First the Government bailed out Northern Rock, then it was Bradford and Bingley.
Now, with nearly every other bank looking as nervous as a turkey on Christmas Eve, the Government has announced a £50 billion rescue package. However it could end up costing us taxpayers up to £500 billion!
The key points of the plan are:
- Banks will have to increase their capital by at least £25 billion and can borrow from the government to do so.
- An additional £25 billion in extra capital will be available in exchange for preference shares.
- £200 billion will be available in short-term loans from the Bank of England, up from £100 billion.
- Up to £250 billion in loan guarantees will be available at commercial rates to encourage the banks to lend to each other.
- To take part in the scheme, banks will have to sign up to an FSA agreement on executive pay and dividends.
Which banks are included?
It seems likely that five of the eight institutions listed in the announcement will participate in the equity raising; Royal Bank of Scotland, Barclays, HBOS, Lloyds TSB and Nationwide – while HSBC, Standard Chartered and Abbey will be more likely to take advantage of the money market operations. Other banks and building societies would be able to apply for inclusion in the plan.
In return for all our taxpayers money, the government insists it has extracted a price from the banks; no more big bonuses, no dividends to shareholders and a pledge to keep lending money to small businesses and would-be homeowners. But, whether this is adhered to, remains to be seen.
How on earth did we get here?
In a nutshell, banks got careless and loaned too much money to people who just couldn’t pay it back. If a lender makes too many bad loans, they go bust. But because these lenders are so vital to the economy, the government has decided we can’t let them go bust; hence the bailout.
How do banks borrow money?
They borrow it from you and me (through savings deposits), or from commercial lenders (through the wholesale money markets), or through issuing bonds. So say the bank has £1 in shareholder equity. It then borrows £9 on top of this. It then writes £10-worth of loans based on this.
There are two serious flaws to this. Firstly, you have to make sure the people you lend to will repay you and secondly, if everyone you’ve borrowed from wants their money back at the same time, you’re in trouble, because you’ve loaned most of it out. So you have to keep an eye on when your payments are falling due.
Most bank lending is done over the long-term (like a 25-year mortgage) and banks charge more for this, as it’s taking a bigger risk. Most bank borrowing, however, is done short-term, via instant access deposit accounts and 30 or 90-day loans from the money markets. This borrowing is cheap, because it’s only short-term.
What went wrong?
All this is fine as when a short-term loan comes to an end, the bank just rolls it over, which the lender is usually happy to do.
Notice the word ‘usually’…
When the US sub-prime mortgages started going wrong, it was clear that the loans that banks had been writing were worthless. Would you be keen to fund a bank giving out bad loans? If it doesn’t get its money back, maybe you won’t either. More to the point, many of the people doing the lending are banks themselves. So they realise they’re going to need that ‘spare’ money, and hang on to it.
So the money markets dry up as institutions hoard their cash and that is what the central banks have been trying to deal with. This is the liquidity problem, which is what scuppered Northern Rock. It relied too much on wholesale markets, couldn’t repay its debts when they fell due and couldn’t be rolled over, so it went to the wall.
Northern Rock; more of your money down the drain
What does all of this mean?
It means we’ve acknowledged that UK banks are broke. But by offering extra capital and vast liquidity to the banks, this may unblock the money markets, reduce inter-bank interest rates, and encourage banks to lend to each other again.
In this scenario, credit for businesses and individuals should become cheaper and more widely available. For now, this should stop the immediate panic about the security of British banks, but how will things be in a year’s time? What about 5 year’s time?
The Government can play a very long game, holding these assets for years, or even decades, until they recover in value.
For instance, Sweden bailed out its banks in this way in 1992, and made a profit for Swedish taxpayers. So, while this plan may be a short-term lemon, it could prove to be a long-term cherry.
How much will it cost all of us?
With about 25 million UK households, the £50 billion rescue plan works out at £2,000 per household added to our national debt.
What it also means that the part nationalisation gives us all a stake in these lenders; hence we mustn’t allow them to take our money and then lend it back to us at high rates of interest!
Though they may be recapitalised, banks can’t return to rampant lending. None of this will be over until the property crash ends, because as long as property markets continue to tumble, the asset side of banks’ balance sheets remains under question.
PS: One piece of good news: the government has guaranteed all £4.5 billion of savings in failed Icelandic bank Icesave (and plans to sue the Icelandic government for withdrawing its savings safety-net).
What do you think of the Government’s decision?
Should they be bailing out the organisations who should have known better or are they not left with much choice?
Why not let us know what you think in the comments below?
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October 9th, 2008 at 9:06 pm
Firstly, Gordon Brown has not done enough in terms of legislation to keep the banks in check. Essentially, we have just given the banks a blank cheque with no controls what-so-ever. The very people who put us in this situation, now have a lot more money(taxpayers money) to play around with and pay themselves fat bonuses-just look at AIG’s $430 000 weekend. I am not a communist, but i suggest that the govt take more control of these banks using legislation- maybe even consider prosecution of some of these shady individuals. As for the councils, they are frankly to blame and the public should not be made to pay for their incompetence in the form of council tax increases. Having said that, their incompetence is nothing compared to bankers. The councils should be accountable for the losses and must find a way to recoup this money. Why should the common person suffer because of the gross incompetence of a few. Frankly, i am sick and tired of this. Funny enough, last year i posted a message on the money hospital website stating that the government needs to monitor and control the banks. If the councils plan to raise council tax, then we should consider a legal challenge to this.If needs be, a combined public effort to fund the best legal teams may be an idea in order to mount a serious and effective legal challenge. It is so ridiculous that we have to keep forking out our hard earned cash to bail out greedy, incompetent bankers and councillors who haven’t a clue. Its about time the taxpayer took a stand. One last note-the banks have been fleecing us anyway with unlawful bank charges- and now this. Its the final straw.
October 11th, 2008 at 10:39 am
Nick Leeson received a jail sentence for mis-using bank funds ~ TAKING BIG RISKS WITH PUBLIC/BANKS MONEY ~ and losing it!!!!.
Why are none of the ‘Big Fat Cat Bankers’ suffering the same fate???????????????
October 13th, 2008 at 11:24 am
Probably because they are financial supporters of our present Government…
October 13th, 2008 at 8:25 pm
I work to pay my bills —WHY ARE THE BANKS NOT REDUCING THEIR MORTGAGE RATES TO US SMALL TIME HONEST BORROWERS –i AM ON THE SVR rate AS I WASNT ALLOWED A NEW DEAL –IT MAKES ME VOMIT TO THINK i MAY GET REPOSSESED AFTER NEVER EVER BEING LATE IN PAYING MY MORTGAGE YET FAT CITY BOSSES AND OTHERS WILL JUST GET A TICKINGOFF —WHY ARENT WE COMPLAINING MORE AS IT IS US THAT WILL BE PAYING TAX FOR THIS *******BAILOUT
October 13th, 2008 at 8:45 pm
Why are we subsidising HBOS to the tune of £15billion? if the Lloyds TSB bank is taking them over surely this is giving Lloyds TSB another £15billion on top ofthe £5billion we have to subsidise the Lloyds TSB.
October 14th, 2008 at 9:47 am
With all this funny how bank charges are not mentioned who is going to help us with claims
October 14th, 2008 at 10:08 am
I couldn’t agree more with Stephen.
I run a small business and if I make a mistake I have to pay for it. The people in charge of banks & councils are supposed to be experts (or at least have teams of experts to call on) and are on a much, much higher salary than I. Why should we be asked to bail them out? Why should the public have to pay for their mistakes? Sack them and get someone else in who knows what they are doing. Maybe new directors should be made to sign a contract with a ‘responsibility’ clause related to paying back damages if (or when) they screw up!
The previous suggestion of legal inetrvention should councils raise their tax is a fair comment and I think it is a great idea. When councils ‘do’ get it right, they never offer the council tax payers a rebate!
October 14th, 2008 at 10:42 am
I thought we had ‘sapiential authority’ in this country, which means that you are responsible for your actions if you should have known better due to your training or expertise? Are bankers, or Gordon Brown for that matter, finally admitting that they are amateurs? If so, just how are the large salaries justified?
October 14th, 2008 at 11:24 am
Ideally the banks should go bust and survivors and new banks should take over. The value of a bank lies almost entirely in its good name. Once that is gone its value lies in some buildings and some software (especially secuity software) and a share of an interbank network. The value of its staff in terms of special skills and other intellectual property is very limited, e.g. if compared to a SmithKlineGlaxo. By using the internet and experienced programmers a viable bank can be established at very low cost, but access to bank networks and ATMs would be essential. A good reputation could be established e.g. by operating on a mutual and local basis.
This should be the way forward, but given the monumental screw up that these chumps have made perhaps there isn’t time to let ‘nature take its course’. How much longer have we got to wait before people who don’t understand the tools that they use (e.g. risk analysis software) are replaced by people who do!
October 15th, 2008 at 8:12 am
Having worked for one of the major banks years ago-I can only say one thing -greedy, greedy fat cats!pushing the staff and branches to mis-sell and mis advise-and now things have gone wrong its those customers they ripped off that will evidently have to end up paying for the total hash-up they have made of the Economy ! disgusting –if any other sector have behaved in this way -lawsuits would be flying all over the place, and if it wasen’t for the fact that We need the most basic account to run direct debits and credits, I am guessing that a majority of the british public would go back to putting money under the matress
October 15th, 2008 at 12:44 pm
My only comment: Use Co-operative bank.
January 22nd, 2009 at 11:24 am
In years past there were banks and building societies, the banks thought that they could take a big slice of this market.
The general feeling of the day was that they couldn’t cope, the general feeling won the day!!
The banks failure is built on greed,high interest rates breeds mega high salaries for the few,the so called FEW are no more qualified than the rest of us,though they would have us believe they are,they profess to be risk takers, but wheres the risk,when they fail, they get bailed out .When we fail at our jobs we get sacked without an additional bonus.
Sack all the big chiefs and make the maximum salary paid, less than £100k and minimise the shareholder dividends
If this is unacceptable then why not return to the old system,Building Societies for the housing market and savings—– the banks for those who like being screwed!!!
June 25th, 2010 at 10:00 am
[...] if not hundreds of millions of pounds (http://www.moneyhospital.co.uk/blog/post/the-50-billion-british-bank-bail-out) of taxpayers money was used to bail out the banks, much more than the deficit. Make the banks [...]