Northern Rock – the real questions it raises

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I’ve been asked by a couple of people to do an update on Northern Rock. There are two reasons. The first is that, as the Guardian has reported, at least £23 billion has now been lent by the UK government to banks facing meltdown as a result of the UK sub-prime crisis. At least £18 billion of this has gone to Northern Rock and that bank does itself admit it might need £25 billion before the situation is resolved. The number is so big I have been asked to comment what it might mean. The second request was for comment on the absurd article written by my Hecklers foe, Tim Congdon on this issue in the FT a day or two ago.

£23 billion is a number beyond most people’s imaginations. Unless you’re used to national income accounting (and these days I seem to do rather a lot of that) then I’m not surprised. Let’s just spell it out in full for a start. It’s £23,000,000,000. To put it another way that’s twenty three thousand million. Unsurprising that it’s an inconceivable sum to most, so let’s ground it in some reality.

It’s near enough the total sum raised in Council Tax this financial year.

It’s more than the government’s whole housing and environment budget for this year.

It’s one third of the education budget for the year.

The average UK mortgage at this precise moment is £98,517. So it’s 233,462 mortgages.

The average UK house price is £210,000. You could 109,523 houses for that. Given there are about 25 million households and about 60.6 million people living in the UK average house occupancy is 2.4 (amazingly!). Which suggests that £23 billion could house over 260,000 people.

Median UK wages are about £24,000 now. £23 billion would keep 958,000 people in work for a year on median pay.

But is this the real way of looking at this issue? Or should we just think this is a loan and that it has no further consequence? After all, if the average Northern Rock mortgage account holder pays as they are expected to the entire loan will be paid back to the Bank of England over time, and as Tim Congdon argues the Treasury will have earned a very good rate of return during that period at the expense of the ordinary shareholders of Northern Rock because the interest rate charged means Northern Rock must be losing money on mortgages financed using this money.

Well, Congdon has a point, and he rightly asserts that this £23 billion did come out of thin air. Before Northern Rock asked for this £23 billion it simply did not exist elsewhere, and was being used for no other purpose. I have explained how this works here. But let me be quite clear. Congdon is also horribly wrong, or naive, or both when he argues as a result that this means that Northern Rock has no cost to society. Actually the cost is enormous.

First of all, if as Congdon argues, government can benefit society by lending whenever it likes by simply creating the cash to do so then quite clearly it should not be borrowing as it does now. It should be a lender. It should replace banks. After all, why should banks get the benefit of lending when the government could do so itself, make 100% of the profit on the deal and reduce the tax burden on us all as a result instead of allowing the select few shareholders of our banks to do so instead? Now maybe hat’s what Congdon is arguing (and I personally have some considerable sympathy with this argument and for the reclaiming of what is called seignorage by the State). But I suspect that he is saying no such thing. I suspect he believes banks do have a useful role.

But what is clear is that in this case the banks, despite having a useful role for which they have been given the right to claim for themselves about 97% of all seignorage, worth about £45 billion a year for their profits, have declined to support Northern Rock even though it is, according to the Bark of England solvent and able to pay its way. In which case the £23 billion does not have “no cost”. Its cost is the alternative purpose for which that money is now being used. And there is an alternative, because the Bank of England’s money simply replaced commercial money which is now being used elsewhere. In effect, the £23 billion has not really been used to shore up Northern Rock at all but has instead been used to provide other banks who wanted to sell out of Northern Rock with the option to invest this cash elsewhere.

That’s what worries me. The government can create £23 billion, seemingly at will to shore up the banking system (not just one bank) but not attach condition as to what it is being used for even though the sum in question is so enormous. And in this sense the loan is pure and simple state aid for banking, a sector that has no apparent need for it, because as is readily apparent from its continued capacity to fund all sorts of other activity, it has no obvious shortage of liquidity at all. So that money will now be used for purposes like funding takeovers, private equity deals and other such wastes of resources. The main purpose of these is to fund the pockets of merchant bankers and other advisers such as the Big 4 firms of accountants. This is done at costs to the ordinary shareholders of the companies subject to such deals and in turn to society itself because, as KPMG have noted, many such deals simply don’t deliver any benefit at all to anyone bar the advisers.

So that’s what creating £23 billion of cash “out of thin air” has actually done. And in that case we’re completely entitled to ask what could it have done instead.

Think about it this way. A return is needed on the money to service the debt. The justification for the loan to Northern Rock is that its mortgages provide that return. But there are other ways of generating returns as well. For example, Transport for London has proved that it can used fares to service debt whilst restructuring the whole of Network Rail is not expected to cost more than £10 billion.

The Housing Finance Corporation earns money from lending to finance social housing in the UK – and has total loans of £1,672 million. Think how the whole problem of affordable housing could be transformed with 13.75 times that sum – which is what £23 billion is. The stress and life prospects of an enormous number of young people in this country who face the burden of a mortgage forever would be relieved at a stroke.

Just £1 billion could upgrade the entire housing stock of Birmingham (Europe’s biggest landlord) so that every home in the City was of an acceptable standard. Can you imagine the social benefit of that? And rent could be used to repay it.

But instead the money, never budgeted for and certainly not guaranteed to be recovered, has been found to support the banking system. Now, of course I accept that a banking crisis would have imposed a massive shock on our economy. I’m not naive. But my point is simple. If money can be found for banking it can be found for other purposes. And the social benefits in the long term might be much higher. What is more, this could be afforded. These projects would earn the revenue streams to pay for them. There’s only one obstacle, and that’s a lack of faith in the capacity of the public sector or assets in public ownership to pay a return, even though there’s absolutely no evidence that there is any difficulty in doing so.

To promote this alternative use of borrowed funds I’m pleased to be a part of an embryonic idea called “The Green New Deal” referred to in the Guardian last week. We believe borrowing is a part of raising government revenue and it should be encouraged when it is to be used to fund capital projects that can pay a positive financial and / or social return for society. Of course the use of government funding has to be carefully directed. We argue for strong governance and local accountability of projects to enhance it. But Northern Rock proves money is available when required. Now we need to use it wisely. And we need to provide appropriate structures so that better saving mechanisms are available that direct those savings towards the creation of real jobs undertaken by people with real skills that result in assets that meet real needs of people in the UK economy, and not just our financiers. Things like schools and hospitals built without the burden of PFI debt, or social housing, and green energy and transport systems.

We think that can be done. An early exploration of the idea can be found here. An application for development use is available here, with the specific aim of risk sharing in the most appropriate manner with the private sector. More will follow, and ongoing discussions are happening right now with some local authorities in the UK about the possibility of using innovative finance to meet their needs.

But what we really want is to promote debate right now, because it’s becoming increasingly clear that the current system of finance and savings that we have in the UK and USA, which together dominate the world, is unsustainable. Which is hardly surprising. Who but a fool would place their hopes for their retirement on the value of second hand bits of paper, which is what placing your hope on long term returns from shares really is? We’re suggesting an alternative, asset backed, income generating, wealth promoting means of saving from which the returns are twofold: the first is an immediate improvement in the well being of your community and the second a financial return.

There’s only one impediment to progress, which is a belief that only the private sector generates wealth. We know that’s wrong: right now it’s very obvious it’s spectacularly good at destroying it. And that that’s why we hope politicians of all hues will listen and debate this approach to funding our future and our pensions, and then adopt it. Because at the end of the day this is about the most important public: private partnership we can imagine, from which everyone gains. And that’s far removed from what’s happening at Northern Rock where the fact is massive amounts of public money are being used to ensure bankers can continue to take risk at the expense of society. And that’s no longer acceptable.