Borrow, borrow, borrow
Just as we have been discussing levels of debt, Robert Peston informs us that the UK government will be guaranteeing billions of pounds more of corporate and consumer lending, starting tomorrow. This is somewhere between the US government's guarantees of Citigroup and Bank of America's debts, and a giant credit default swap (CDS). Quite clever, in that respect.
CDSs were a good business for lots of insurance companies for a long time, and now that the worst of the losses have probably been written off by banks already, they could be a good business again. CDSs do, I believe, increase economic efficiency by aggregating a portfolio of risks and allowing capital to flow to the most productive destination without being hampered by the "one bottle of poison" problem.
The state is by far the best provider of these services, because there is no counterparty risk, and because control is correlated with a positive return. That is, because the government has the ability to directly contribute to keeping businesses from going under.
The only real risk of public involvement in this business is that it might lead to underpricing of the risks; but the government has a genuine cost advantage over private companies in providing this service, so that is unlikely.
But I do object to Peston's characterisation of the situation:
"the paradox is that the Government wants to make more credit available to reduce the severity of a recession that was caused by a decade-long, crazy lending binge."
In fact, I am coming round to the view that the recession was not caused at all by lending, but by the contraction of lending - and that the appropriate level of debt may well be higher than it is. See my last post for a more detailed discussion of this point.
And on the other moral hazard issue - the idea that we are bailing out banks which should be suffering for their reckless decisions - let's remember two things:
- We are now substantial shareholders in several of these banks, and we will benefit too if they return to health
- We are being paid an insurance premium in return for these guarantees
- "The banks" are not an evil cabal who are the deadly enemies of the rest of the economy. They are an integral part of it, and their success enables and contributes to the success of all other companies. Punishing the banks would be cutting off our nose to spite our faces. At most, we may want to further dilute the equity of bank shareholders, and perhaps regulate the rewards of some bank executives; but even that is far from a proven case.