical plan to get credit flowing. One that I will quote extensively:
Yet most if not all countries have ongoing public lenders of various types (even the US has the SBA), and their existence on a limited scale, while perhaps wasteful at the margin, does not lead to the destruction of the private-sector banking systems in those countries. (Posen (2009a)) Let us remember that the UK and other western private-sector banks did that themselves during a period of financial liberalization and privatization unprecedented in postwar economic history.
In any event, these are not normal times. The existence of such a public institution for lending to SMEs and new business is a response to the dysfunctional credit system we now have, and is likely to allocate capital better under such circumstances than in the normal situation. Since adverse selection is at work in the banking system, it will be easier to find good investment projects and borrowers that were overlooked than in normal times. Ultimately, this entity can and should be privatized, perhaps in more than one part depending upon its scale, when the situation improves. And just like with the financial institutions currently in the government’s hands, such privatization would be an opportunity to restructure the British financial system to a more competitive one which provides better high-street lending, our historic financial weakness.
The other institution I would encourage the Government to set up would be an entity to bundle and securitize loans made to SMEs. Essentially, we need a good version of Fannie Mae and Freddie Mac to create a more liquid and deep market for illiquid securities which can then be sold off of bank(s) balance sheets. It is worth remembering that for decades the mortgage ‘agencies’ in the US provided a vital service and did not undermine financial stability. It was only in recent years when they were allowed to keep mortgages on their own books in pursuit of excessive short-term payouts to their management, and were not strictly enough supervised given their perceived government guarantees, that they did harm (admittedly quite serious).
That is why I suggest that such an entity should be a separate institution than the bank or banks which do the new SME lending, so it can be incentivized to scrutinize the loans being offered for securitization. I would also suggest requiring that the securities being issued by this agency – let’s call it Bennie, the “British Enterprise Investment Entity” –be comprised of loans very transparently sorted and distinguished by type, so segregated (no general Bennie securities). And I would say we should insist that the securities that emerge meet all the standards for high quality assets that the Bank of England currently insists upon to be willing to lend against something. And this is where the Bank of England comes in. Both of these entities, the new SME lender(s) and Bennie, would need an initial infusion of capital. The Bank could then commit to discounting the securities from Bennie (so long as they meet our previously set standards) and, as needed, various loans and other assets from the new SME bank (though obviously not individual corporate loans and not those bundles of loans rejected by Bennie as sub-standard). Some might say the Bank can already do that without any further agreement or announcement. I would suggest that this misses the point and perhaps an opportunity.
I.e. he not only calls for a state backed lending institution but notes how it could be funded using QE. Something I proposed two years ago. Radical indeed.