The Swedish roots of the UK bailout plan
Gillian Tett makes a good point in today’s FT about the clear benefits of a systemic solution to crisis. Where the UK policy makers were bumbling along until today, they have taken the problem firmly in hand, finally recognizing the systemic risk. Tett sees this sensible policy as one hearkening back to the Swedish solution last decade. The U.S. would do well to take notice.
During much of the past year, British financial authorities have looked like Bertie Wooster-style, bumbling amateurs in the face of the banking meltdown. Now, finally – albeit belatedly – they have got something right.
Alistair Darling, chancellor of the exchequer, on Wednesday announced that the government would spend up to £400bn underpinning the banks. The only thing more startling than those dazzling zeroes is that Mr Darling is now overseeing a policy package that is arguably more sensible than anything else emanating from the western world.
For this package suggests that British mandarins have finally learnt to draw sensible lessons from the past, most notably from the 1990s crises in Japan and Sweden. More striking still, these moves could also provide pointers for how the U.S. authorities could improve their own policies.
There are at least three reasons to cheer. The first is that the UK government has acknowledged something the Americans remain reluctant to admit: that when a banking crisis is this bad, it makes more sense to recapitalise banks by buying preference shares than by purchasing their duff assets.
That does not necessarily mean that a “Tarp” – the scheme the U.S. is creating to purchase toxic debt – is a bad idea. On the contrary, if the Tarp creates a liquid market for mortgage debt and removes rot from bank books, then all financial players will benefit – including those in London. This puts the British authorities in an unusually favourable position in formulating their own policies.
However, the problem with the Tarp is that the toxic assets are so fiendishly complex that they cannot be easily valued or traded. Even in good times, it can take a computer several days to price complex collateralised debt obligations. That creates daunting logistical obstacles for a Tarp, which could delay or blur the balance sheet benefits.
Putting money directly into the banks, by contrast, is a fast and transparent way to help them. Moreover, it worked relatively well when it was employed by Japan and Sweden a decade ago, in tandem with various initiatives to purchase toxic assets. Better still, while both Sweden and Japan badly underestimated the scale of their crisis when it started, once they finally produced a hefty bail-out plan, they eventually recouped most of their investment.
A second point of cheer is that the British now also seem ready to take other steps to get credit and money markets moving again. The most eye-catching element of this revolves around injections into the money markets. However, what is equally important is a pledge that debt issued by banks will be protected from default.
That may sound arcane. However, it is crucial. Until last month, European and U.S. investors assumed that bonds issued by large banks were safe, since they had been protected in previous decades. But the manner of Lehman Brothers’ collapse shattered that belief in a manner that sparked a catastrophic chain of fear. The Federal Reserve’s apparent failure to anticipate that shock represents one of its biggest single policy mistakes. Wednesday’s announcement suggests the UK authorities have no intention of repeating this disastrous error. So much the better.
However, the third reason for cheer lies not in arcane finance – but sociology. Right now many voters are understandably furious with bankers. No wonder. When the banking crisis hit Japan a decade ago, bankers bowed to show their public remorse; this time, however, barely a single western banker has even said “sorry”.
Now, there is no guarantee that the British government can assuage this anger; but on Wednesday it did at least promise to impose more “discipline” on bankers. That may turn out to be mere window dressing; but it is more than anything offered by Washington so far.
Of course, none of this guarantees the UK can now end its banking woes, let alone avoid a recession. Unlike the Japanese and Swedish crises, this one is international. As a result, the fortunes of British finance now depend on more than UK policymaking alone.
But, with a bit of international co-ordination – and a hefty dose of luck – London does now have a chance of stabilising its banking system. The tragedy is that it took so much incompetence and denial – on both sides of the Atlantic – to arrive at this point. If nothing else, the next generation of bankers and financial bureaucrats should be compelled to start their careers by spending time studying financial history books.
The writer is capital markets editor
Stopping a Financial Crisis, the Swedish Way – Bo Lundgren, NY Times
A shift from bumbling to sensible policy – Gillian Tett, FT