Don’t believe the hype: there’s no upside to the PPI scandal

It is the gift that keeps on giving. The scandal over the mis-selling of payment protection insurance (PPI) by high-street banks has gone on for longer than anyone could have imagined. This week Lloyds set aside another £1.8bn to cover the compensation for all the policies it sold to people who didn't need them. In total, the main British banks have now paid out a staggering £20bn.

Yet somehow the banks, or their PR people, have managed to sell the idea that this helps the economy. Switch on the news, or read about it in the paper, and you'll hear that while it is of course a terrible mess at least PPI payments boost the economy by stimulating spending. This is nonsense, just as the argument that higher government spending helps the economy is nonsense too. All it does is shift spending from one place to another. The reality is that PPI is just a disgrace to the financial system.

Looking back, it is surprising that anyone ever bought a PPI policy in the first place. You only had to read a few clauses of the contract to see that, while the bank was happy to take your money every month, there were very few circumstances in which it would give any of it back.

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But heavy-pressure sales tactics from bank staff, spurred on by generous bonus schemes, meant that a remarkable number of people did take out these policies, misguidedly believing that the insurance would help them service their debts if they lost their job or fell ill.

PPI was an unpleasant line of business preying on people's anxieties and exploiting them to fleece them of money they could probably not afford, and the companies involved have quite rightly been punished. It's not hard to imagine the spin doctors being stumped as to how to mitigate the damage to their clients' reputations.

But then they came up with a brainwave. They would plant the idea that, although regrettable, PPI actually helps the economy, because the people receiving their compensation will go out and spend it. Remarkably, this line appears to have achieved some traction.

"These PPI payments have played a very big role in encouraging economic recovery," BBC business editor Robert Peston told listeners to the Today programme on Monday, as he reported news of the Lloyds provisions.

"From an economic point of view, the timing of these payouts is quite good," said Jonathan Portes, director of the National Institute for Economic and Social Research, of an earlier round of pay-outs. "This is a good time for the money to be flowing into the economy." PPI bonanzas were even linked to the recent surge in car sales.

Economists and business editors often talk rubbish, of course. It is less than a year since we were being told that the government's very modest austerity programme would plunge us into a fresh recession. Even so, this is a spectacularly stupid argument.It is the same fallacy as the idea that increased government spending helps the economy. Yes, it is obviously true that the money the government spends helps create some demand, both from the goods it buys directly, and from the wages it pays to staff.

But, as anyone apart from the shadow chancellor, Ed Balls, should have realised by now, the higher taxes and borrowing needed to pay for that extra spending reduces demand by a similar amount. The net result is zero. In fact, it is slightly less than zero, because the state spending is more likely to be wasted than the private-sector spending.

Likewise, PPI payouts clearly create some spending. If you receive two grand from Lloyds, you may well buy a new car, take a holiday, or spend more at the shops. But the money came from somewhere. It means lower profits for the bank, which means fewer dividends to shareholders (when it starts paying them again), less money for its staff, and probably fewer loans to small businesses as well. The net result will be zero extra spending. It is a mistake to look only at what money is put into the economy without also asking what has been taken out.

Look at it this way: if mis-selling by the banks is so fantastic, why not encourage more of it? Get rid of the Financial Conduct Authority, and get them to mis-sell us all kinds of things insurance against heavy rain, catching the flu in winter, or getting stuck in traffic on the M25, all of which they would have to compensate us for when the claims were never honoured.

And why not get the energy companies and broadband providers and supermarkets to mis-sell us lots of stuff too, and get them all paying compensation? Then just sit back and watch the economy boom.That would be crazy but it is the essence of the PPI lobby's argument.

In truth, a sound economy arises from well-managed companies selling good-quality products at decent prices in a free, competitive market. PPI was a failure of that system. It has shattered trust in banks and wasted vast sums of money on lawyers and regulators to get the mess cleaned up. It is a scandal, from which no good comes and anyone who suggests otherwise is being spun by the banks.