The Bank of England is facing the consequences of its own mistakes

by Shaun Richards

Yesterday brought us some new insights into the thinking of the Bank of England and indeed the UK establishment. This was because what you might consider the ultimate insider gave evidence to Parliament as Sir John Cunliffe joined the Department of the Environment as long ago as 1980. Intriguingly his degrees and lecturing experience in English Literature apparently qualified him to high level roles in HM Treasury. So he is also an example of how HM Treasury established the Bank of England as “independent” but then took back control. Actually I think all the Deputy Governors have been at the Treasury at some point in their careers. Also if we return to his degree we see another feature of modern life where those on the lower rungs have to be highly qualified in their sphere whereas it is no issue at all for those at the top. That is because they are considered to be – by themselves if nobody else – so highly intelligent that qualifications are unnecessary.

Sir John gave us a warning about the future.

One pocket of rapid growth that the FPC is monitoring closely is in leveraged lending which appears to have been driven by strong investor demand for holding the loans,
typically in non-bank structures such as CLOs (collateralised loan obligation funds). Gross issuance of leveraged loans by UK non-financial companies reached a record level of £38 billion in 2017 and a further £30 billion has already been issued in 2018. And lending terms have loosened with only around 20% of leveraged loans now having maintenance covenants, which used to be standard for all loans. The global leveraged loan market is larger than – and growing as quickly as – the US subprime mortgage market was in 2006.

The Bank of England Financial Policy Committee of which Sir John is a member ( he has nearly as many jobs as George Osborne) also posted a warning according to BusinessInsider.

Leveraged lending to corporates has ballooned in recent years, with the global market reaching a value of around $1.4 trillion, according to recent estimates.

Thus we see the establishment at play. Let us note that the ground is being prepared to blame “Johnny Foreigner” and also that as Nicola Duke points out below another deflection technique is at play.

This is how central bankers prepare for the next financial crisis. They take no action while ensuring they have their excuses in order. “We warned you in 2018”.

Let us take her point and see what is actually being done and the answer as usual appears to so far be nothing.

The FPC is planning to assess any implications for banks in the 2018 stress test and we will also review how the
increasing role of non-bank lenders and changes in the distribution of corporate debt could pose risks to financial stability.

As ever this is reactive and frankly a lagged reactive at that. These bodies never act in advance and are invariably asleep at the wheel whilst it is taking place. Of course if their real role is merely to describe what has happened then I may have been mistaken about Sir John’s qualifications for the job as suddenly English Literature becomes useful.

But there is an elephant in the room which is way that the Bank of England itself has fed this. It slashed interest-rates in response to the credit crunch and even now they are only 0.75% or around 4% below where they were previously. It has deployed some £435 billion of conventional QE and £10 billion of corporate bond QE. Then in 2012 it did this too.

The Funding for Lending Scheme is designed to encourage banks and building societies to lend more to households and businesses. It does this by providing funding to these firms for an extended period, with the quantity of funding we provide linked to their lending performance.

So the system has been flush with cash or to be more technically accurate, liquidity. Can anybody be surprised that like the ship of state the monetary system is a leaky vessel? Or to use a word from a couple of decades or so ago we are seeing another form of disintermediation. But wait there is more.

Since the referendum, the Bank of  England has augmented these capital and liquidity buffers by making available more than £250 billion of liquidity and by lowering banks’ Counter-Cyclical Capital Buffer to facilitate an extra £150 billion of lending.

This is from a speech given by Chief Economist Andy Haldane which was liked so much it was if you recall published twice just to make sure we got the message. Well perhaps the leveraged loans industry did! We’ve got your backs lads ( and lasses). But wait there was even more.

Put differently, I would rather run the risk of taking a sledgehammer to crack a nut than taking a miniature
rock hammer to tunnel my way out of prison – like another Andy, the one in the Shawshank Redemption………And this monetary response, if it is to buttress expectations and confidence, needs I think to be delivered promptly as well as muscularly.

The Bank of England has claimed some 250,000 jobs were saved/created ignoring that it would have been perhaps the fastest response to a monetary policy change in history. That leads it into conflict with the ECB that thinks the response time slowed. But if we return to what we might label in this instance as disintermediation there have been two clear examples.

  1. A surge in unsecured lending pushing into annual growth in the double digits that is still above 8%
  2. Corporate lending now increasingly leveraged with underwriting standards dropping like a stone.

Peter Gabriel may have done this but the Bank of England merely repeated the same old song.

I’ve kicked the habit
shed my skin
this is the new stuff

I go dancing in, we go dancing in

Comment

There are plenty of familiar themes at play today as we look again at how the establishment operates. There is a clear asymmetry between the way a move sees even fantasies proclaimed as triumphs but failures get ignored. It is the same way that “vigilant” means asleep and “we will also review” means a review will be necessary as by then it will probably have blown up. Fortunately we can then claim to be experts and specialists ( in failure to quote Jose Mourinho ) and sit on the various committees set up to discover what went wrong? That will of course make sure that those asleep at the wheel do not get the blame, as long as they can manage to stay awake during the meetings of the new committee.

Meanwhile the UK economy continues to bumble along. Whilst today’s headline may appear not so good it is in fact pretty strong.

In September 2018, the quantity bought declined by 0.8% when compared with August 2018, due mainly to a large fall of 1.5% in food stores; the largest decline in food store sales since October 2015.

That made the Office of National Statistics uncomfortable enough to delay it to the third paragraph of the release. But actually with a little perspective and somewhat amazingly the UK consumer continues to spend.

In the three months to September 2018, the quantity bought in retail sales increased by 1.2% when compared with the previous three months………When compared with September 2017, the quantity bought in September 2018 increased by 3.0%, with growth across all sectors except department stores.

Presently in economic terms ( as opposed to political) the main dangers to the UK economy have been created by the Bank of England.

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