Part-nationalisation of British banks is an economic necessity for all, so why the long face?
The government this morning announced details of its much heralded plan to shore up the British banking system. The far-reaching plan comes in three not-so-bite-sized chunks, with a 'public appeasement' kicker:
- Part-nationalisation of a group of leading banks currently struggling for capital - Abbey, Barclays, HBOS, HSBC, Lloyds TSB, Nationwide Building Society, Royal Bank of Scotland and Standard Chartered. At a cost of £50bn
- Pumping an additional £200bn into its Special Liquidity Scheme, which provides short term (three month) loans for banks, secured against bank assets
- A further provision of £250bn to underwrite inter-bank lending. Designed to restore confidence in the money markets, for a fee of course
The £500bn overall package will be funded from the public purse, but some caveats have been put in place to ensure that those banks taking advantage of the plan toe the line (and to sweeten the pill for tax-payers).
First of all, every bank taking part must sign up to a set of terms and conditions designed to ensure that we all feel some benefit from the national investment. Those terms set limits on executive pay and shareholder dividends, whilst banks must commit to supporting business and households through the provision of credit and mortgage finance. As Chancellor, Alistair Darling put it, "This is not a licence for banks to continue to trade as normal".
Secondly, the nationalisation scheme will see the banks swap 'preferential shares' for government finance. Essentially, those shares will be first in line for any dividend payable to shareholders and would get first dibs on bank assets should any of them ultimately go to the wall.
So, contrary to reports in the ever-balanced Daily Mail, this is not really a "...desperate £500bn semi-nationalisation of Britain's banks." Yes there are risks. What happens if the government guarantees interbank lending and but ultimately has to cough up the cash? Well, we'd all bit in hock to the tune of up to £250bn. At the same time, if the banks being part-nationalised fail, then that £50bn investment will turn sour pretty quickly. On the up-side, the £200bn lending facility is much more secure, since it is secured against top-grade bank collateral.
In reality, it is an entirely necessary £50bn part-nationalisation of the banks, with a further £450bn earmarked to attempt to grease the wheels of interbank lending which has practically ground to a halt in recent months. The two are, of course, inter-dependent - the second measure helping to protect the first. That is, the strength of a bank's balance sheet has a direct impact on other banks', and sources of private finance, willingness to lend them money - the injection of up to £15bn each will certainly help on that score.
Equally, underwriting bank lending helps to mitigate perceived risk - if lenders feel confident they will get their money back, they will be more likely to lend, and at more attractive rates of interest. When you consider how close RBS came the brink over the last few days (at one point shares were traded for as little as 1p as investors ran for the hills) it's easy to see why the government had to act, and this plan does seem to strike at the heart of the issue. Of course, banks shares dropped again in the immediate aftermath as shareholders bleated about capped dividends and diluted holdings and investor reacted to turmoil in the Asian markets. But the hope is that they will start to stabilise sooner rather than later...
Predictably though, and I'm getting to the point now, the public reaction seems to be one of outrage at 'propping up the banks so they can make more money from us'. That's an understandable view, after all the banks were hardly flavour of the month before this turmoil began. But to simply moan about taxes and 'preferring to have the £2,000 this could cost each taxpayer as a lump sum' is myopic in the extreme. A functioning banking system is fundamental to every aspect of modern life. If the banks were allowed to go to the wall, the cost to each of us would make £2,000 look like pocket money. Even in the short term, if they have no access to credit on the money markets, they simply hoard cash, putting vital finance out of the reach of businesses and home-owners.
At the same time, there is an opportunity for the public finances to make a healthy return on the national investment. If all goes to plan, those preferential shares can be sold in the future for a profit, whilst the £450bn in guarantees and loan finance would all be paid back with interest. Personally, I think that is vastly preferable to simply buying up a load of 'toxic mortgage debt' from the banks as is the current plan in the US. There’s no getting away from it there - the taxpayer pays.
Ultimately, we are all set for a period of painful financial turmoil as the economy slips into recession. The hope is that it will not be anything like as vicious, or as enduring, as it would have been if the current state of banking had been allowed to run its course. Decisive action was necessary and now we've got it.
For now, as prospective shareholders in some of Britain's biggest financial institutions, we'll all just have to get used to being a bunch of bankers.
Update: In a separate move, seven central banks have today cut interests rates by 0.5%, reacting to fears of a global economic downturn. This will also help to ease the burden on the banks, and ultimately business and consumers.
