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why UK failed state risk bankruptcy

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    why UK failed state risk bankruptcy

    http://www.ft.com/cms/s/825cf2ea-09b...Fhome%2Feurope

    #2
    Full article for those who dont want to register

    Big risks for the insurer of last resort
    By Martin Wolf

    Published: March 5 2009 19:23 | Last updated: March 5 2009 19:23

    The UK government looks increasingly like a python that has swallowed a hippopotamus. In acting as insurer of last resort to the British-based banking system, it is taking on huge risks on behalf of taxpayers. If this turned out to be a global depression, with huge losses for British-based banks, fiscal solvency might even come into question. Can this make sense? I doubt it.

    At the end of last year, total assets of the British-based banking system were £7,919bn ($11,188bn, €8,908bn) or 5.5 times gross domestic product. These aggregate assets increased by £956bn between the end of 2007 and the end of 2008 and by £4,493bn, or by 130 per cent, between the end of 2001 and the end of 2008. Royal Bank of Scotland alone accounted for 45 per cent of this latter increase. At the end of last year, RBS had the largest assets of any British bank, at 166 per cent of GDP. These asset positions are enormous. It should be noted, however, that they include gross derivatives positions (which is not the case under US accounting). Net derivatives exposures were far smaller.

    RBS was a small Scottish bank that wanted to be big. It succeeded. Yet, today, the market capitalisation of RBS is a mere £9bn. Even this is only because the Treasury has not wiped out private shareholders. The bank is in effect nationalised. Taxpayers bear the cost of guaranteeing this fruit of megalomania. I must confess an interest: I am a depositor at RBS. As such, I am grateful.

    Implicitly, the UK government is guaranteeing the liabilities of the swollen UK banks. Explicitly, it seems likely to guarantee at least £600bn of toxic assets of RBS and Lloyds under its “asset protection scheme”. I am no populist. Yet when I think of the sums earned by those responsible for dumping this mess on to the UK taxpayer, even my blood boils.

    RBS has definitely received £325bn of insurance of toxic assets. The first 6 per cent of any losses (£19.5bn) will fall on RBS, with RBS taking 10 per cent of the losses above this limit. The overall fee paid by RBS for this insurance is about 4 per cent of the amount insured. A part of this is paid in RBS shares, which are, to put it mildly, funny money. To keep this behemoth breathing, the Treasury has pumped in £25.5bn of extra capital.

    My colleague, Willem Buiter, in his magnificent blog states bluntly that: “like its American and Dutch counterparts, this toxic asset insurance scheme is without redeeming social value: it is inefficient, unfair and expensive”. Is he being too harsh? Not much.

    Clearly, the biggest attraction of such a scheme, to both politicians and beneficiaries, is that its costs are removed from the public accounts. How large might these costs be? I understand that internal calculations of the International Monetary Fund suggest a fiscal cost of all UK bank support of 13 per cent of GDP, or £200bn. I suspect this is too optimistic. Certainly, together with the costs of the economic slump, an increase of well over 50 percentage points in the ratio of public sector debt to GDP is highly likely. Such are the wages of financial mania. They would be similar to the fiscal costs of a war.

    Why should not more of the losses fall on creditors, other than the insured depositors? That is the question asked by many economists. It is the approach recommended by proponents of a “good bank” solution.

    The big point here is that the losses against which the government is now offering such generous insurance relate strictly to bygones. If we want banks to make new loans, it makes far more sense to guarantee those, rather than bail out all those who financed the mistakes of the past. So, suggest the radicals, toxic assets should have been left with the shareholders and uninsured creditors of the old bank, who would also gain a claim on a clean new bank. Moral hazard would disappear and taxpayers would be left relatively unharmed.

    The arguments against this are two: first, the possibility of a default would create a wave of panic worse than the one that followed the bankruptcy of Lehman last September; and, second, for this reason, no individual government could dare to go it alone.

    Unlike Professor Buiter, I recognise that these could be valid arguments in the current circumstances. I certainly have no desire to make the slump even worse than it is. But, if so, they have compelling implications.

    One is that we must create effective mechanisms for orderly bankruptcy of very large financial institutions. Indeed, this is far and away the most important lesson of the crisis. Another is that if large institutions are too big and interconnected to fail, precisely because they are bound to get into serious trouble together, then talk of maintaining them as “commercial” operations, as the chancellor of the exchequer does, is a sick joke. Such banks are not commercial operations; they are expensive wards of the state and must be treated as such.

    The UK government has to make a decision. If it believes that costly bail-out must be piled upon ever more costly bail-out, then the banking system can never be treated as a commercial activity again: it is a regulated utility – end of story. If the government does want it to be a commercial activity, then defaults are necessary, as some now argue. Take your pick. But do not believe you can have both. The UK cannot afford it.

    ==========================

    The last paragraph is spot on.

    Comment


      #3
      Originally posted by BrilloPad View Post
      ...
      The UK government has to make a decision. If it believes that costly bail-out must be piled upon ever more costly bail-out, then the banking system can never be treated as a commercial activity again: it is a regulated utility – end of story. If the government does want it to be a commercial activity, then defaults are necessary, as some now argue. Take your pick. But do not believe you can have both. The UK cannot afford it.

      ==========================

      The last paragraph is spot on.
      Failing businesses are an essential part of Capitalism at work. If you don't allow an unsuccessful business to fail, then what you have is a public service (who pays for that?), not a business; and no incentive to succeed rather than fail.

      Comment


        #4
        Originally posted by expat View Post
        Failing businesses are an essential part of Capitalism at work. If you don't allow an unsuccessful business to fail, then what you have is a public service (who pays for that?), not a business; and no incentive to succeed rather than fail.
        And the process should have been started by letting LTCM go to the wall in 1998. For too long banks have be coseted by the assumption that they are too important to fail. Not helped by the Grrenspan put.....

        Comment

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