Evercore Pan Asset

A few weeks ago the Financial Policy Committee of the Bank of England produced its first Report. This is the new Bank Committee responsible for bank regulation, and for ensuring the economic system is strong, solvent and working well. As you might expect from such an august body, its Report was full of charts, details and analysis. It reeked professionalism and authority.

Yet at the heart of its analysis and its recommendations there is a cruel dilemma. Is the priority to require ever more cash and capital from the banks, to buttress their balance sheets and guarantee no more failures? Or is the priority now to see some more lending in the UK economy, so we can resume a faster rate of growth?

The paradox is acute. Both the public and the private sectors have borrowed too much. Both need to get their deficits, if not their debts, down. They can only do so easily if there is more growth in the economy. Growth brings higher asset values, cutting the debt relative to assets and giving the overborrowed the option of selling assets to cut it. Growth brings higher incomes and more tax revenues, cutting the running deficits and making it easier to pay the interest bills.

If money and banking policy induces a big fall in output and asset values, as in 2008-9, indebtedness surges. Individuals and the government find it much more difficult to service the debts let alone repay them. Far from stabilising an overextended banking system, a large recession induces a banking crash – and vice versa.

So the FPC faces this conundrum. If it does not demand enough cash and capital, weak banks might fail and bring the system down again, hitting asset values and output. If it demands too much cash and capital from the banks they will not be able to lend extra to business or individuals. This in turn limits or stifles growth, making it more difficult for people and businesses to pay their interest and repay their debts on time.

The FPC and their friends at the Monetary Policy Committee need to find the Goldilocks solution, where the banking regulation and money growth is neither too hot nor too cold. At the moment they seem more preoccupied with protecting banks from further disasters by demanding more cash and capital, than they are concerned about the sluggish pace of bank lending to the UK domestic economy. Outside London the result is weak property prices, and difficulty in financing new property transactions and business expansion. The shortage of credit for small and medium sized businesses is partly reflected by an absence of good projects and a shortage of entrepreneurs who think it is worthwhile having a go.

UK shares are relatively cheap by world standards, reflecting Euro uncertainties and the slow rate of growth at home. Many of the larger companies of course primarily earn their living abroad and benefit from the growth in Asia and elsewhere. The UK index does, however, have a high weighting in oil and mining, sectors which are currently suffering from falls in commodity and energy prices. The Credit Crunch has cast a very long shadow over the west. In the UK and the US is taking time to unwind the excessive debts and high prices in real estate. In Euroland it is taking time to resolve the problem of excessive deficits run up by some of the governments within the zone. There are faster growing and better places to invest around the world whilst these deep rooted problems are being sorted out.

As published in Investment Week