Recapitalising Britain

Prime Minister Gordon Brown has finally pulled the trigger. In the most momentous move yet in the credit crisis, the UK government is effectively partially nationalising the UK banking system. For months, I have maintained that the financial system needed to be recapitalised in the UK and elsewhere. If any country is to work its way out of these difficulties, it will need to address the lack of capital that financial institutions now have.

Yes, this will cost UK taxpayers tens of billions and yes this is a very bold move. But, it is wholly necessary if Britain is to have a chance to escape this credit crisis without succumbing to a deflationary spiral.

I commend Brown on having the courage to do this. As I examine the details, I will keep you abreast of how effective this measure is likely to be. On the face of it, Brown seems to have done the right thing. Other countries, especially the US, should take note. This is far more powerful and effective use of taxpayers’ money than simply buying up bad assets at inflated prices.

Gordon Brown, the UK prime minister, on Tuesday night ordered a massive taxpayer-backed cash injection to rebuild the balance sheets of Britain’s high street banks, effectively part-nationalising the sector at a cost of tens of billions of pounds.

The momentous decision came after a day of turmoil on the London stock exchange, where shares in RBS, the banking group, fell by 39 per cent to add to a 20 per cent tumble the day before. Rival HBOS more than halved over two days.

Faced with an intensifying banking crisis, Mr Brown sanctioned moves for the taxpayer to recapitalise leading banks, in a bid to restore confidence in the system and to encourage them to start lending again.

The total cost of the scheme was estimated at between £35-£50bn, which is expected to be executed through the government acquiring preferred shares. Mr Brown is expected to insist the taxpayer receive generous dividends and profits on the deal if share prices recover.

Full details may not be given until Wednesday morning, although Mr Brown’s team said a statement would be given before the London markets open.

The plan may also include provisions to ensure government representation on the boards of the banks and possible caps on future remuneration for banks’ chiefs, and a fund to ensure they can continue to fund day-to-day operations.

Mr Brown had wanted more time to develop a fully-formed bank rescue package, but was pressured into acting immediately by the markets, after reports circulated that banks were demanding an urgent injection of public money.

At £50bn, the recapitalisation of UK banks would more than double planned public borrowing this year, pushing public sector net borrowing close to £100bn and over 6 per cent of national income, worse than any year since 1994-95.

The additional borrowing, coming on top of increasingly dire independent forecasts for the public finances, will reinforce pressure on Alistair Darling, chancellor of the Exchequer, to explain how the government will reconcile its new desire to borrow at whim with its existing budgetary rules, which prohibit such action.

Mr Darling will seek to explain the actions as necessary emergency measures in an economic downturn in a lecture on Wednesday evening, when he will also set out a new framework seeking to bring borrowing under control in the medium term and restore credibility to the government’s economic framework.

Spain on Tuesday became the latest European nation to take unilateral measures to deal with the world’s deepening financial crisis, announcing a €30-€50bn emergency fund to provide liquidity to the financial system by buying Spanish banks’ assets.

José Luis Rodríguez Zapatero, the prime minister, told a hastily convened news conference that the temporary fund was designed to provide credit for borrowers starved of funds by the seizing up of interbank lending.

European Union governments on Tuesday sought to put aside their differences on how to stop the financial whirlwind sweeping through Europe and announced agreement on a set of principles for rescuing troubled banks.

EU finance ministers said each of the country’s 27 member states would be free to adopt measures ranging from recapitalisation, the purchase of bank assets and state-backed guarantees of bank liabilities.

But the ministers failed to establish clear guidelines for protecting the bank savings of individual depositors, saying all countries would guarantee savings of €50,000 for one year but some countries might raise the figure to €100,000.

Source
Massive rescue plan for banks – FT