If your corporate finance training had gone a little deeper you might have learnt about the laws on financial assistance, in which case you would be puzzled about how the Treasury can buy the shares in a bank using funding obtained through an issue of gilts subscribed by the same banks. It isn’t obvious, but as far as I understand, the Bank of England’s requirement to get the banks to buy more gilts will help the current issuance programme, the proceeds of which will fund the cost of the preference shares for which the government has not yet paid. In the private sector that would probably be illegal.

Reply: I have been explaining the round trip for some time!

They are using the fact that debt £ look just like real £ and the fact that fractional reserve lending means that banks can create 12x more debt £ than they have real £ on deposit.

Lets see how this would work. Recently the government struggled to sell some gilts in the open market. So it might not be a good time to try this especially when treasuries of other stronger nations are also trying to raise money this way. The IMF would be an option but would mean getting voted out in 2010. So the government needs a way to be sure of raising a further £100bn to match its own debt requirements, and it has these banks by the privates.

Lets say the government lends the banks £100bn in cash. It can’t really lend cash because it has £600bn in debt already so its not real cash but it looks like cash. So the banks can take this and create 12x more £ using fractional reserve banking. That’s £1200billion maximum. That amount of money is easily enough to prop up the UK economy as current GDP is only £1600bn. The government then tells the banks to use some of that money to buy gilts. The government used £100bn to bail out the banks so it needs money for that, and it also needs another £100bn to keep subsidising the public sector. So it tells the banks to buy £200bn in gilts. That still leaves the banks with £1000bn to play with, and the government has got itself through another year. The government also tells the banks that they must repay the original £100bn at 12% interest. However, it also tells the banks that their lending rates must be close to the BoE rate currently 2% – so the banks will be forced to lend at say 4%. In order to do this the banks will be forced to shift £300bn in loans on Joe Public just to break even on this deal. And of course it has buy £200bn in gilts too. So thats £500bn of debt that the banks must force on Joe Public. That’s well within the £1200bn so not only can the banks technically do this but they can do the same thing next year too. Which means that with this cunning plan the government can get enough debt capital to stay solvent until the next election, inject a huge amount of cash to refloat the economy and bail out the banks all at the same time. There are just two problems left to deal with:

1] Joe Public might not want to take up another £1200bn in debt over the next two years.

2] The total debt of the UK (government private and corporate) is £6bn as of today. While the nation groans under the strain of this enormous debt the government is planning to add another £1.2bn to this debt just to keep everything ticking over until the next election. The government will know by then there are no more cunning plans and the nation will be completely bankrupt.

Why are labour so keen to stay in power when to do so by this means will bankrupt the nation?

Perhaps they have a cunning plan for us all.

Reply: I think you have lost some noughts from your later numbers. The banks can only gear up the new capital if the regulator’s ratios allow.

If the government loans 10 billion to a Bank then based on a reserve ratio of 8% the bank can lend out 12.5X as much…… This means it now has 125bn it can loan out against assets…..

So it can loan 100bn to the Government and get an effective rate of return of 40% on the money it actually backs up that loan with… Because the interest/capital payback of that loan is backed by the taxpayer – there is no risk to the banks of a default (although more likely now than in the past 600 years)

It also has a further 25 bn it can loan to unsuspecting debt slaves.

So more money for the government and more money for the hard pressed (possibly working) families.

This is the wonder of fiat fiat money……

What is really scary is when a saver (is there any point now) puts in 100 to bank A, it lends 1,000 on the strength of it to bank B, it lends 10,000 to bank C on the strength of that loan, it lends 100,000 back to bank A who gives a morgage for 1,000,000 to the saver at 6% interest. What happens if the saver pulls out the 100?

surely you must know about fractional reserve banking, which means banks can lend out sums much greater than they have reserves for. This is why this little scheme works. The banks don’t lose out. Yes they lend out to the government on a net loss. But by having borrowed from the government they are able to lend out much more. It is on this lending that they balance the books with the government gilts and make a profit.

Is this right? Moral?, etc. I don’t know. But it is an issue bigger than the present government and has been going on for decades.

reply: Of course I understand bank gearing. The point is that the government/Regulator has asked for a higher ratio of capital to lending, so they cannot lend out the extra capital

Cui bono is still a standard rule applied in criminal investigations. Effective use of cui bono depends on various factors