The public get it more than the government

To many people the bank share purchases by the government is the last straw. They see it this way: the government takes money off us in taxes, gives the money to the banks, who then might lend some of it back to us for interest and a fee if we are lucky.

Yesterday in Parliament I pointed out to the Chancellor that the 3 banks he is considering buying shares in have combined balance sheets of £3 trillion. Yes, £3 trillion. That’s twice our national income for the year, and five times our annual tax revenue.

I urged the Chancellor to try to get more private capital into these banks, to cut the risks of the taxpayer. If the taxpayer is to stand behind £3 trillion of bank assets, it puts us at great risk. If the assets turn out to be worth just 1% less than the current value, that loses the taxpayer their share of £30 billion of loss.

As readers of this site will know, I have supported the proposal to put more cash into the markets. That certainly worked yesterday. I have supported the proposal to lend more money for longer to the banks to tide them over, as long as the taxpayer is given full protection with proper security for the loans. I also support the efforts made to increase the banks capital from the private sector, and am glad that 5 of the 8 banks concerned now have more than enough capital or can raise it privately.

That leaves us with RBS, HBOS, and Lloyds. When the government acted as midwife to the birth of a new mega bank through the merger of HBOS and Lloyds, that was to provide a private sector solution to their financing. Both now have access if they need it to public capital. The shareholders of both HBOS and Lloyds have to vote on the merger before it can happen, and have to vote their approval to seek new capital from the government. Some Lloyds shareholders may now take the view that it would be better not to merge, and that Lloyds could go it alone without government share capital.

Yesterday one bank announced it would cut its dividend, and raise more capital from existing shareholders. Its share price went up. RBS announced it would (subject to shareholder approval) raise capital from the government and its share price fell.

The government should do some more work on the capital raising part of its package, with a view to cutting the risks to the taxpayer and cutting the requirement for taxpayer funds. Banks have many ways they can use to increase their cash and their capital to lending ratio. They can cut their dividends to keep more of their profits. They can sell assets. They can reduce costs and retain more of their income as profit.They can reduce their lending activities. The meetings need to be reconvened to see how they can do more of these, to cut the burden on the taxpayer.

Three weeks ago the Regulator was happy with the capital adequacy of the major banks. It appears that in the last three weeks it has demanded more capital to support existing lending. It is more evidence that our regulators are tightening long after the credit bubble has exploded. They should have done that several years ago to choke off the growing bubble.

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12 Comments

  1. crown
    Posted October 14, 2008 at 8:50 am | Permalink

    http://thecrownblogspot.blogspot.com/2008/10/watch-what-they-do-not-what-they-say.html

    Northern Rock (One of Gordon Brown’s banks) has not passed on the full BOE rate cut.

    watch what they do, not what they say

  2. rugfish
    Posted October 14, 2008 at 10:27 am | Permalink

    JR – "To many people the bank share purchases by the government is the last straw. They see it this way: the government takes money off us in taxes, gives the money to the banks, who then might lend some of it back to us for interest and a fee if we are lucky".

    Me – This government's capacity to ignore what's blindly obvious to people never ceases to amaze me.

    Man in pub – "We're all being fleeced but what can we do about it other than vote, but when can we vote except when they say so, and then they don't even make a manifesto we want and even when they do they come up with a reason not to follow it"

    Me – "Yeah I know, what you having Man in pub"

    Man in pub – "Another half please, I'd best not drink a pint in case I have to buy you one back and I can't afford it nowadays, cheers"

  3. Kit
    Posted October 14, 2008 at 10:52 am | Permalink

    A question I would like someone to ask Gordon Brown: why press ahead with the Lloyds HBOS mega-bank now that you have decided to bail-out HBOS?

  4. APL
    Posted October 14, 2008 at 11:05 am | Permalink

    JR: "If the taxpayer is to stand behind £3 trillion of bank assets, it puts us at great risk."

    Yes it does, you don't like abusive posts and name calling, but sometimes if the cap fits …

    I suppose we are about to see the difference between a Tory boom and bust, and a Labour boom and bust. In the case of the former there is a country and an economy to recover.

  5. Alfred T Mahan
    Posted October 14, 2008 at 11:13 am | Permalink

    John, you mention your surprise at the failure of the regulators to act. I’m equally surprised that no one else has yet made the point that the current problems are very similar to the Lloyd’s reinsurance spiral of the early 1990’s. The salient similarities are:

    1 “Groupthink” whereby against the evidence virtually all the market held the same erroneous opinion;

    2 Rare voices of warning treated with scorn;

    3 Adulation before the denouement of star market practitioners achieving high returns by misunderstanding or ignoring the risks they were running;

    4 A device (reinsurance then, CDOs now) which dispersed risk when used sparingly, but concentrated it when used to excess;

    5 A saturated market which forced incumbents into ill-thought out innovation in order to gain turnover;

    6 An external event which should have been within the risk assessment of the players bringing the house down (for Lloyd’s, high claims; for the banks, the property market);

    7 The angry feeling after the event that practitioners had acted nonsensically.

    These should have been spotted by the regulators on both occasions, but weren’t. Whatever the other causes, regulation must carry at least part of the blame in each case but I wonder whether it’s realistic to expect things to be any better next time.

    The reason is that it takes considerable moral courage and a bit of a maverick attitude to stand up against the prevailing market wisdom and denounce a practice as unsafe or stupid. I know from personal experience of the Lloyd’s debacle that saying an established market practice/belief is contrary to common sense only generates pitying looks and disbelief, even from otherwise intelligent people. It requires great self-belief and confidence to stand one’s ground. The type of person that is attracted to a career in regulation is not likely to have those characteristics, and is inherently likely to fall prey to (1) above.

    This means, I think, that the cries for more and/or better regulations will achieve little good except perhaps to slam this particular stable door shut – after everyone has changed their market practice anyway. We also know from experience that regulations have the inevitable side-effect of spawning schemes to get around the rules, and as the rules get more complicated so do the schemes. Thus transparency and intelligibility are lost, and so it becomes easier for “groupthink” (ugly word but the correct one in organisational behaviour theory) to take hold and for a major problem to happen.

    Reply: Thanks for a very good thoughtful piece. I agree with much of it. I think what we need to ensure next time round is a Central Bank that does resist new orthodoxy by sticking to the simple question of how much gearing any institution should accept.

  6. Mark Wadsworth
    Posted October 14, 2008 at 11:54 am | Permalink

    Banks have many ways they can use to increase their cash and their capital to lending ratio…

    You missed the best and most obvious one – the good old fashioned debt-for-equity swap.

  7. StevenL
    Posted October 14, 2008 at 1:56 pm | Permalink

    "Three weeks ago the Regulator was happy with the capital adequacy of the major banks. It appears that in the last three weeks it has demanded more capital to support existing lending." (JR)

    The notices to the markets that I read said they were demanding a return to 2007 levels of lending.

    Banks were hoarding their money to survive the recession. Mr 'no more boom and bust' Brown seems to think that borrowing and inflating the money supply will prevent any recession, and it might do, but there is bound to be unseen consequences.

    He did it through old-fashioned public spending after dotcom and 9/11, we maintained economic growth but have developed a habitual budget deficit as a result.

    This time he is reinflating through bank landing by the looks of things. Is he actually going to set central targets on total mortgage lending and loans to small business? Will the Treasury try and micromanage the money supply? Will there be targets for what type of people/enterprise in what area get what?

    Perhaps he'll find some clever way of stashing all the dodgy loans in off-balance sheet vehicles, claiming that the taxpayer will profit when the loans are paid off.

    Maybe I'm being paranoid, but this government managing bank lending scares me a lot more than losing my job does.

  8. mikestallard
    Posted October 14, 2008 at 6:21 pm | Permalink

    John, you have been saying this consistently for ages: the danger is recession, not inflation. Secondly, you have been saying consistently for ages that the government is dealing in trillions whereas its annual income is in billions. Lots of people are now claiming hindsight – but I was there when you said all this – consistently.
    The trouble with politics and economics is that there is a slight delay between cause and effect.
    It is only now, for instance, that the full realisation of the corruption of the anti-terror legislation is working through.
    The danger here, of course, is that the government will fill up the banks with its own placemen – like the MPC, the House of Lords or the Metropolitan Police Service/Force.
    Time will tell…….
    Meanwhile the BBC are simply not mentioning any form of Conservative thought. This leads to even the Telegraph saying today that the Conservative simply have no policy.
    And maybe, just maybe, Gordon Brown will be re elected in 2010…..

  9. Acorn
    Posted October 14, 2008 at 7:56 pm | Permalink

    They think it's all over, it is not yet. The market guys are much smarter than your average politician and his civil servant adviser. The latter have been well and truly shafted by much bigger brains.

    If you have followed any of my previous links, you will know that the big, big problem is still out there. All this government cash is only going to be used for one purpose. That is funding the "calls" on all those credit default swaps.

    My mate in the thick of it has just e-mailed me to say "read Shah, this will answer all these [deleted] questions you keep [deleted] asking me … got those Salomon skis you recommended, the [deleted] business!".
    http://www.moneymorning.com/2008/10/14/treasury-d

  10. David morris
    Posted October 14, 2008 at 8:36 pm | Permalink

    I don't pretend to properly understand any of this but just can't help feeling that the last time I saw Brown looking so happy, and pleased with himself, was when he announced the doubling of the 10p starting rate of tax, and we all know how that turned out……….

  11. APL
    Posted October 15, 2008 at 1:09 pm | Permalink

    Who is the terrorist now?
    http://www.timesonline.co.uk/tol/comment/columnis

    "Brown's response? To seize the UK assets, not of the bank that ran Icesave, but of a wholly unrelated bank, Kaupthing, thereby collapsing it. Icelanders, who had been expecting to negotiate a guarantee to British depositors – eventually agreed on Monday – were stunned"

    Read this and weep, how can we have permitted such a despicable stupid man to take control of the UK.

    Some nonentity in the Labour cabinet once said on Question Time, in six months, you will be wishing Blair was back.

  12. APL
    Posted October 16, 2008 at 4:09 pm | Permalink

    Mr Redwood, by what authority is Gordon Brown proposing to buy a stake in or nationalise the banks?

    The Royal perogative?

    One or other of the civil contingency act measures?

    I don't believe it has been debated in Parliament?

  • About John Redwood


    John Redwood won a free place at Kent College, Canterbury, and graduated from Magdalen College Oxford. He is a Distinguished fellow of All Souls, Oxford. A businessman by background, he has set up an investment management business, was both executive and non executive chairman of a quoted industrial PLC, and chaired a manufacturing company with factories in Birmingham, Chicago, India and China. He is the MP for Wokingham, first elected in 1987.

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