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We rescued the banks. Here’s how they can help us rescue the economy.

A brighter future for the British economy - download PDFThere is a growing momentum behind the idea that the government's holdings in the high street banks should be used for investment to revive the economy and bring an end to stagnation, public sector cuts and rising unemployment. The Financial Times’ veteran economics commentator Samuel Brittan has recently argued for the state’s holdings in the banks to be used as the basis for creating a new state bank focused on productive investment.

He echoes calls from Adam Posen, perhaps the sole member of the current Bank of England Monetary Policy Committee who understands the gravity of the current situation and is not constrained by official orthodoxy in seeking remedies. Posen argues that the disastrous fall in bank lending needs to be corrected by decisive state action.

Brittan's concept resembles that of our pamphlet, 'A Brighter Economic Vision for Britain' (pdf), which argues the resources of RBS and the other banks rescued by the state should be used to fund investment in key areas. The channel for that could be a new National Investment Bank. Of his own proposals, Brittan says:

"Who knows what obstacles well-paid lawyers could think up? But in principle this could start next week. The main thing needed would be a Treasury directive to these banks to replace profit maximisation with a requirement to promote economic recovery."

One reason for the renewed slump in the share price of leading British banks is their exposure to the sovereign debt crisis. Yet Lloyds-TSB, which has no significant exposures to sovereign debt markets, has seen the price of its shares fall from 74p at the time of the government’s share-buying programme to 34p (at close of trading on 23 September). This compares with the collapse of RBS’s share price to 22p against a government purchase price of 52p.

This is because the main driver of the slump in banks’ shares is not the debt crisis, severe though that it is. Share prices have collapsed because of economic weakness and the deterioration in the banks’ existing loan book, personal, business, mortgage and other loans. While refusing to lend to new, productive areas, the banks are simply sitting on existing – and deteriorating – loan books.

Government can break the log-jam by initiating and guiding investment in housing, infrastructure, transport and education. Labour MP Jon Trickett described the idea of using the state's control over the banks as a way to resolve the crisis as "poetic justice". The private sector would benefit. Government contracts would mainly be awarded to large firms, but they tend to sub-contract or purchase inputs from SMEs and individuals.

The whole economy would benefit. All that is needed is for government to take the intiative.

Michael Burke is an economist and blogs at Socialist Economic Bulletin.

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