Financial crisis: The banks are still sinking
Ministers plan a 'toxic bank’ to soak up bad debts and unfreeze the money markets. But will it work, asks Katherine Griffiths.
Last Updated: 12:08PM GMT 16 Jan 2009
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Hang on – didn’t we save Britain’s banks in October? That was when the Government gave £500 billion to inject capital into Royal Bank of Scotland (RBS), Lloyds and HBOS and pledged ongoing support to get high-street lenders back on their feet.
So, why are banks’ share prices still plummeting, while they refuse to lend to each other because they are suspicious about what hidden nasties are on their rivals’ balance sheets? Their chief executives privately warn the Government – they are reluctant to deliver this message in public – that they do not have the cash to provide mortgages and loans to individuals and businesses.
The reality is that, while the Prime Minister, the self-styled saviour of the world, rode high in public opinion in October and November for leading the charge to deal with the global banking crisis, in fact what the Government had done was to carry out emergency surgery to save the banks – and the entire financial system – from immediate collapse.
Now it is time for the more painful process of restoring the patient to health. For the banks the medicine is going to be unpleasant to swallow – it will mean shrunken salaries and no bonuses for many. For the rest of us it is going to be expensive and could take years to administer.
The Government is understandably unwilling to come out with this prognosis, but it needs to do so soon. The US has been ahead of Britain in preparing for a second round of emergency operations on its banks, with Citigroup set to be split into a “good” and “bad” bank so that investors can feel confident about owning its shares again.
Switzerland has also set up a special entity to swallow about £30 billion of toxic assets from its largest bank, UBS, so that it can begin the process of recovery.
In the UK, we have seen this week measures from Lord Mandelson’s department to help small businesses, but they will only have a marginal impact unless ministers can deal with the banking disease at the heart of the problem.
Now, the word out of Downing Street is that ministers are on the case and are preparing to announce the creation of a “toxic bank” to soak up more than £30 billion of British banks’ bad debts. The plan will form the centrepiece of a fresh bail-out designed to get them lending again, to each other and to their customers.
The difficulties the Government faces are immense.
The wholesale markets, which banks use for much of their funding so that they can lend to customers, remain frozen. This is because of a breakdown of trust between financial institutions: no one can be sure what problems banks are sitting on, so investors do not want to lend them money in case more difficulties emerge and they lose their cash.
What is needed most is clarity: what really is on the books of each bank? It is difficult to put a price on their troubled assets, many of which are based on the collapsed subprime loans sector in the US.
The Government is hoping that clarity is coming soon. In the next few weeks, the banks will report their results for 2008, and to do so they need to get their figures signed off by auditors. The auditing firms – such as PricewaterhouseCoopers, KPMG and Deloitte – will have to agree to the valuation of banks’ assets.
The accountants will want to get these values right because, if their banking clients should fail later, the first port of call for potential shareholders’ lawsuits will be the deep-pocketed auditors.
In anticipation, ministers are preparing the creation of that “toxic bank” to allow for a fresh start.
In theory, it will suck in all of the failing assets that have poisoned the banks’ balance sheets and destroyed confidence in the system. That would leave the remaining banks cleansed and able to attract both investors who want to put their capital in banks’ shares, and providers of funds so that the wholesale markets would be defrosted, and lending could be restarted.
Of course, if it was as simple as that, a bad bank would have been constituted months ago and Gordon Brown and Alistair Darling would be hailing it as part of their world-leading financial recovery plan.
As Sweden found when it had to take similar measures in the early Nineties, creating a bad bank is fraught with problems. As with this entire crisis, the main challenge is how to value the assets.
In order to take control of the toxic investments, the Government would have to give the banks some money in return.
If it sets the price too low, banks will either refuse to hand the assets over, thereby not solving the systemic problem of a lack of confidence, or will have to take new write-downs to recognise the lower value, further weakening their own books. If the price is too high, there will be an outcry that taxpayers’ money is being squandered to save bankers’ skins.
Ministers are keen to ensure that banks are not seen by the public as being let off the hook. Consequently, they are informing executives that we are entering a new world of lower bonuses, less risk-taking and smaller profits.
Rather than the “green shoots” of recovery suggested by business minister Baroness Vadera on Wednesday, the Government has to be prepared to come out with more bleak news.
RBS, until a year and a half ago Britain’s biggest banking success story, is now almost 60 per cent owned by the taxpayer and in its present state is essentially finished as a private institution. The problems at HBOS, comprised of Halifax and Bank of Scotland, are greater than anticipated, and its new owner – Lloyds TSB – will struggle to cope unless it receives more help from the public purse.
Northern Rock, which the Government had hoped to flip from its nationalised state back to the private sector for a quick profit, now looks like the most sensible home for the bad bank and so will have to spend many years in public hands.
And Barclays, the only major high street bank apart from HSBC to avoid participating in the October bail-out, looks increasingly as if it will have to accept government cash, either by using the bad bank or by being involved in a potential further round of cash injections into the banking sector.
It is not all doom and gloom. The Government can make a reasonable case that it is more sensible to create a bad bank than to inject more cash straight into banks, as the investments could simply be wiped out.
This would lead to complete nationalisation of the banking sector, which the Government is unwilling to do until it has tried other measures first.
But a bad bank alone will not kick-start the economy. The Government must get to work with other countries to rethink the “Basle II” banking rules that dictate how institutions lend. They contributed to the banks’ lending bubble, rather than preventing it, by enabling them to place large amounts of new types of debt off balance sheets and beyond the reach of regulators.
And it is clear that in Britain, the tweaks to VAT were inadequate: more tax cuts are required fast.
It is not difficult to see why ministers have taken their time: many, along with their advisers, have not lived through difficult economic times. While the Government had to react quickly last year to a succession of blow-ups, it says it now wants to get its policy right for the longer term.
To do otherwise will lead to lawsuits, such as the one going through the courts over Northern Rock’s nationalisation.
More importantly, spending billions of pounds more of taxpayers’ money on a policy that fails to hit the mark would be disastrous.
The Government has the critical next stage of its rescue of the banking system close to completion. An announcement is expected as early as next week.
All of us, consumers and bankers, had better hope it works.
http://www.telegraph.co.uk/finance/financetopics/recession/4250231/Financial-crisis-The-banks-are-still-sinking.html
Comment:
This is akin to Danaharta and Danamodal approach adopted by Malaysia in 1997-1998 Asian Financial Crisis.
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