17 January 2009

Back at the BBC (British Banking Crisis): deja vu after only 3 months

Exciting news from the world of finance... Bank shares fall sharply, and the consequent fears over the solvency of the banks prompt ministers to call in the head honchos for emergency meetings with Treasury officials.

It all would look mighty scary if we weren't all suffering shock fatigue from having been here scarcely more than 3 months ago.

So, where did the £39 billion of taxpayers' money that was meant to shore up the banks go? Many people would say "down a big hole", which probably isn't completely right: after all, the banks might have collapsed completely if the govt hadn't put that money in. The problem is that it's - well, not exactly a drop in the ocean, but more like a cup of water in the washing up bowl. The banks may well be sitting on hundreds of billions of pounds of losses, and £39 billion was enough to stop the system from seizing up completely, but not enough to get any kind of confidence back.

That lack of confidence explains why bank lending has been so low. Even when the banks have funds available, the economic situation looks so poor that they ain't gonna lend money out because it's highly unlikely the firm they're lending to will be able to repay the loan if the economy keeps spiralling downwards. So of course, the lack of credit depresses the economy even further... and we have a self-fulfilling prophecy.

There is a way out of this but it will require more drastic action than the govt has so far been willing to contemplate. Essentially, the govt needs to take over the entire UK banking system and then force the banks to start lending out money on the basis that the economy will recover a few years down the line. This would do two useful things:

  1. nationalisation would effectively underwrite the banks' entire losses, which solves the bad debt problem (admittedly with a huge liability to taxpayers); 
  2. as soon as the banks start lending out money on the basis that the economy will recover, this makes it much more likely that the economy actually will recover. 

Of course, international co-ordination would help massively here; if every country did something like this we could probably be back to a high level of economic growth in 12 months' time. Nonetheless, the plan is preferable to the alternative of a deflationary spiral, even in the absence of a co-ordinated international effort.

Once the economy recovers, bank profitability should recover - and hence the government should be able to recoup its investment by selling the banks off when the economy is doing a lot better. Of course, we need much better controls and regulations on banks to prevent exactly the same lunacy in the financial sector which got us into this best. And that's the really tough bit. But that will have to be left to a future post.

So what is the govt coming up with? Apparently an "insurance scheme" whereby the taxpayer underwrites bad debts. This would achieve one of the objectives set out above - it would draw a line under bad losses - but I'm still not convinced that, operating independently under their own commercial imperatives, banks will start lending, because to each one of them individually, the economy still looks f***ed. There needs to be some collective suspension of disbelief effected here. And the best means to do that is to just FORCE the banks to lend. For which you would, in my view, need nationalisation.

So the govt has half a good policy, but that probably isn't enough. And there's an additional problem: if the policy works, but only a bit, it's very easy for the opposition to make the argument that it hasn't worked at all - due to the general deterioration of the economic situation. This would kill off the govt's chances at the next election - recent opinion polls already show them slipping back somewhat from October and November's bounce, although the situation remains highly volatile.

So this really needs to work, guys. My advice to Brown and Darling would be just to wade in with the highest level of intervention imaginable: so far, the more they've intervened, the more popular Labour has become. It's no time for half measures.

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