What happens if you give a load of small businesses emergency loans during an economic crisis of indeterminate length? It’s not a hard question: you’d expect quite a few of them to go bad.
Let’s throw in another factor: what if those loans are made with essentially no scrutiny and in a very big hurry? That’s not a hard question either – you’d expect even more of them to go bad. So the only really tough question is: who’ll pay for that?
Let’s find out.
Bounce back loans will only bounce back so high
“UK banks warn 40-50% of ‘bounce back’ borrowers will default”. That’s a headline on the FT website this morning.
Here’s the story: the chancellor has put in place a Bounce Back Loan Scheme (that’s BBLS for acronym fans, though I won’t be using it). If you are a small business, and you’re in trouble, you can get a bank loan of up to £50,000, repayable over up to six years.
Here’s the good part: it’s 100% government guaranteed, so banks take no risk at all in writing these loans. The reason for that is to make sure that they actually hand over the money.
This is designed to keep small businesses with liquidity issues (ie, they’ve run out of cash because they’ve been forced to shut, not because they are bad businesses) afloat amid the coronavirus lockdown.
The risk is that a lot of these small firms actually have solvency issues (ie, they were going to go to the wall at some point soon regardless of how strong the underlying economy was; or their business model has been fatally undermined by Covid-19 in some way). That means they won’t bounce back – instead they’ll just munch through the £50k and go under anyway.
But why are the banks worried? I mean, all of the risk falls on the taxpayer.
Well… not quite all of the risk. Here’s the trouble: the banks don’t take a hit if the loans go bad, but they are in charge of chasing lenders for the debt. And how’s that going to look?
As the FT puts it: “executives are worried that pursuing through the courts hundreds of thousands of small, often family-run businesses – which have borrowed an average of £30,000 each – would be logistically impossible and a ‘PR disaster’.”
Banks should be scared – this is their shot at redemption
The banks are of course, absolutely right to fear a PR disaster. They are still trying to launder the damage done to their reputations over the decade that followed 2007.
You know: the queues outside Northern Rock; the subsequent collapse of much of the building society sector – remember when names like Bradford & Bingley and Alliance & Leicester were actually significant brands? – the nationalisation of RBS and then Lloyds; the PPI scandal; the Libor scandal; the various other individual scandals and court cases. I could go on, but you get the picture.
2020 could be the golden opportunity for them to prove they can be helpful during the bad times rather than predatory during the good times… and the bad times. It could also leave them up to their necks in admin and reputation management disasters.
So they’re getting some pre-emptive strikes in now. They’re warning the government – you told us to lend to these people (“one executive said about a quarter of the loans would not have been made under normal lending practices”), so you need to own the consequences if they can’t pay up.
Sajid Javid, the former chancellor, has hinted at the idea of a “bad bank”, where all the loans that go bad could end up. Presumably you’d then be able to divorce the bad debt chasing from the banks who’d initially made the loans, although the state won’t be keen to take the hit either.
Here’s how we’re going to pay for all this – via inflation
My heart goes out to anyone who set up a small business going into this, or has seen a long-running successful business brought to the brink of disaster by Covid and its knock-on effects. That should go without saying, but it’s funny how many things that shouldn’t need to be said are in fact important to say.
But taking a broader view, the questions this raises about how we deal with the debt fallout from all this are applicable across the board.
Here’s one issue: if you go too easy on those who borrow this money but then default on it, how are the business owners who paid it back going to feel? To make this politically acceptable, there needs to be a clear consequence to failing to repay (hence the “bad bank” idea).
At the same time, you don’t really want to cripple a whole chunk of the economy with onerous debt. So, in practical terms, when these loans go bad, the lion’s share of the bad debt is going to be swallowed by the government’s balance sheet.
Usually in these cases, I would say the taxpayer. Here, I don’t think that’s the case. You see, as my colleague Merryn has been saying for ages, this sort of thing is like a mini-debt jubilee. Write off a debt here, and another debt there, and pretty soon you’ve handed out a lot of money.
This also – as James Ferguson of the MacroStrategy Partnership has been pointing out – is where 2020 differs from the post-2008 rescue package (you can hear more from James in the latest MoneyWeek Podcast).
In 2009, central banks needed to patch up the global banking sector. Let’s envisage the financial system as a network of pipes with water running through them (it’s not always a good model but it works for this metaphor). In 2008, the pipes all burst as it turned out that banks had been doing their own plumbing, but had been total cowboys about it.
As fast as central banks pumped money into the system, it flooded out of one or more leaks. It took a long time for all the leaks to be plugged (and arguably there are still some outstanding, although as the eurozone creeps closer and closer to some sort of fiscal union, that’s less of an issue).
So that money didn’t get into the “real” economy. Instead the banks were like a giant sponge, helped (or hindered) by lots of new regulations that required them to be better capitalised and to hold more “safe” assets generally.
This time, it’s different. The central bank is printing money to support the issuance of ever-more government debt. That government debt is being used – as above – to back loans (via the banking sector) that might never be repaid. Or it is being used to pay wages that would otherwise not have been paid (for staff who were furloughed rather than laid off, for example).
So the extra money is getting out there. The demand hit from Covid-19 itself is deflationary. And rising unemployment is deflationary (although only inasmuch as it’s not offset by increased government spending on benefits). But the added money supply is very much an inflationary influence this time around.
That’s before you even start thinking about how this is going to be paid back. Some people are still talking about spending cuts or tax hikes. The Times is currently printing a lot of opinion columns in this vein just now for some reason.
But you think that’s going to wash? In this political environment? After we’ve taken this sort of economic hit? With all the instability and general levels of confusion and anger about? I think that’s just wilfully blind.
This debt is going to be paid back the way that’s easy for politicians, but fraught with risk for investors – and that’s via the good old inflation tax.
We’ll talk a lot more about this over the coming months in MoneyWeek magazine (including what sorts of things you need to be investing in, of course, plus the mechanisms by which inflation could happen). Get your first six issues free here (plus an ebook on past crashes which might also throw a few hints as to the next one into the mix).