Cut the taxpayers risk with the banks

What should we do with RBS, now we are all enforced owners?

RBS is too big for the taxpayer to stand behind. The bank made a foolish acquisition of ABN Amro near the top of the market which stretched it too far. It is now being made to repair its capital ratios, against a backdrop of reporting large losses on its credit market positions and its loans. I don’t think the taxpayer should be made to pay for the past mistakes.

We need the government to get a grip on this leviathan, and to slim it down quickly before it does more damage to the taxpayer and the national accounts. Presumably the government’s justification for taking it over is to safeguard and increase the lending to UK individuals and companies. This is a small portion of what RBS does.

In the half year figures for 2008 we learn that only £282 billion of loans have been made to UK borrowers. The rest of the £721 billion loan book is overseas. The total UK loans are only 15% of the balance sheet, a manageable amount for the UK government. It is the remaining £1700 billion of risk that is over the top for UK taxpayers.

The sensible thing to do is to slim the bank down to the bit that the government is concerned about. It should seek to sell:

1. The Insurance company
2. The Manufacturing division
3. ABN Amro
4. Citizens bank in the US

Taxpayers are on risk for nearly £500 billion of derivatives. That’s playing with the whole tax revenue of the country for a year. Why? Why aren’t these speculations on currencies, interest rates and commodities closed down? The Bank says much of it is matched business, but there is always scope for it to go wrong. In the first half of last year the bank wrote £5 billion off its credit market assets. They need attention.

The costs of the bank are huge. In 2007 10 non executive directors averaged more than £100,000 a year each for a part time job. Why not have fewer at more realistic fees for a loss making company? The 6 executive directors were paid £15 million between them, or an average of £2.5 million each. Nice work if you can get it. In its current state I wouldn’t pay the executives more than one tenth of that, until they can make some profits again and slash the risks.

RBS showed just £6 billion of “impairment” or potential loss on its lending book of £721 billion at the last half year. This looks very low for the conditions. Presumably all the current fuss has come about because they now realise they need to put in much larger figures for possible losses on their loans and their financial instruments. This just makes it crazier that the government rushed in to buy shares in them when they did without demanding a proper analysis of the loans and financial instruments then, and sensible write downs for the conditions. It is possible the bank will have to declare that is has lost most of the government’s new capital in the second half of 2008.

There is no need to panic today. The falling share price does not undermine the bank. The depositors are not in a panic as they assume the government stands behind them and the bank has substantial liquid assets. What needs to happen is the production of some sensible figures on the current state of the loans, and some active management of the bank to cut our risks.

We need to see a string of disposals of the non banking interests and the overseas banks. We need some serious cost cutting starting with the top executives pay. We need some intelligent new UK lending to re start the business.

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22 Comments

  1. Michael Taylor
    Posted January 18, 2009 at 11:10 am | Permalink

    Look, there’s a crucial number which everyone seems reluctant to talk about, but without it, you’ll have no idea about how small the universe of possible workouts is: by end-June 08, there were US$54.6 trillion worth of credit default swaps ‘notionally’ outstanding. These alone were equivalent to 1.75x total bank lending by US, Eurozone and Japanese banks combined.

    At the moment, no-one knows how these will be settled, and consequently, no banks can be assumed creditworthy.

    What that number tells you is that the rest of the economy cannot possibly be squeezed to settle these possible liabilities.

    What the number also tells you is that no government can afford to take on settling these liabilities either – it can and will bankrupt any government that goes near it.

    That’s the (unbelievably bad) news. The good news is two-fold: first that, according to Deposit Trust & Clearing Corp Data, 91.3% of this toxis stuff is effectively inter-bank stuff, which could, in theory, be netted out. The second piece of good news is that commercial banks, as a 17th century technology, aren’t absolutely necessary in this world, and it’s quite possible to see how you can reconstruct a financial system without them.

    All this suggests how this will end: the commercial banks will have to be told that these ‘off balance sheet liabilities’ will indeed be treated as off balance sheet, and their losses will not be allowed to destroy savings of on-balance-sheet depositors. If commercial banks can’t agree how to net off the ‘off balance sheet’ stuff, governments must (and eventually will) demand that ‘real assets’ and ‘real liabilities’ are carved out from the damned mess, and refloated as mutual money market funds.

    My guess is that there are plenty of people in the worldwide City know this – including, I guess, you John. The problem is that unless our political establishment recognizes what the problem is, they’ll continue to sacrifice the interests and livelihoods of the ‘on balance sheet’ real economy in an attempt to refloat an international banking system that really really really can’t be saved.

    Be honest, and hit the ‘radical restructuring’ button as hard and as soon as one can.

    • a-tracy
      Posted January 18, 2009 at 4:51 pm | Permalink

      Well said.

    • Steve M
      Posted January 19, 2009 at 12:41 am | Permalink

      Michael, perfectly put. Problem is you are way too smart for the designates at hand. They will only arrive at your conclusions with a wholesale change of political order.

      • Michael Taylor
        Posted January 19, 2009 at 8:25 am | Permalink

        Not sure that’s true. One of the ‘sleepers’ of this crisis is that one of members of the US Fed, Randy Kroszner, has, in an earlier incarnation in Hong Kong, sketched out in some detail just how a financial system could operate without commercial banks as we know them. In the 15-20yrs since he wrote it, information distribution costs have fallen practically to zero, which hugely amplifies and endorses his original insights.

        My guess is he probably hasn’t forgotten them. Hope not, anyway.

        In the meantime, John’s observations about banks being utilities attached to a casino, are absolutely spot on.

  2. Posted January 18, 2009 at 12:23 pm | Permalink

    John

    Are you suggesting that we taxpayers should only underwrite RBS’s local businesses?

    That’s pretty much what the USA is doing. But when the Icelanders emulated Uncle Sam, Gordon Brown used ‘terror laws’ to change their mind. Ireland took heed and now guarantees UK deposits there. Will it just come down in the end to power – to big countries dumping risks on little ones? That worries me. First, little countries don’t have much money. Second, bank regulators playing beggar-my-neighbour is too close to Smoot-Hawley for comfort.

    Conservatives have believed in free trade since the mid-19th century. How does that belief translate to policy here? Financial protectionism, more nationalised businesses and contracting trade credit together are a real witches’ brew. And it is going to matter to MPs soon enough. For example, a friend of mine lost his job last week at the UK subsidiary of a US carmaker, whose new masters in Congress prefer to export job losses. What should David Cameron say to him?

  3. Posted January 18, 2009 at 12:26 pm | Permalink

    True John, but: who will buy?

    There would be bids from overseas interests for the profitable bits of the overseas banks they own.

  4. Posted January 18, 2009 at 12:53 pm | Permalink

    What’s the real deal with the recession ?

    The media says that the government is set to announce an Insurance Aid Plan for Banks next week in an attempt “To try to revive confidence in the industry.” – But surely the cost of premiums would exacerbate the banks problems and simply shift the problem to the insurer which it intends to be us taxpayers. Robert Peston, the BBC’s business editor says; “It’ll be designed to give banks and their investors a bit more certainty about the losses they’d face as the recession undermines the ability of many borrowers to repay their debts”, and that “Our biggest banks would identify their bad loans and foolish investments, then pay a fee to a new state-backed insurer to protect [ themselves ] from the losses over a certain level.”

    I wonder whether Peston knows what he’s talking about or has any idea of the losses which banks stand to lose ?

    For instance, the “foolish investments” he refers to are worldwide investments of mammoth proportion which no one can identify until they fall. Our banks have invested heavily in cumulative financial instruments, derivatives and securities which are malfunctioning because they were severely lacking in proper risk assessment. The very fact they are of an unknown value which is depreciating daily as business owners are hurled into bankruptcy and homeowners into foreclosure, means they are known to be getting worse, despite no one knows their value or where the risks lie, and in this way it still remains an incalculable risk for an insurer.

    In particular, U.S.A “Alt – A” and “Option Arm” mortgages which carry huge risks of an estimated $2 Trillion, are still to fall and economists estimate a 70% default rate. – see the 60 minute video and defaulted lending ratio’s about to hit the world as I wouldn’t want to put my expletives on here.

    http://rugfish.blogspot.com/2009/01/mind-horse-shit.html#links

  5. StevenL
    Posted January 18, 2009 at 1:59 pm | Permalink

    “Why? Why aren’t these speculations on currencies, interest rates and commodities closed down?” (JR)

    Because this is what the financial services industry does. They’ve long grown out of just floating companies, trading their stock and provoking the odd hostil takeover or merger.

    Now they invent all manner of derivatives, look for cash flows to securitise and make little (or big) markets to trade them in. It’s how they make their money so they ain’t going to stop doing it.

    If Gordon Brown is stupid enough to keep throwing money at investment banks they’ll keep ‘trading’ (they don’t do the ‘g’ word) with it. Because it’s what they do.

    • alan jutson
      Posted January 18, 2009 at 3:55 pm | Permalink

      At Last the Financial Services Industry has been shown up for what it is, a virtual Casino where numbers mean nothing, losses are hidden, and bonuses paid no matter the result.

      For years Governments have praised the profits which these businesses bought into the Country with overseas currency, but it would seem no one thought about the possible losses.

      The Financial Services Authority have been absolutely useless as a regulatory safeguard. The Government has been hoodwinked as have the shareholders.

      RBS made two rights issues last year and at the time it would seem it clearly did not disclose its real Financial position to its shareholders. If true this really is tantermount to fraud.

      Why do the Government not show our Monthly trading status anymore (Balance of Trade Figures) I would suggest because these are equally frightening.

      It may seem very simplistic but I firmly believe that the trading of shares should only be allowed, after they have been paid for. Deliberately talking the market up or down in order to make a profit when all you have done is agreed to buy or sell at a future time and price is really market manipulation at the expense of the Companies involved.

      Lets get some honesty back into the market, world wide please.

      • Lola
        Posted January 18, 2009 at 7:17 pm | Permalink

        You are right about the FSA being useless – I run a small FS advice business under its thrall. Thing is tho’ it runs a regime of nationalisation lite. Its rule book has been prescriptive and limiting. This is much of its problem. Yes, we need better regulation, not more regulation. And we do not need more ‘rules’.

  6. Lola
    Posted January 18, 2009 at 2:39 pm | Permalink

    Why not just put RBS into administration? It’s bust. This would get rid of the useless incumbent management and the viable bits of the rump would be bought by someone, surely?

  7. Rob
    Posted January 18, 2009 at 4:14 pm | Permalink

    I quite agree that the banks should be much more transparent when it comes to including items on there balance sheet: but the government should also be far more forthcoming about the amount of liabilities it is taken on for political reasons, to try to conceal its pivotal role in the disaster, which were the total failure of the regulatory reforms introduced by Gordon Brown while Chancellor.

    The government is gettign the country more and more heavily into debt trying to persuade people who can’t service their existing borrowing to borrow more. And people wonder why we have lost confidence in the system and the government.

  8. Graham Eardley
    Posted January 18, 2009 at 4:55 pm | Permalink

    Sir Fred Goodwin quite clearly had a an appetite for acquisitions and mergers of Financial take overs during his time at the helm of RBS.

    I would contest that due to way and speed of growth of the group that it did in part fall foul to the law of law of diminishing returns returns.

    In so much as has the banking group grew each acquisition didn’t have enough time to bed down into the group before the economies of scale where sort (through enviable Job losses) thus putting a strain on the parts of the group which were left.

    So I believe a a de-merger along the lines that you have suggested would be a good first step. Perhaps with Nat West having to de-merge further down the line?

    Also as any thought been given to issues such as pension liabilities in nationalising the banks?

  9. Dave
    Posted January 18, 2009 at 5:06 pm | Permalink

    At some point the government is going to have to stop shelling out.

    Some financial institutions are just going to have to be allowed to fail, we can’t possibly support them all AND fund everything else that the government is supposed to do.

    When a company faces financial difficulties it has to get rid of staff so that the company can survive and pay its retained staff. No-one likes to have to do this and only the most callous person can do it with no regrets but it has to be done.

    It is going to be painful to allow a financial institution to fail and lots of people are going to be hurt but saddling us with a life time of astronomically high taxation isn’t a viable solution.

    What we seem to have is a Government that would sooner we all fail equally i.e. a collective failure but no collective responsibility?

  10. mikestallard
    Posted January 18, 2009 at 8:27 pm | Permalink

    Thank you for a (now to be expected) clear explanation of the problem and how Mr Brown ought to deal with it.
    The big question must be this: if we can understand it (see above) why can’t he?
    If Michael Taylor (see above) has got his figures right, then we are in for Zimbabwe/Weimar/Argentina/Turkey. Why? Our government’s annual income is just about 0.5 trillion pounds. If we guarantee 54.6 trillion dollars, we are going to go broke. (I have no means of knowing future exchange rates).
    Sometimes politicians make monumental mistakes. Chamberlain trusted Adolf Hitler. Napoleon invaded Russia. Julius Caesar went down to the Senate on the Ides of March.
    Mr Brown is now making a mistake of the same magnitude if he guarantees the banks’ international loans, even by mistake.
    We’re all DOOMED!

    PS Time for Mr George Osborne to say something before we lose our shirts?

  11. Nick
    Posted January 18, 2009 at 8:56 pm | Permalink

    So what? It’s peanuts compared to the governments off balance sheet machinations.

    If the government can’t handle the debts of RBS, it can’t handle the trillions in unfunded state pension systems.

    (Joke which makes the point that people often look at a small issue when a large one is staring them in the face-ed) They are worried about RBS, when at the same time they are sitting on massive toxic waste.

    Nick

  12. Ian Jones
    Posted January 18, 2009 at 9:47 pm | Permalink

    I guess the trillions invested in derivatives is why the Fed is printing so much money and giving out money to anyone who wants a loan. They are trying to stop the companies and banks going under which would result in the derivatives to stop netting out and bringing down the whole system. Where do they end it is the question, that shows how much of a panic they are in!

    I didnt realise RBS and others had so much exposure overseas, the question is what is the net position of loans versus borrowing in overseas currencies and what is the level of risk on the loans. If RBS (i.e. the British Govt) has to stump up a trillion in foreign currency then we are doomed!

    Would a default by the British banks on their overseas loans bring down the country or not?

  13. Jason
    Posted January 19, 2009 at 12:54 am | Permalink

    As one of your constituents and an RBS employee who has previously always voted conservative i have to say that this post has really anoyed me possibly to the point of not voting conservative.

    It has demonstrated that you are commenting on something that you know very little of.

    You suggest disposing of 4 divisions.

    Insurance – This is actually a reasonably stable income stream for the bank and certainly a reasonable diversification from core banking. Can understand the rationale for disposing of but as it’s been for sale for several months with no takers are you suggesting that another way of getting shot is possible?

    Manufacturing – This is laughable. Manufacturing “do the work” they open accounts, close them, send money around, answer the phone, deal with the buildings, look after the It etc. get rid of it and you don;t have a bank anymore – you just have a collection of brands and customers but no way to do anything with them. Also who would buy manufacturing – only another bank would want bank infrastructure and i think they all have one?

    ABN – what about the bits of ABN that have already been integrated into RBS – go to the expense of getting them seperate – who would buy? What about the transactional businesses? I agree with hindsight it’s not the best deal ever but isn’t the key part to make sure that it’s profitable ratehr than to think it;s still a separate business

    Citizens – Could go but again would you accept a fire sale? WHo would want to buy a bank.

    Why no mention of GBM? its the Global Banking and Markets division that dealt in the so called “Toxic” assets yet you seem to want to retain the bit that caused the problem.

    If you follow your plan you end up with a bank that can’t function. That demonstrates that your plan is either flawed or was thought through hastily on sketchy information.

    You have a great opportunity here to clobber cyclops brown. I think it was Robert Peston who pointed out at the time of the first bail out that the gvernment had been deluded to insist on the 12% preference shares and the conditions re dividends yet by insisting on this they reduced the chance of shareholders taking up rights as the shares were worth less.

    The government have now agreed to convert the preference shares. If they had got it right in the first place then we the tax payer wold own far less as more shareholders would have taken their rights.

    Reply: If you look back you will see I was very critical of the Pref capital and explained how it would mean RBS lost money on the transaction.
    You are right that now is a difficult time to sell anything, but the risk to the taxpayer is too great. There are some good businesses/activities in RBS which would be better off in the private sector, including manufacturing which acts for a range of clients and could sells its services back to the basic bank which the government wishes to nationalise. The taxpayer needs to raise some cash from this very large Group. Disposals have started and are possible, as the recent sales of Chinese bank shares illustrate. The Chinese market has fallen further than Wall Street in the last year.

  14. david
    Posted January 19, 2009 at 7:15 am | Permalink

    I’m sorry to see you still haven’t supported the 3rd runway decision, I’m sure you will.

    On the other hand I await your, ‘overwhelming support’ for the return of your old friend Kenneth Clarke.

  15. Posted January 19, 2009 at 10:21 am | Permalink

    Michael Taylor writes: “The second piece of good news is that commercial banks, as a 17th century technology, aren’t absolutely necessary in this world, and it’s quite possible to see how you can reconstruct a financial system without them.”

    I think this is correct. I operate a very small business. Increasingly customers pay by PayPal. Switching to PayPal saved me about £60 per month in bank/credit card service charges.

    My guess is there is an opportunity out there for the principle to be extended.

    • Michael Taylor
      Posted January 19, 2009 at 4:07 pm | Permalink

      I am sure it will be extended. First, because when it comes to sorting out good companies from bad companies, I’m prepared to bet that peer review (a la EBay recommendations) will perform just as well as export review (ie, credit rating agencies) when it comes to general commercial lending. Second, because the one thing you can absolutely certain of is that nationalised banks will be devastatingly inefficient, offering dreadful returns to savers, and high interest rates to borrowers. And that represents an opportunity for the money market mutual funds which will not be ignored for long.

  16. THE ESSEX BOYS
    Posted January 19, 2009 at 12:35 pm | Permalink

    We met over breakfast to watch the Downing Streeet press conference. Still no admission of failure or setback in the October package or in the action and events since!

    As disappointing is the failure of the 4th Estate to ask the right questions and put Messrs Brown and Darling on the spot.

    * IF THEY’RE NOW ANGRY AT HIDDEN LOSSES WHY NO DUE DILIGENCE AT THE TIME?

    * WHY IS THE NON-DISCLOSURE/REGULATION ON RBS A ‘GLOBAL’ ISSUE – IT’S A BRITISH BANK.

    * WERE WE NOT LED TO BELIEVE IN OCTOBER THAT A PRIME OBJECTIVE WAS TO ‘GET THE BANKS LENDING’ WITH THAT PACKAGE? WHY DIDN’T IT HAPPEN AND WHY SHOULD IT THIS TIME?

    * HOW MUCH VALUE HAS TAXPAYER SHAREHOLDING IN BANKS LOST TO DATE?

    * WHY ARE EXECUTIVES IN THE BANKS SURVIVING ON TAXPAYER FUNDS STILL ON SKY-HIGH SALARY & BENEFITS PACKAGES?

    * GB SAID TODAY THAT HE WOULDN’T LET THE ECONOMY COLLAPSE ‘BECAUSE OF THE MISTAKES OF A FEW BANKERS’.
    IS THAT REALLY AN HONEST APPRAISAL PRIME MINISTER?

    Readers of this blog are far better equiped to ask the questions than our supine and poorly-briefed journalists. Frustratingly we see this at every press conference. Having said that both GB – who passed the buck on every quantitative question – and AD were their usual evasive, unimpressive selves!

    We blogged several sites before Xmas that if the banks would not or could not re-loan the taxpayers funds – even to each other – why not form a sub-branch of the BoE (thus keeping it isolated from the main activities of the Bank) to do the job directly?
    Is the £50bn part of this latest package in fact that concept?

  • 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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