Mervyn and leverage
The Governor of the Bank of England didn't pull out the stops to cheer us up in his speech last night.
What was particularly striking were his closing remarks, when he said that he was sure an economic recovery would come and that there would certainly be a positive outcome from all those interest rate cuts and the hundreds of billions of taxpayers' cash allocated to pumping up the wilting banking system and stimulating demand.
But - and it's an important qualification - he couldn't be sure when the economy would turn. He said: "No one can know at what point the impact of all this stimulus will have a visible effect on activity; the lags in economy policy are notoriously long and unpredictable".
Oh dear. If the economists we trust to steer us through this mess ever had a torch, the battery appears to be flat.
Nor did I feel particularly reassured by his assessment of when the great cause of our woes will be fixed, the reduction in borrowing and lending by banks and other financial institutions.
To remind those who don't live and breathe bankers' jargon, when Mervyn King talks about "leverage ratios" he means the relationship between a bank's debts and its capital resources. He said that the "leverage ratios of large banks remain at remarkably high levels and the required adjustment will not happen quickly... With fresh capital from the private sector difficult to obtain, banks have opted to reduce their lending and that is why the flow of credit to all parts of the economy, here and abroad, has been heavily disrupted."
It's that stress on the leverage ratios of banks still being "remarkably high" that slightly surprises me. Not because it's wrong. But the Treasury and the Financial Services Authority have frantically been trying to reassure the banks that they have ample capital resources to finance their balance sheets - and Mr King does seem to be saying something different.
Mr King went on to say that "banks are encouraged to run down their capital to enable them to absorb losses while continuing to lend, but in the long run they will need more capital".
Again, this is not quite what the FSA is saying. The City watchdog's message - which it repeated loudly on Monday - is that our banks currently have enough capital to absorb the losses they'll incur as the recession causes increasing difficulties for borrowers. It says that their capital ratios will still be at acceptable levels even after the losses have been absorbed.
But if the Governor is right that banks have inadequate capital for the long term, the markets will price that in today, in the form of lower share prices for banks and much more demanding terms for the credit they require.
Considering the mullering of bank share prices in the past couple of days, it looks as though the Governor is right. But I doubt the Treasury or the FSA will thank him for pointing it out.
It's not all gloomy news, according to King. He says that because so much of banks' excessive lending and borrowing has been with other financial institutions, there is "scope for a reduction in the leverage of banks without restricting lending to the 'real' economy".
There are two things to say about this.
First, as John Gieve, the Deputy Governor of the Bank of England, told me in an interview for my Panorama documentary before Christmas, the Bank of England was too sanguine during the boom years that there was some kind of cordon sanitaire around the debt and asset bubble, such that when the bubble was pricked it wouldn't infect the real economy too much.
That turned out to be spectacularly wrong. It's therefore reasonable to question whether the non-financial sector (that's you and me, and "real" businesses) can be protected from the massive reduction of lending between financial institutions.
Also, the way the Treasury is trying to protect the non-financial sector is by imposing formal quantitative targets for lending to businesses and households on those banks in receipt of financial support from taxpayers. As you've noticed, it's instructing the banks to lend considerably more to all of us.
Which is all very well.
But as I've pointed out before, if all countries forced their banks to concentrate their lending on domestic markets, that would lead to an even sharper fall in cross-border flows of funds and capital than is already taking place.
It would amount to a kind of financial protectionism, a beggar-my-neighbour policy, that could impoverish us a lot more than would otherwise be the case.
So the Treasury should tread a little warily, I think, before forcing all our banks to do nothing but their patriotic duty.
PS: Mervyn King is at pains to point out that he hasn't run out of all tools to revive lending and the economy.
He confirmed that we're probably about to enter the relatively uncharted wilderness of "unconventional measures" to stimulate the flow of credit and money: what's called quantitative easing, or the creation of reserves at commercial banks by the Bank of England buying all manner of financial assets, in the hope that the banks won't just sit on these reserves but will convert them into loans to the private sector.
It's reasonable to see this as the creation of new money. The big question is whether it would circulate and stimulate transactions - which is what the Bank of England would want - or would be hoarded.
In fact, within a matter of weeks, we'll see the Bank take an imaginative first step in that direction, when it starts to buy up corporate debt (not for cash, but in exchange for Treasury Bills), in the hope that the liquidity of the market for corporate debt will be significantly improved and thus make it cheaper and easier for big companies to borrow.
This may sound tediously technical. But it is big stuff. It represents the public sector, us as taxpayers, lending directly to companies (even though the Bank will be buying this stuff on the secondary market).