If you find it repugnant to take stakes in banks Mr Paulson, don’t do it

I have opposed bank nationalisation in any circumstances, and have asked authorities to work with the banks to recapitalise themselves through private money rather than public. I find it bizarre that Mr Paulson is going to require US banks to take public share capital when some of them have not asked for it and do not need it.He himself expresses his distaste for the policy. He should follow his instincts.

A bank can boost its capital in many ways. It can raise new share capital from existing shareholders or from new shareholders. It can sell assets or businesses accumulated within these large groups. It could pay its high earners a lot less for a year or two to keep more of the cash. It can cut its dividend payments to shareholders. It can reduce the numbers of employees, sell branches, increase the amount of fee earning business it does or otherwise boost its profits and cashflow. I do not believe for one moment that the banks of the world have done all these things as much as they might where they need stronger balance sheets.

In the UK it is unclear why the government wants to allow the merger of Lloyds with HBOS. That just adds more risk to taxpayers, as Lloyds could go it alone like Barclays without the merger. It is unclear how much of the extra capital proposed for RBS and HBOS is now a regulatory requirement, and why the regulatory requirement should suddenly have increased. If ever there were a time for the government and Regulator to be working quietly behind the scenes with these two banks to ask them to raise more capital through any of the ways open to them over a realistic time period, this was it.

At a time when governments are correctly preaching to banks that they should not borrow too much and be overextended, they should be ensuring that governments themselves do not become similarly overextended and over borrowed. There are limits to what the US and UK taxpayers can afford. Giving banks too easy an access to public money is not a good idea. What we need is tough regulation, in private , to get the weaker banks into shape. If some of them need loans and gurantees to tide them over until they have raised more money privately, so be it. That is what a Central Bank is for , as lender of last resort. The taxpayer should always take full security for loans, and charge a fee for guarantees. That would be a much better way forward than requiring all main banks to take taxpayers money, or encouraging mergers which then leave a large bank that needs taxpayer support.

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21 Comments

  1. Philip Clayton
    Posted October 15, 2008 at 9:16 am | Permalink

    However badly the banks have been run in recent years, they will be worse under government control. All the best talent will gravitate to the fully private banks who won't be constrained by the government's pay policies. Lloyds TSB are making a mistake for their shareholders. The HBOS deal does not look so great when it comes with government strings attached. The shareholders should urge the board to drop the deal and go down the same capital raising route as Barclays. After a couple of years of government managment, HBOS will be even cheaper.

  2. Tony Makara
    Posted October 15, 2008 at 10:07 am | Permalink

    The most troubling thing about the recent crisis is that solutions have had to be produced ad hoc, that there were not already contingency plans laid out to deal with such a scenario. We can only hope that future governments will set up exhaustive inquires as to the cause and effect of the lending crisis and how to respond in future to other similar eventualities. On the matter of buying in to bail-out failed lenders, it would have been far more sensible for national governments to establish a national state bank as a save haven for depositors and to guarantee liquidity and allow the private lenders to sink or swim. If money gravitated toward the state bank then so be it. The private lenders have to be able to stand on their own feet, without government money, but government can still provide security with a national bank. Throwing taxpayers money at bad business is bad politics.

  3. James
    Posted October 15, 2008 at 10:12 am | Permalink

    I notice that Simon Heffer is praising you in his article today as being the only person in the Tory Party who knows what is going on.

    Many of your readers/contributors have thought that all along.

    Glad Heffer has caught up with us.

    DC should make you Shadow Chancellor.
    Soon as possible.

    Reply: I like and support George Osborne, and have not spoken to Simon Heffer recently. The issue is the state of our economy, not who sits on the Tory front bench.

  4. Brian Tomkinson
    Posted October 15, 2008 at 10:15 am | Permalink

    Despite all the unjustified praise for Brown in the press, many of the present difficulties have been exacerbated by this government since the problems with Northern Rock first appeared. Government action since then has done nothing to bolster confidence either amongst savers or investors in banks. In the case of Bradford and Bingley, the bank issued a rights issue to which many people subscribed in good faith only to see their good money, along with their previous share value, confiscated by the government almost immediately. In such circumstances, it is not difficult to see why investors will be wary of helping banks to raise capital.

  5. Posted October 15, 2008 at 10:22 am | Permalink

    Paulson is just following our 'saviour' Gordon Brown, and I'm sure many other international leaders will also jump on the same bailout train – even though there are other options available.
    http://lettersfromatory.wordpress.com

  6. Stuart Fairney
    Posted October 15, 2008 at 11:15 am | Permalink

    With calculator-busting figures, thank god for spread sheets!

    If the total public sector debt is around £2 Trillion (which I believe is the accurate figure) and public spending (so more or less income from taxes) is around £0.6 Trillion, isn't UK PLC a company with more than three times its income in unsecured debt? Or put another way, it's like a man earning £30,000 a year with a £100,000 Barclaycard debt? A better definition of national bankruptcy I do not know?

    Or if we look at the interest liability on national debt at say 5% it is £100B a year, or about four times the entire defence budget!! The interest-only payments on the debt are £3,571 for every taxpayer or £298 tax on your monthly salary to stand still and just pay the interest.

    I presume when government bonds cease to be purchased, or are only purchased at highly punitive rates and the tax base collapses as the economy shrinks, we then declare bankruptcy by trotting off to the IMF? (He wouldn't be the first Labour chancellor to do thus).

    Does anyone know what happens to Sterling in such cases? Seriously, is the currency abolished and started again a la Germany in 1945? Or will they just print money a la Mugabe to contract the debt via inflation, thereby smashing the purchasing power of Sterling? Perhaps an Argentine-style confiscation of money from the middle classes? (Hey they already run some of the banks, how hard would it be?) Looking at the above figures I'm honestly starting to think the government "guarantees" aren't worth a damn and perhaps it's time to be in nice Swiss Francs or something? Serious question, does anyone know the answer?

    • mikestallard
      Posted October 15, 2008 at 7:36 pm | Permalink

      Stuart Finlay – I totally agree with your excellent, clear, compelling and lucid analysis. I have been reading up on all this, just like you. But, unlike you, I came at it fresh.
      Even the staid, boring old Telegraph today, in the Leader Column, referred to French and Spanish bankruptcy at the height of their power.
      National bankruptcy is a very real possibility.
      Maybe the bluff will work, though – for a bit. Nevertheless, sooner or later the money will have to be repaid. In Germany (1920s) the currency collapsed with all the debts. Remember the Rouble at Perestroika? Maybe, as you say, this will happen here.
      Either way it is the middle class who go onto the streets and sell things in the snow to pay for their next meal.
      The only thing I can disagree with you on, therefore, is this: not so much thank God for spreadsheets as thank God for Charity Shops and E Bay.

  7. oldtimer
    Posted October 15, 2008 at 11:22 am | Permalink

    The reports of the FSA/bank negotiations over the latest "bullet proofed" capital requirements makes disturbing reading. The size of, and method used for, the capital raising has already had devastating consequences for the share holders of Lloyds-TSB. For them, there is no merit in the proposed merger with HBOS; they should reject it.

    I do not know enough about the RBS situation. It is said that to £20 billion of capital will raise the tier 1 ratio to 12.6%. This implies very significant losses have yet to be declared – as much as £10 billion? Yet RBS does possess significant assets and a strong cash flow. It is disappointing that time does not appear to allow for alternative restructuring arrangements to be explored to overcome its predicament.

    |Reply: A bank has to declare all known losses as soon as they are known and make proper provision.

    • oldtimer
      Posted October 15, 2008 at 1:50 pm | Permalink

      If RBS has declared all its known losses then why does it need a 12.6% tier 1 ratio?

      In his Monday press conference, Brown made reference to losses expected in future years by an unspecified bank. I took these to be undeclared losses and RBS the likely culprit because of its acquisition of ABNAmro.

      I should like to be wrong about this because if I am RBS should try to fund itself with the c9% ratio that is deemed appropriate for HSBC and Barclays.

      Reply: I have no idea which bank the PM was referring to. Any bank which becomes aware of extra losses has a duty to report them to the Stock Exchange asap.

  8. Posted October 15, 2008 at 11:36 am | Permalink

    JR: "In the UK it is unclear why the government wants to allow the merger of Lloyds with HBOS. That just adds more risk to taxpayers, as Lloyds could go it alone like Barclays without the merger."

    Three questions spring to mind re Lloyds TSB and HBOS:
    (1) If Lloyds were sound enough a couple of weeks ago to takeover HBOS without Government financial support, why do they now need a capital injection from the Government?
    (2) If they were not sound enough, without this capital injection why were the PM and Chancellor supporting their acquisition of HBOS?
    (3) If the proposed acquisition were cancelled would Lloyds still need the capital injection from the Government? If not why not cancel the acquisition and save the taxpayer money?

    I think the public needs answers to these questions so that we can understand why Lloyds (who do not appear to be in a distressed state) suddenly need a capital injection from the Treasury.

    • APL
      Posted October 15, 2008 at 6:08 pm | Permalink

      Ex Northere Crock saver: "(1), (2), (3)"

      It's the same brainless forced merger that was tried in order to save the british motor industry creating British Leyland. The result died.

      If the government do this to the banking industry, the same thing will happen, instead of (getting into financial difficulties -ed) today, it'll happen in a few years time, after being stuffed with government subsidies and stupid policies about equality and the other socialist claptrap.

  9. Posted October 15, 2008 at 12:29 pm | Permalink

    The reason that the US is following the UK's lead in the part nationalisation of their leading banks is because Mr. Paulson's plan, so loudly trumpeted as essential for the US to avoid financial Armageddon has turned out to be a damp squib. In Europe nobody had even thought of a plan. The sole reason that Gordon Brown's ideas have been so widely adopted is therefore nothing more than a simple matter of – 'In the land of the blind the one eyed man is King.'

  10. not an economist
    Posted October 15, 2008 at 2:39 pm | Permalink

    I must have misunderstood shtg with the Lloyds/HBOS thing. I thought originally that Lloyds was healthy and was simply making a bid to take over HBOS to stop HBOS from going under. Now all of a sudden the govt is buying a substantial amount of shares in Lloyds. Why? I thought Lloyds' balance sheet was in good health before. I guess I am wrong cos Super-Flash-Gordon-master-of-the universe-he'll-save-everyone-of-us-Brown can do no wrong at the minute.

    Confused of Dorset me-thinks.

  11. Tinxx
    Posted October 15, 2008 at 3:49 pm | Permalink

    " Three questions spring to mind re Lloyds TSB and HBOS:
    (1) If Lloyds were sound enough a couple of weeks ago to takeover HBOS without Government financial support, why do they now need a capital injection from the Government?
    (2) If they were not sound enough, without this capital injection why were the PM and Chancellor supporting their acquisition of HBOS?
    (3) If the proposed acquisition were cancelled would Lloyds still need the capital injection from the Government? If not why not cancel the acquisition and save the taxpayer money?"

    I think a fourth follows from this:

    (4) If the competition rules were being overridden in the national interest back in September for Lloyds to take over HBOS – is there still a justification for that now? If not, why are we tearing up these concerns when a simple "bail out" of HBOS – or merger with Northern Rock as a state bank would still have allowed competition on the high street but without the need to put any capital into Lloyds or demand a slash of their dividends?
    With the implication that until the 12% pref shares are redeemed for the WHOLE combined entity, no existing LLoyds shareholder will get paid a dividend, one wonders why any LLoyds shareholder would want to vote for this unless they are Victor Blank who is being given licence to run – with Government support and confiscated shareholder revenues – a UK megabank.

  12. David Herr
    Posted October 15, 2008 at 7:04 pm | Permalink

    I share your trepodation about de facto bank nationalization, but, at least in the US, there is a good reason for the government in inject capital into the banks. Here in the US, some $4.5 trillion of deposits are insured by the government; another $2.7T in deposits are uninsured, mostly corporate transaction accounts for payrolls, inventory, etc. If the deflationary spiral in real estate continues, and the banks become insolvent and have to be closed, the full bill to the taxpayers would be staggering. I, for one, will take adding $250B, or, for that matter, $700B to the national debt to add to bank capital, to prevent, if possible, a complete collapse that would cost taxpayers $4.5T in direct costs, and trillions more in expense if the uninsured deposits are wiped out (because the government would never let payrolls get wiped out).

    The keys are to invite private capital to participate alongside the government, and to establish a timeframe on which the government preferred shares are bought out. I am thinking 10 years — that is how long it will take for lending to recover, after sane lending standards are reimposed.

    As for US debt, even after the Bush deficits, the US government's publicly held debt stands at under 40% of GDP, which gives the government room to borrow. The extra interest costs might even force a reduction in domestic spending, which has exploded under Bush. Borrowing an extra $1T at 5% would cost $50B per year. Believe me when I tell you, at least 5 times that amount could be cut from the budget with hardly anyone except plugged in lobbyists feeling any adverse effects.

    The U.K.'s higher public debt to GDP ratio constrains their government a bit more, but as I understand it, Brown increased spending a lot during the boom years, which means that there is ample room for cuts to make up for the higher interest expense.

  13. Socrates
    Posted October 15, 2008 at 8:12 pm | Permalink

    If the Government is buying stakes in some major banks – why do we need the Lloyds HBOS takeover? Surely in the future, providing the socialists have gone – when the shares are sold back to private ownership we will have allowed the creation of a megabank which we would normally consider to be anti competitive – why would this be a good idea?

  14. mikestallard
    Posted October 15, 2008 at 8:37 pm | Permalink

    In all the confusion, here are a points on which, I think, most people agree:
    1. Gordon Brown has won the publicity battle. The conservatives are nowhere.
    2. This is all rather rushed and therefore very sinister. Rumours are bound to spread. But we can trust Gordon Brown because, as he says, he is a Rock you can depend on.
    3. Nationalistation of the banking system, or part thereof is sinister to Tories, but nobody has clearly spelled out why think this. To Labour supporters, however, it is a victory which they could not even dream about a year ago.
    4. Everyone is agreed that things are getting better after the crisis.

    If I were Gordon Brown, I should pencil in a general election for early November, before people see through the con trick and spin.

    • not an economist
      Posted October 16, 2008 at 8:16 am | Permalink

      RE(1): Currently he has, but there are the longer term implications. In particular whether or not his ploy will work. The market rallied earlier in the week but the question is whether it will continue to do so and if it doesn't what next? More nationalisation? More bail outs? Yet further increased public borrowing to fund these bailouts which will presumably have to be monetised and so will ulitmately have inflationary repercussions as well as destabilising the pound? Plus this is only beginning to hit what the Americans call Mean Street. Soon there will be bankruptcies throughout the economy as it inevitably slows.

      In some respects – and I accept this will be heresy around here – I hope Labour does win the next election. (Indeed I have been expecting them to win for a while now despite what the opinion polls say). Labour were instrumental in creating this mess. It would be nice to see them having to clear it up and make all the hard, tough, unpopular decisions to sort it out instead of a conservative govt having to come in and do that for them and accordingly getting all the flack for those decisions. This, I would argue , happened when the Tories won the 1979 election and had to tidy up after the Wilson/Callaghan govts (and, to be fair, Heath's effort of a govt in 1970 to 1974).

      Re (3): I sort ofagree here. I woullreally like to see an indepth article/analysis of why the nationalisation of the banks is bad for the economy, esp in the context of the recent credit crisis. I mean, it feels sort of weak to say nationalsiation would be bad for the banking industry 'cos of innefficiency etc.., when you condiseder that arguably privatisation of the banks has resulted in the financial turmoil of the last year or so.

  15. Derek
    Posted October 15, 2008 at 9:39 pm | Permalink

    Someone mentioned the Competition Commission, who were last heard of noisily producing a whitewash on the supermarkets. The banks are coalescing into ever smaller numbers to choose from whilst Philip Green is buying up whatever's left of the High St he doesn't already own. If nothing is being referred to the Competition Commission surely it should be mothballed and a large, taxpayer funded, payroll bill saved?

  16. Lola
    Posted October 15, 2008 at 10:18 pm | Permalink

    Now Mr. Redwood sir, you know full well that this bank nationalisation has nothing to do with the state of the banks finances or their abaility to raise their own capital. You know full well that is has everything to do with Gordon Brown's public finances and political capital.

  17. Worried Al
    Posted October 16, 2008 at 12:29 am | Permalink

    I too find bank nationalisation distateful and I am very nervous of using public money to bolster bank's balance sheets.

    The only flaw to Mr Redwood's argument is that some banks have assets that no-one wishes to buy as private buyers are worried about the future.

    And why are private buyers worried? They are worried because US and UK are in recession. With or without certain banks failing we would still be in recession because after a boom period markets have become saturated – how many mobile phones, DS Lites, flat screen TVs etc are people expected to own? Bank balance sheets are now reflecting that we are in recession – they have duff assets no one (but Government) wants.

    Finally, do any bloggers remember what happened with the Lloyds syndicate crisis in the late 1980s? Toxic assets (ie. CDOs and derivatives) are stakes in a debt and so liability can increase geometrically if things go wrong. The Lloyds syndicates were underwriters for insurance policies and were the final port of call for insurance claims – the liability from the underwriting was unlimited. Are there any lessons to learn from the Lloyds disaster?

  • 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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