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Posen the question

4 October 2011 By George Hay

George Osborne is gazing across the Rubicon, and hesitating. It is still hard to see what exactly the UK Chancellor of the Exchequer meant when he talked about “credit easing” in his speech to the Conservative Party conference on Oct 3. But the concept looks more radical than the ill-fated Project Merlin earlier this year.

Osborne is trying to solve the major problem of funneling credit to small and medium-size enterprises (SMEs) in order to boost growth. Merlin set the banks formal lending targets. But banks could claim the demand wasn’t there.

Credit easing looks more inventive, with the Treasury shouldering the ultimate risk of loans to SMEs. The government could possibly revive the Bank of England’s 50 billion pound Asset Purchase Facility, originally intended for big companies that ended up using capital markets instead. The intention would be to lower yields by buying SME debt, with the Treasury guaranteeing any losses.

But according to a Treasury source, Osborne is also looking at ways to help banks get SME loans off their balance sheets, by selling their securitised loans to investors and guaranteeing purchasers against losses. Alternatively, he might set up a UK version of Fannie Mae and Freddie Mac, which helped establish a liquid market for U.S. mortgage-backed securities. The government is even pondering a version of the U.S. Term Asset-backed Securities Loan Facility (TALF), whereby the government could lend money to potential acquirers of SME debt.

These ideas, many of which seem to be cribbed from BoE dove Adam Posen, are all interesting. Asset purchases could be done in a way to avoid increasing the UK’s deficit, although they are still riddled with fiscal risks in case of actual losses. But the basic assumption is that the problem for SMEs is an inadequate supply of acceptably-priced loans, rather than a lack of demand in the face of gloomy economic prospects.

In spite of the government’s push, banks might still withhold credit, or make it too pricey for many SMEs seen as too risky. To get round that, Osborne could cut out the middleman entirely and adopt another of Posen’s nuclear suggestions – go into full-interventionist mode and set up a state-owned bank to offer cheap loans to small enterprises, like Germany’s KfW. But for a British Conservative chancellor, this ’Plan C’ really would be crossing the Rubicon.


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