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.
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Hi Richard – thats a big bee you have in your bonnet!
It might help you to comprehend this if rather than try and demonstrate how big £23bn is as an absolute number, instead you place it in context, and see how small it is. For example, compare it to total annnual government spending, or GDP, or the total worth of the UK housing stock, or the total of all UK bank assets, or even the assets of Northern Rock. Perhaps you might also like to consider the pound note cost of a bank failure. In that context a £23bn loan to support the assets until they are sold is a no brainer.
You will never persuade the government to do this, because if it becomes widely known that the government can create money out of thin air for any purpose, they will never be able to win the debate against doing things they don’t want to do with the current all-conquering “we can’t afford it” argument.
The problem of fractional reserve banking, and replacing it, goes a lot deeper of course. Henry Ford said “it is well that the general public don’t understand our system of banking, because if they did there would be a revolution by tomorrow”.
Have you read “the grip of death”? Excellent book.
Alastair
I have made clear, I do think staving off a banking crisis important.
But what I was also seeking to make clear is that there are very many better uses for money, and they’re not being pursued. The fact is that we have massively over stated the importance of banking, financial services and wealth non-creation in our economy.
I am interested in the welath £23 billion could create. And in that context this is an enormous sum.
Richard
Tom
I entirely agree with your analysis – but am less pessimistic as to the prospect for long term change.
The book is http://www.amazon.co.uk/Grip-Death-Slavery-Destructive-Economics/dp/1897766408/ref=pd_bbs_sr_1/202-2815298-3973439?ie=UTF8&s=books&qid=1194255638&sr=8-1 and is recommended by me as well.
Richard
Richard, I also think there are better uses for the money that government raises. I tend to subscribe to the view that it is markets that are the best arbiter for such choices. Unfortunately the government does not, which is a shame. Until they do I guess we will both be frustrated!
Alastair
It’s precisely because markets can’t do this that we have the Northern Rok crisis
So I think you’re flogging a dead horse
Richard
Richard, surely if anything is clear it is that markets can, and governments can’t.
Alastair
That is only clear to those who will not see
The truth is both can, when the occassion is right
Your comment makes you part of the problem, not part of the solution
Those of us who know that the market has its limits are the solution right now
Richard
I agree, but only if the government knows and abides by its limits. Although I know the Northern Rock problem is complex, and cause and effect are difficult, I suspect that ultimately it will be clear that the failure was caused by a mixture of bad management decisions and regulatory failure. Perhaps it is pointless to speculate but I believe that if Brown had not switched regulation from Bank of England to FSA then the (market based) regulation would have been more successful.
For me the Northern Rock debacle is a merely symptom of a money creation process that is flawed and flawed intentionally by its designers and rulers. The flaw engineers a situation where ever more fiscal power accrues in fewer and fewer hands.
It is an engineering problem, ably described by Sir Fredrick Soddy (and others) over 80 years ago. If interest is charged on loans that are created out of thin air, a feedback loop is placed into the system that simply causes eternal loss of purchasing power. The banks lend out 10, but hold a claim for 11. This “interest” virus self-replicates and consumes up the host – ie civilisation.
I was of the understanding that income tax (certainly in the US, I do not know UK figures) merely covers the interest payments due on the outstanding national debt. New money is continually borrowed into existance (at interest) simply to enable us to stand still. Govt’s do not oppose this process as to do so would strip them of the ability to raise money to pay for their rash electoral promises.
The major aspect, in my view, is not the mechanics of the system(s), both money creation and tax deception, but the psychological state of the type of people that inhabit this realm of fiscal fascism. They are in the main sociopathic and in pockets, psychopathic. I do not hold with the idea that Roosevelt’s “New Deal” was somehow a good thing. Acting as a shill for the private banking cartel that had intentionally engineered the crash, he stole the gold of US citizens and then borrowed huge fiat sums to create a bogus atmosphere of recovery, a recovery only fully attained with the banker engineered slaughter of World War 2 (nothing quite like a war if you are a banker).
Richard you said “If money can be found for banking it can be found for other purposes.” Yes, but it won’t a make a shred of difference if that new money has interest riding on it.
“Those of us who know that the market has its limits are the solution right now”
What a strange thing to say. We do, of course, live in an imperfect world. But the rules of logic still apply.
Let’s take an example:
There are two solutions to a problem, X and Y.
Approach X is imperfect
Therefore we must use Y.
Under what rules of logic does this “proof” work?
Yes… there are cases where governmental intervention are required and this may be one of them (although the regulatory changes that many believe made the problem worse and today’s revelation that Darling’s fingerprints were all over the disaster don’t bode well). However, evidence of a non-optimal outcome from a market is not proof that an alternative approach would be better.
Richard
I’m afraid the perverse logic is yours alone.
I was referring to facts. Facts like the succes of the state (and the state alone) in the UK in achieving the following:
a) Health through the provision of sewage faciliites
b) Life expectancy through the NHS
c) Universal education
d) Higher education on an unprecedented scale
e) Massive increases in housing quality (until market solutions were sought)
f) Heat, light and power (in the main – often through local auhtority initiative in the first place – then by nationalised industry)
g) The road system.
I could go on, and on.
I don’t need to. The argument that the State can’t supply is nonsensical. It can. So too, of course, can the market. I completely agree with that argment. But unlike you I am open to the idea that the best mechanism should be used when required – and that’s not the market by default. It’s that precise assumption inherent in your post that is the cause of massive problems right now, starting with the absurd market logic used in the NHS to the market madness of de-regulation in the banking system.
And that’s why those of who believe the market has its limits are the solution, because those who think as you do have caused these problems.
Richard
Richard, I continue to be intrigued by your championing of “the state”, but some facts concerning your list:
a) Sewage is not a public good – it is owned by private investors
b) It might sound logical to link life expectancy and the NHS but I don’t think there is much evidence to establish a causal link – the best you can expect is a contributory factor, and in any case it is the provision of a health service that is significant, rather than how it is funded.
c) there is some evidence to suggest that this is a public bad!
d) ditto c – the dumbing down of education is something of a problem in all sectors.
e) are you referring to the high rises in inner cities?
f) same comment as sewage – perhaps apart from Nuclear, which requires public subsidy because of the immense social cost, and wind which requires public subsidy because otherwise it does not make financial sense.
g) is that the road system that is grinding to a halt because of underinvestment?
Sure “the state” can supply but it is demonstrably less efficient than free markets. This is an interesting argument – we could trade “facts” until the cows come home – but what has it got to do with Norther Rock?
Richard – BTW there is not a UK sub prime crisis – the UK problem is liquidity, the sub prime crisis is American. Whilst some think something similar might hit the UK it has not yet
The liquidity problems are just a symptom of the fundamentals though. Fact is, valuations of all mortgage backed securities, be they prime, subprime, UK or US have not been reflecting their true inherent risk for some time:
http://ftalphaville.ft.com/blog/2007/11/07/8715/fundamentals-not-liquidity-conditions-are-behind-mbs-crash/
I get frustrated when I hear people describing the current situation as a “sub prime” crisis. The fact is it is an asset-backed securities crisis that has been led by a US housing market crash. It has shown up in sub-prime first because those mortgages had their rate resets first, but the fundamental cause is falling house prices, and eventually it will affect all mortgages. This new-found extra risk has demonstrated that the valuations of all mortgage backed securities are severely in doubt and the models that have been used to value them in the past are worthless.
Alasatir – your response to my suggestion on benefits provided by the State shows you too live in a fantasy, and one based on the distortion of the use of language.
There is no serious commentator who could or would agree with your views.
But unlike you I am open to the idea that the best mechanism should be used when required – and that’s not the market by default.
Richard, I think you have misunderstood my opinion.
You are, indeed, right that some issues are best tackled collectively and that some issues are best tackled individually. However, it is perfectly noble to believe, as I do, that the presumption should be towards allowing individuals to work together to solve problems unless it can be shown that a collective solution is needed, and would be better.
And that’s why those of who believe the market has its limits are the solution, because those who think as you do have caused these problems.
Who could disagree with the notion that markets have limits? But you’ve fallen into the same logical trap that I tried (and failed) to highlight in my previous comment. It simply isn’t good enough to say “approach x has failed; therefore, we must use y”. It really can be the case that there is *no* good solution to a problem and that all the alternatives to the current one could be *worse*.
To repeat, you have to do more than identify a failing in the market if you are to make the case for an alternative (statist) solution. You have to demonstrate why this alternative would be better. (And, of course, the converse applies but that’s not the direction being advocated here)
Richard
I disagree – if the market cannot meet a need (and it is quite clear that is very often the case) it does not mean the need does not exist. That is what you seem to be saying. It’s not true. Other signals of need are in existence. The democratic mandate is one.
Dealing with a need is the duty of elected governments. Markets do not over-rule that.
Richard
if the market cannot meet a need (and it is quite clear that is very often the case) it does not mean the need does not exist.
Correct.
That is what you seem to be saying.
With respect, it is not. Denying that there may be a perfect solution to a problem is not the same as denying the problem exists.
In any case, you are confusing intent with outcome:
Dealing with a need is the duty of elected governments.
Voters may, indeed, intend to see a problem fixed and elected governments may intend to fix them. However, what matters is the outcome. As a matter of basic logic, it simply doesn’t follow that any alternative to an imperfect solution is a better one. The intent of those proposing a solution really isn’t relevant to any discussion of its potential efficacy.
I should say I’m a litle perplexed by your attempt to change the terms of debate by introducing terms I didn’t use. I said nothing about “need” in my comments; I talked about “issues” and “problems”. Diferent words with very different connotations. I guess it’s your blog so you can do as you choose but it’s not helpful to reasoned discussion!
Richard
Can you have debate if you don’t move forward?
I’m confused too – but simply because you, like the majority of right wingers who like to read this site don’t speak a language I recognise. I sometimes presume it is based on braille – because it seems to be a language of the blind – or at least, of those not willing to see.
You can say this is abusive Iif you don’t, someone else will) – but actually it is about communicaton. If you comment here you’ll have to assume that it is my blog – and the engagement is with a person and (I think) a community of readers who simply don’t share your views. In which case the communication problem is your, not mine – because it’s you who is not using the language that I or most readers do not understand – and indeed often find incomprehensible.
So I make clear this is your problem, not mine. It’s entirely up to you if you ant to engage – but please don’t ask me to use your language and its inherent philosophy – it’s one I do not wish to embrace.
Richard
because it’s you who is not using the language that I or most readers do not understand – and indeed often find incomprehensible.
I assume you’re talking about language that has been used in other comments here? You clearly must understand the difference between “intent” and “outcome” – and realise that there is a very real difference between a “problem” (something that can be defined and reasoned about in terms of costs, benefits, outcomes, tradeoffs, etc) and a “need” (something far more emotive, where appeals to justice or morality can be used as alternatives to reason).
They both have their place but when talking about the very interesting subject of when any given approach is superior or inferior to another, surely it’s better to frame the underlying issue in objective terms so that the area of disagreement can be focussed on?
Richard
You are seeking to use normative language to promote your positive agenda.
I am normative through and through.
And that’s the way life is. Only economists and those on the right who buy the conventional economic model pretend otherwise.
In a normative world a problem relates to a need.
Richard
You are seeking to use normative language to promote your positive agenda.
I am normative through and through.
And that’s the way life is. Only economists and those on the right who buy the conventional economic model pretend otherwise.
In a normative world a problem relates to a need.
A very interesting point. At the risk of sounding like Alan Partridge, I looked up “normative” and “positive” after I read your comment and you have captured our difference perfectly.
However, I still believe there is a problem: you are incorrectly merging two quite different domains.
There is a problem/need domain and a solution domain in discussions of state vs market approaches.
In the problem domain, as you quite rightly suggest, one can discuss problems in terms of what *is* or in terms of what *should be*. That is fine.
However, in the solution domain, it doesn’t work. One may have used value judgements or morality to determine that something must be done. But when determing what that something should be, you can only evaluate options correctly if you think in terms of outcomes: “which of the available options is the best way of achieving the outcome we have decided we want?”
Ignoring this crucial subtlety means that good solutions can be dismissed out of hand, sometimes with tragic consequences.
Richard
Now you’re accusing me of absuing the naturalistic fallacy.
I don’t think I am – but that’s because we have different starting points. Our assumptions are so fundamentally different that I can derive my argument from those I use – and you cannot because you do not share them.
Richard
This discussion appears to have lost sight of its original focus – the merits of the BoE loan to Northern Rock.
If I may return to that issue, I wish to raise two issues. I will raise the second issue in a separate posting.
The first issue relates to your description of the loan itself. I hesitate to quible with a professional accountant, but I will anyway.
You wrote:
‘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.
You also point to your own explanation as to how that works. It seems to me that that explanation, and your further comments, are based on a paradigm and terminology associated with the use of precious coins as ‘money’ (with a meaningful quantity in circulation). Of course, no-one uses precious coins as ‘money’ any moore. However, it seems to me that you have used that paradigm and terminology erroneously to describe the current use of debt as ‘money’.
As an example of debt administration, if a citizen withdraws assets from Northern Rock and deposits those assets with (say) Barclays, then that single integral transaction is recorded in four (or more) sets of ‘books’:
1. The citizen (if he actually bothers to maintain ‘books’) credits Northern Rock and debits Barclays.
2. Barclays credits the citizen and debits the BoE.
3. The BoE credits Barclays and debits Northern Rock.
4. Northern Rock credits the BoE and debits the citizen.
This single integral transaction is a zero-sum closed-circle of zero-sum double-entry postings. Either the whole closed circle is posted, or the whole closed circle is cancelled. No net assets or liabilities are ever ‘created out of thin air’. No party is any richer or poorer. Debt administration is not like tracking physical precious coins (where there needs to be an ‘it’). With debt administration, there is never any actual ‘it’ to exist either before or after the transaction.
The global zero-sum network of owed-wealth (money or non-money without distinction) is simply a zero-sum book-keeping exercise which ‘keeps the score’ on where we are in our non-barter trading and employment activity. Those who have sold more than they have bought accumulate a net positive balance, and those who have bought more than they have sold accumulate a net negative balance. The grand total (of course) is zero. The distinction between money-wealth and non-money-wealth is (or ought to be) a purely-administrative factor; of interest only to students of the history of routine financial administration. Thus, macro-economists, central bankers and politicians (and this discussion) should ignore all concepts, expressions and aggregates associated with the expressions ‘money’ and ‘monetary policy’.
The loan to Northern Rock di not in any way divert resources from any other use, and any other propositions requiring and justifying a loan could proceed independently.
The second issue relates to your failure to distinguish clearly enough between solvency and liquidity. Again, I hesitate to quible with a professional accountant, but I will anyway.
A financial institution is solvent if it has positive net equity. The risk-weighted value of its loans (and hence, the value of its net equity) is determined according to the rules of the Basel Accord; as is its ability to lend.
A financial institution is liquid, if it doesn’t have a cash-flow problem.
As far as I know, Northern Rock is solvent but has a cash-flow problem. The BoE is simply replacing the fleeing depositors (including other banks) in providing cash-flow. You appear to be describing this a taking over the risks associated with a ‘failing bank’, without distinguishing between solvency and liquidity. The whole purpose of the Basel Accord, and regulation by the BoE/FSA, is that the risk of failure should be covered by equity. If the risk of failure is not covered by equity, then the BoE/FSA has failed in their role as regulators, and should bail out depositors on that account. If the risk of failure is covered by equity, the BoE ought to act as the lender of FIRST recourse at market rates, not LAST recourse at penal rates. In effect, all deposits should be on-lent to the BoE (and hence to a world bank), and all lending should be on-borrowed from the BoE (and hence a world bank).
You appear to be proposing that the BoE/FSA (with all their expertise, insights and regulatory influence) should allow financial institutions to borrow from ordinary citizens (without any realistic means to judge the solvency of a financial institution), whilst holding back themselves from lending. That appears to be the reverse of the normal arragements.
Tim, you seem to be suggesting that once a NRK customer has pulled their deposits and stuck them in Barclays instead, that Barclays somehow “deposits” this cash into the BoE. But this is not the case. Barclays now has that deposit money available to invest in whatever they like.
[…] http://www.taxresearch.org.uk/Blog/2007/11/05/northern-rock-the-real-questions-it-raises/ […]
just had a letter off Northern Rock saying our mortgage payments are going up by just over £195.00 a month – nearly a 20% increase in our monthly payments – not sure how this is helping to keep people in houses. Have only had the property 2 years and in that time it has fallen £28, 000 so unsure if any other lender would feel comfortable taking over (as Northern Rock have advised us to do!) 🙁