Marcus Evans Group | Worldwide Headquarters | American Offices | Latin America | European Offices | African / Asian Offices

George Osborne’s credit easing to fill gap left by Project Merlin

The chancellor announces steps to avoid another credit crunch

George Osborne’s use of the phrase “credit easing” at the Conservative party conference is attracting much interest. While the precise details are being worked on, one thing does seem clear: Project Merlin – signed only in February – is not working.

As a reminder, Merlin was intended to curb bonuses and keep banks lending. This is what Merlin said at the time.

A clear statement of their desire to see the banks’ net lending balances to UK businesses increase responsibly (especially with respect to small and medium-sized businesses and the non real estate and construction sectors), recognising the actual outcome will be based on decisions by customers.

This is what Osborne said to the Tory party conference on Monday.

Everyone knows Britain’s small firms are struggling to get credit and banks are weak. So as part of my determination to get the economy moving I have set the Treasury to work on ways to inject money directly into parts of the economy that need it such as small businesses. It’s known as credit easing.

It’s another form of monetary activism. It’s similar to the National Loan Guarantee Scheme we talked about in opposition. It could help prevent another credit crunch; provide a real boost to British business; and over time help solve that age old problem in Britain: not enough long-term investment in small business and enterprise.

In the late 2008, the Tories called for a £50bn national loan guarantee scheme that would underwrite a “significant percentage” of new loans to UK businesses.

It seems that all options are being considered by Osborne and the Treasury about how his idea for “credit easing” would work and could go beyond the national loan guarantee scheme. Answers are promised in the autumn statement.

But, a couple of ideas are being floated. Corporate bonds could be bought. This market is around £180bn in size and the bonds could be bought directly from the market. Or loans to small and medium sized enterprises (SMEs) could be packaged up in so-called securitisations and then hoovered up.

That raises the question of who might by them. The Treasury could ask the Bank of England to act as agent and buy them directly, or create some sort of special purpose vehicle that would buy them instead.

How would the money feed through small businesses? It seems that Osborne is trying to avoid the scenario where the Treasury starts directing lending itself and instead encourages banks to be willing to take on more risks and lend to businesses that might otherwise be turned away. There is also an idea used in America called Talf – Term Asset-Backed Securities Loan Facility – which was used to encourage credit to SMEs which lent money to the issuers of bonds instead.

Crucially, Osborne will be hoping that what ever his “credit easing” looks like, it does not hamper his efforts to cut the deficit. As long the government is only on the hook for a guarantee, then the chancellor’s deficit reduction programme will not be affected, provided that the guarantee never turns into an underperforming loan.

If the government buys assets, it becomes more complicated and depends on the judgement of the Office for National Statistics which decides whether it is “liquid”. If it is not liquid – essentially able to bought and sold on the market – the debt increases but borrowing doesn’t. If it is liquid, it is treated by the ONS in the same way as the guarantee.

The chancellor will be trying to conjure up a plan that looks like a guarantee – but with the same impact as a giant loan. © 2011 Guardian News and Media Limited or its affiliated companies. All rights reserved. | Use of this content is subject to our Terms & Conditions | More Feeds