Home > Uncategorized > What is lending good for? The Frances Coppola view.

What is lending good for? The Frances Coppola view.

from: Frances Coppola (guest post)

Editor´s introduction: a pivotal discussion. The banking sector has been at the center of macro-economic problems. Not once, but again and again. And again. What to do? Some people argue that we should restrict bank lending to ´primary´ markets which produce new ´GDP´ goods and services, to prevent credit fuelled bubbles on ´secondary´ markets, like the market for existing dwellings or the art and stock market. Frances Coppola warns for a simplified view of the primary and secondary market: there are many and complicated micro-economic linkages which should not be ignored. I hope to publish some other guest posts about this very important problem in the near future. M.K. 

GDP transactions in secondary markets

There is a widespread view that much bank lending is unproductive, i.e. does not raise GDP – or if it does, it does so in an unsustainable way by inflating asset prices or increasing inflation, rather than by increasing production. Many proposals for bank reform therefore envisage restricting banks to “productive” lending, by which usually seems to be meant business finance and short-term consumer credit. Financial transactions on secondary markets, and the purchase of second-hand property, are regarded as unproductive.

This appears attractive. Banks do indeed lend far more for property purchase than they do for business finance, and most of the properties purchased are second-hand. So, the thinking goes, if we could eliminate unproductive housing finance, banks would lend more to businesses, and that would mean higher GDP in the longer term.

But I’m afraid there is a serious fallacy here. Lending for secondary market purchases does contribute to GDP, and not just in unhealthy asset price inflation. Without secondary markets, primary markets are diminished, and – by extension – so is GDP.

Here is an example. Suppose I buy a brand-new house off plan. Clearly, the building of my new house employs a significant number of people in various trades, who collectively create a “product” – a house – so my purchase is a GDP transaction. The bank that lends me the money to buy my house has therefore lent productively. Few in the UK would disagree with this. But in Spain or Ireland they might see things differently: after all, building houses there became a wholly unproductive activity prior to 2008.

But suppose I buy a listed building with no roof, rotten floors, shattered windows and holes in the walls, which I then restore for subsequent sale?  For the restoration, I employ a significant number of people in various trades, who collectively create a “product” – a refurbished house – that can be sold for a much higher price than the original dilapidated shell. Clearly, this contributes to GDP. It also brings into use a house that previously was not suitable for habitation. Please tell me why the borrowing to finance this should be regarded as “unproductive” when the borrowing to buy a brand-new house is not?


Perhaps, though, this is too obvious an example. Suppose I buy a house owned by an elderly lady who has lived there for 50 years. The house is not in poor condition, but the décor is not to my taste and it needs modernisation. I could do it up gradually, paying for improvements entirely from earned income. But I choose to front-load the upgrade by taking out a Home Improvement Loan. This is consumer credit that I would not have taken out if I had not bought the house. Because I borrow to do up the house, I provide employment to assorted tradesmen, revenue to the suppliers of kitchen & bathroom equipment and income to the staff on the tills at B&Q. And when I have finished decorating, I buy new carpets and furnishings, probably also on consumer credit. None of this would have happened if I had not bought the house. So although buying a house in good condition on the secondary market does not itself contribute to GDP, since the house was built long before I was born, the things I do after buying it to make it a place I like to live in do contribute to GDP. Is financing a secondary market house purchase of this type “unproductive”? I don’t think so.


In fact most people purchasing second-hand houses decorate and refurnish them, and most do so using consumer credit. The second-hand housing market gives considerable impetus to GDP through these consequential transactions.

And there is another side to this. What happens to the money I pay to buy the house?

In my first example, I pay a deposit up front, and my final payment when the house is completed and all snags resolved. The money goes to the builder, who pays down the loan he has taken out to fund the building of the house. So the money I borrow simply refinances the builder’s loan. Is this a contribution to GDP? No. It is the original builder’s loan that contributes to GDP. My subsequent mortgage does not, directly – though without people like me borrowing to buy houses, builders would quickly default on their loans, as Ireland’s banks discovered.

In my second example, I pay for the shell up-front. The person I buy the shell from, hugely relieved to have got rid of the unproductive millstone round his neck, splashes out some of the money on a much-needed holiday in the Seychelles, and uses the rest to buy a brand new top-of-the range BMW. Does this contribute to GDP? Clearly yes, though the holiday mostly contributes to the GDP of the Seychelles and the BMW to the GDP of Germany. So my shell purchase is productive in more ways than one.

In my third example, the elderly lady is going into residential care, and the money raised from the sale of her house will go towards paying for her care. The sale of her house therefore funds employment in the care sector, which contributes to GDP.

But even if my elderly lady were only buying a retirement flat, the transaction would still contribute to GDP, since my house is worth more than her retirement flat and she can use the difference to top-up her consumption spending.

So secondary market purchases of property DO contribute to GDP, in lots of ways. In fact the refurbishment example is the most GDP-enhancing of these purchases, and the elderly lady example is arguably the most socially useful. Surely the lending to finance these should be regarded as “productive”.

But all secondary market transactions are potentially GDP enhancing. This is because of their “pull” effect on primary markets. For example, consider someone who owns a 5-year-old BMW. He wants to buy a brand new car, but he needs to sell his current one in order to afford a new one. So he trades in his car. If there were no secondary market for cars he would be unable to do this: he would drive his BMW until it fell apart, rather than buying a new one every 5 years. True, car manufacturers might respond by cutting the prices of new cars to entice purchases, and they might run a scrappage scheme for cars older than 5 years: but could this really be called “productive”?

When there is no secondary market for long-dated assets, the issue of new assets in that class is limited by the availability of new entrants to the market. Secondary markets are essential to maintain liquidity: restricting finance for secondary markets actually diminishes, rather than increasing, primary market activity.

So the idea that secondary market purchases are “unproductive” is thus incorrect on many counts. Restricting finance for secondary market purchases, whether cars, houses or financial assets, puts downwards pressure on GDP.


  1. Joseph Feredoes
    September 22, 2015 at 9:14 am

    Just one simple thought … Why are we so keen on watching the GDP all the time? Is increasing the GDP is the only aim of a society? Society can function pretty well without assessing everything on the basis of GDP – which is a fairly false indicator anyway. Wellbeing of people is much more complicated than this – in fact, many GDP-increasing factors do more harm than profit. (on a rainy day car accidents are more frequent – more job to panelbeaters, hence increased GDP. The earthquake in Christchurch (NZ) generated a lot of building orders – increased GDP – great!). Forget about this damn indicator altogether and let us concentrate on factors which increase general wellbeing and satisfaction people.

    • merijnknibbe
      September 22, 2015 at 9:29 am

      Dear Joseph,

      GDP is a monetary society an emergent variable.And as such not a fairly false indicator.

      It is a three dimensional variable with income as one dimension, the value added of production as the second dimension and ´GDP/spending´ as the third dimension. Count these flows independently and precisely and you will end up with estimates which are surprisingly alike (though there are always mismeasurements and conceptual issues).

      It is however not about well being.The way we measure it is not designed to measure well being. It is about monetary production, paid employment and spending. It only covers the monetary side of life.

      As such, this variable can only be understood as part of the national accounts, which map flows and stocks of labour, spending, income, wealth, production, debts as well as materials.

      However, when GDP goes down income and employment go down too (though there is quite a difference between the consequences of a construction bust and an oil production bust). Which is abslutely detrimental to well being.

      And even if it does not grow, the flows of income, production and spending are highly dependend on gross flows of credit. That´s in fact one of the points of this discussion. A part of the total flow of credit is necessary to enable the flows (which includes my job), in direct and indirect ways.

      And the way these flows are financed does matter, even during busts. Changing the financial system without taking due account of these interrelations is asking for trouble.So, read ´GDP enhancing flows of credit´ as ´flows of credit which enable people to work and produce, for instance in health care and agriculture´.

  2. September 22, 2015 at 1:40 pm

    I think the argument misses a few things. Banks not lending to secondary markets does not eliminate secondary markets. There is no bank lending for second hand computers, but when I sell mine most of that money will be be immediately ‘respent’ on part of a new computer. No banks at all.

    In the first few cases there is a really big miss in terms of land vs improvements. Building a house is not a secondary market, just a building a new tractor is not. But the land component certainly is, and the property asset market is actually a land market (the asset) which happens to have some productive equipment attached to it.

    This distinction is often made directly in property finance for new developments – financing land/site purchases (the asset) is quite different to financing the construction component (the productive part). If this distinction can be made in the quite large development finance market, surely it can be made in the mortgage market generally.

  3. Marko
    September 22, 2015 at 4:14 pm

    Lending which fails to contribute to gdp has not been the norm in the U.S. over the last 60+ yrs , thankfully , or we’d be in even worse shape. Additionally , when bad lending does occur , it doesn’t all happen in a few weeks or months , it’s over a period of several years , leaving plenty of time to detect and correct the problem. Our problem has been that we’ve chosen to ignore these periods of “bankers gone wild” until a crisis ensues – specifically in the ’80s with the S&L crisis and in the 2000s with the GFC.

    When economy-wide debt/gdp is rising , by definition you’re not growing gdp as fast as you’re growing debt. Set a benchmark – say 10-15% above a baseline % debt/gdp – and when you exceed that benchmark , start flooding the banks with FBI agents – they’ll find plenty to do , I’m sure. And lending will suddenly , like magic , become “gdp-producing” again.

    Look at this chart , and imagine the troubles that could have been averted if we’d done this in 1983-84 , and again in 2003-04 – periods when debt/gdp had clearly started to rise in an unusual fashion:


    Responsible lending generally results in loans that can be paid back , and in stable debt/gdp ratios. Leave bankers to their own devices , however , and you can expect trouble.

  4. September 22, 2015 at 5:05 pm

    The Coppola method: Adam Smith reincarnated?
    Comment on ‘What is lending good for? The Frances Coppola view.’

    “… Adam Smith … disliked whatever went beyond plain common sense. He never moved above the heads of even the dullest readers. He led them on gently, encouraging them by trivialities and homely observations, making them feel comfortable all along.” (Schumpeter, 1994, p. 185)

    Frances Coppola correctly identifies the problem: “[She] warns for a simplified view of the primary and secondary market: there are many and complicated micro-economic linkages which should not be ignored.” (See intro)

    This, of course, is true but economic analysis does not consist of ‘trivialities and homely observations’ and a heap of examples. What is needed is a consistent big picture of all interconnections. Examples that are not imbedded into a comprehensive analytical framework are worthless. This is what Whitehead called the fallacy of misplaced realism.

    What is missing in Coppola’s micro-partial-approach is the interconnection of total saving/dissaving, changes in the stock of money/credit/debt, and total profit/loss for the economy as a whole. For the correct approach see (2011; 2013; 2014).

    Egmont Kakarot-Handtke

    Kakarot-Handtke, E. (2011). Primary and Secondary Markets. SSRN Working Paper
    Series, 1917012: 1–26. URL http://ssrn.com/abstract=1917012.
    Kakarot-Handtke, E. (2013). Settling the Theory of Saving. SSRN Working Paper
    Series, 2220651: 1–23. URL http://ssrn.com/abstract=2220651.
    Kakarot-Handtke, E. (2014). Loanable Funds vs. Endogenous Money: Krugman
    is Wrong, Keen is Right. SSRN Working Paper Series, 2389341: 1–17. URL
    Schumpeter, J. A. (1994). History of Economic Analysis. New York, NY: Oxford
    University Press.

  5. antireifier
    September 22, 2015 at 5:09 pm

    GDP is one of those theoretical measurements that makes little sense. In the examples given, the waste disposal of a new house where the builder may bury some toxic materials in the ground does not count in the GDP until problems arise years later and it has to be cleaned up at the taxpayers’ expense. If the builder properly disposes of it immediately it counts in the GDP immediately. So some things that should be counted are not counted and some things that should not be counted are included weighting the GDP in favour of disasters, waste and environmental degradation. The time and effort of women who work in the home looking after family, shopping, volunteering in the schools and daycares, etc. do not count in the GDP although their husbands sitting at a desk all day watching radar for incoming missiles do count (see the documentary If Women Counted).

    It is easy to increase GDP by promoting disasters — no fire regulations or building standards for example. The drones bombing ISIS, Iraq, Syria, etc. contribute to the GDP hugely. The cleanup and reconstruction after if we bring in another Marshall plan will boost GDP hugely. But the collatoral damage — dead people — does not get counted. Their surviving family members will not be comforted knowing that the dead contributed to a growth in GDP!

  6. September 22, 2015 at 6:08 pm

    This is amazingly naive (deliberately so?). Why did people start to think that bank lending is unproductive and leads to bubbles? Because of the Global Financial Crisis. Loans were given to customers to enable them to buy overvalued houses which further increased the value of the houses — so the loans were made to buy into a bubble. The level of FRAUD in making such loans, where banks KNEW that the customer would be unable to make his payments, and DOCTORED the documents to make him appear eligible, so they could SELL the mortgage as a security has been documented in many places — see for example House of Debt by Mian and Sufi.

    The author shows how bank lending can stimulate the economy and simple IGNORES all cases where this does not hold., She fails to consider the fact that there have been hundreds of economic crises due to excessive lending by banks in the past few decades. Why did this happen if all lending is always productive? Her analyses makes no mention of the scenarios where bank lending into a bubble leads to collapse. Although the author does know about it, she makes no mention of The Minsky Financial Fragility theory, and how excessive bank lending creates Ponzi schemes. The post seems designed to try to fool the reader into trusting banks again, after this trust has been lost in the recent crisis.

    • merijnknibbe
      September 22, 2015 at 9:12 pm

      I take issue with the phrase ´naive´. It´s based upon a distinction between primary and secondary markets as well as upon the idea tha banks create money in a pretty unhampered way, instead of a loanable funds idea. Try to find that in a economics textbook… that´s where you will find really naive ideas.

  7. shah8
    September 22, 2015 at 9:21 pm

    Bank lending in property tends to have bad GDP results because there are a lot of rentier extraction associated with property. Such rentier dominance have negative second and third order effects like low propensity to spend, etc, etc.

  8. September 23, 2015 at 2:16 am

    The arguments are red herrings. It has been demonstrated over and over and over again that excessive credit availability — due to power of money creation — leads to speculative binges — Manias, Panics and Crashes. Reasons for this are given by Minsky, that bank credit creation is pro-cyclical, when correct monetary policy should be countercyclical. To counter this by saying that there are cases where bank lending is productive is just a distraction — it does not address the main arguments against excess money creation by banks.

    There is a very nice video I saw recently: A Twelve Year Old Reveals One of the Best Kept Secrets — this 12yr old has more insight into banking than Frances Coppola:

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