Amid the slew of dreadful news, collapsing share prices and political brawling, it is easy to lose sight of the policy debate – the outcome of which will eventually decide how long this crisis will last.
I was reminded of this last week while watching a senior British politician on the TV news, railing against the latest "fat cat" banker who is alleged to have made off like a bandit, leaving his customers and shareholders in ruins. In Britain at least the credit crunch, in political terms, has become a fight for the next headline. It is a short-term scrap, where promoting or defending personal reputation is judged far more important than actually finding a remedy to what is now a Very Big Problem.
That is not the case everywhere. I notice that in Washington, among the think-tanks that crowd the American capital, an essentially up-lifting debate is certainly under way. Whether it throws up the right remedies, and whether those remedies are pursed by congress and the Obama administration, is another matter. But at least the debate is happening.
A DIFFERENT VIEWPOINT
Take the views of Adam Posen, a senior economic thinker at the Peterson Institute. He has put forward a passionate plea for more decisive governmental action, with his closely-argued plan of action submitted to Congress at the end of February. His views on the action required by the US Government can be summarised thus:
- Recognise that the money is gone from the banking system, and banks already are in a dangerous public-private hybrid state.
- Immediately evaluate the solvency and future viability of individual banks.
- Rapidly sort the banks into those that can survive with limited additional capital and those that should be closed, merged, or nationalised.
- Use government ownership and control of some banks to prepare for rapid resale to the private sector, while limiting any distortions from such temporary ownership.
- When reselling and merging failed banks, do so with some limit on bank sizes.
- Do all of this before the stimulus package's benefits run out in mid-2010.
- And buy illiquid assets on the Resolution Trust Corporation (RTC) model, and avoid getting hung up on finding the "right price" for distressed assets or trying to get private investment up front, which will only delay matters and waste money.
Easier said than done, you might say. But I suspect Posen is right. This is probably where we are headed – an aggressive, expensive, heavy-handed programme of direct government intervention, followed by a schedule of re-privatisation of financial institutions down the line. The real question is how quickly a consensus can be reached that such intervention is necessary, because that will decide just how long this mess continues.
That may sound extreme, overly dramatic even. It may not mesh with the sentiments I have expressed in this column before. But as the saying goes, if events change things I for one am happy to change with them.
THE UK REALITY
Take events in the UK over the past weekend. After weeks of furious behind-the-scenes negotiation, the British Government agreed a plan to fund a fresh bailout of Lloyds Banking Group, itself formed by the emergency merger of Lloyds and the insolvent HBOS last October.
Under the plan, the British Government will insure some £260bn (Dh1.22trn) of Lloyds' toxic assets. In payment for that insurance – which may well inflict losses running to many billions of pounds on UK tax payers – the government will take majority control. Which is where a great big fudge has come in.
Lloyds needs a cool £15.6bn to insure its toxic assets. It will fund this by issuing new equity to the government, which takes the state's economic interest in the bank from 43 per cent to 75 per cent. However, while this new equity attracts dividends it does not carry any votes. Under a separate plan, the government will convert £4bn of Lloyds preference shares issued during the last bailout into pure equity, but this will take its vote-carrying shareholding to just 65 per cent.
Why faff around like this? If Lloyds needs more than £15bn to underpin its toxic assets, and requires another £4bn to bolster its balance sheet as Britain plunges deep into recession, then it is effectively a bust bank. Plain and simple.
In such circumstances, given the structural importance of Lloyds to the British economy (with HBOS it accounts for more than 30 per cent of the UK mortgage market), the British Government should step in and take full control of what is a stricken institution. Instead it is being left in that "dangerous public-private hybrid state" identified by Posen above.
The ramifications of this are potentially huge – not least for other, struggling members of the British banking sector.
I have written here before about the particular perils facing Barclays, for instance – a bank that has relied on strong support from UAE investors. My fear now is that its position has just got substantially worse.
For what are probably reasons of luck rather than past strategic decisions, another London-based global bank, HSBC, was able to tap shareholders for more than £12bn last week – the biggest rights issue ever seen in Britain. HSBC struggled for years to establish itself as a meaningful presence in the investment banking industry, but to a large degree failed. While it did expand into sub-prime lending in the US, its failure to break into investment banking meant it avoided much of the structured finance toxicity now poisoning other banks from the inside out.
In the event, that means shareholders have now been ready to help it underpin its balance sheet in a substantial way.
BARCLAYS LEFT DANGLING
But what of Barclays? It does have structured finance problems, although it denies the situation is anything like as bad as its detractors suggest. At the same time, it has steadfastly refused to sign up to the British Government's past offers of financial assistance.
Barclays would clearly now benefit from the British Government's offer to insure toxic loans, but unless it belated hands the government a substantial slice of its equity (something that would cost the current board their jobs) it is left searching for enough cash to sign up for the government scheme.
Barclays, in short, is left dangling between two quasi-state controlled zombie banks (Lloyds and also RBS) on the one side, and a freshly replenished mega-rival (HSBC) on the other.
That does not look good.
- The writer is an Associate Editor with the Financial Times