Op-Ed Columnist
By PAUL KRUGMAN
Published: October 12, 2008
Has Gordon Brown, the British prime minister, saved the world financial system?
O.K., the question is premature — we still don’t know the exact shape of the planned financial rescues in Europe or for that matter the United States, let alone whether they’ll really work. What we do know, however, is that Mr. Brown and Alistair Darling, the chancellor of the Exchequer (equivalent to our Treasury secretary), have defined the character of the worldwide rescue effort, with other wealthy nations playing catch-up.
This is an unexpected turn of events. The British government is, after all, very much a junior partner when it comes to world economic affairs. It’s true that London is one of the world’s great financial centers, but the British economy is far smaller than the U.S. economy, and the Bank of England doesn’t have anything like the influence either of the Federal Reserve or of the European Central Bank. So you don’t expect to see Britain playing a leadership role.
But the Brown government has shown itself willing to think clearly about the financial crisis, and act quickly on its conclusions. And this combination of clarity and decisiveness hasn’t been matched by any other Western government, least of all our own.
What is the nature of the crisis? The details can be insanely complex, but the basics are fairly simple. The bursting of the housing bubble has led to large losses for anyone who bought assets backed by mortgage payments; these losses have left many financial institutions with too much debt and too little capital to provide the credit the economy needs; troubled financial institutions have tried to meet their debts and increase their capital by selling assets, but this has driven asset prices down, reducing their capital even further.
What can be done to stem the crisis? Aid to homeowners, though desirable, can’t prevent large losses on bad loans, and in any case will take effect too slowly to help in the current panic. The natural thing to do, then — and the solution adopted in many previous financial crises — is to deal with the problem of inadequate financial capital by having governments provide financial institutions with more capital in return for a share of ownership.
This sort of temporary part-nationalization, which is often referred to as an “equity injection,” is the crisis solution advocated by many economists — and sources told The Times that it was also the solution privately favored by Ben Bernanke, the Federal Reserve chairman.
linkThe rescue planThe plan provides for several sources of funding to be made available, to an aggregate total of £500 billion in loans and guarantees. Most simply, £200 billion will be made available for short terms loans through the Bank of England's Special Liquidity Scheme. Secondly, the Government will support British banks in their plan to increase their market capitalisation through the newly formed Bank Recapitalisation Fund, by £25 billion in the first instance with a further £25 billion to be called upon if needed. Thirdly, the Government will temporarily underwrite any eligible lending between British banks, giving a loan guarantee of around £250 billion.<2> However, only £400 billion of this is 'fresh money', as there is already in place a system for short term loans to the value of £100 billion.<3>
Alistair Darling, the Chancellor of the Exchequer, told the House of Commons in a statement on 8 October 2008 that the proposals were "designed to restore confidence in the banking system", and that the funding would "put the banks on a stronger footing".<4> Prime Minister Gordon Brown suggested that the government's actions had 'led the way' for other nations to follow whilst Shadow Chancellor George Osborne stated that "This is the final chapter of the age of irresponsibility and it’s absolutely extraordinary that a government has been driven by events to today's announcement"; in addition to offering opposition support for the plan.<5>
Also on the 8 October 2008 there was a strategic and co-ordinated global effort by seven central banks to calm the current financial crisis, by cutting interest rates by 0.5%. The banks where all members of the OECD and included The Bank of England, The European Central Bank and the U.S Federal reserve along with central banks in China, Switzerland, Canada and Sweden. In a reaction to the move, European stock exchanges began to recover from the losses they had made after trading had opened. The decision to make the cut came after exchanges in the Far East closed on a day of heavy losses.
The British rescue plan differs from the $700bn US bailout formally entitled the Troubled Asset Relief Program (TARP), in that the £50bn being invested by the U.K. Government will see them purchasing shares in the banks (which in the future could see a return being made to the taxpayer), whereas the American program is primarily devoted to the U.S. government purchasing the mortgage backed securities of the American banks which are not able to be sold in the secondary mortgage securities market. The U.S. program does require the U.S. government to take an equity interest in financial organisations selling their securities into the TARP<6> The U.S. programme therefore does not address the fundamental solvency problem faced by the banking sector, but rather is aimed at tackling the immediate funding shortfall; the UK package tackles both solvency, through the £50bn recapitalisation plan, and funding, through the government guarantee for banks' debt issuances and the expansion of the Bank of England's Special Liquidity Scheme.
Capital investmentThrough the Bank Recapitalisation Fund, the government will buy a combination of ordinary shares and preference shares in affected banks. The amount and proportion of the stake that will be taken in any one bank is to be negotiated with the individual bank. Banks that take the rescue packages will have restrictions on executive pay and dividends to existing shareholders, as well as a mandate to offer reasonable credit to homeowners and small businesses.<3> The long-term government plan is to offset the cost of this program by receiving dividends from these shares,<2> and in the long run, to sell the shares after a market recovery.<3> This plan may potentially extend to underwriting new issues of shares by any participating bank.<2> The plan has been characterised as, in effect, partial nationalisation.<7>
The extent to which different banks participate will vary according to their needs. HSBC Group issued a statement announcing it was injecting £750 m of capital into the UK bank and therefore has "no plans to utilise the UK government's recapitalisation initiative ... (as) the Group remains one of the most strongly capitalised and liquid banks in the world".<8> Standard Chartered also declared its support for the scheme but its intention not to participate in the capital injection element.<9> Barclays intends to raise £6.5 billion from private investors, and will cancel its final dividend for the year for a net saving of £2 billion.<10>
The Royal Bank of Scotland Group will raise £20 billion from the Bank Recapitalisation Fund, with £5 billion in preference shares and a further £15 billion being issued as ordinary shares.<11> HBOS and Lloyds TSB will together raise £17 billion, £8.5 billion in preference shares and a further £8.5 billion issue of ordinary shares. The Fund will purchase the preference shares outright, for a total £13.5 billion investment, and will underwrite the issues of ordinary shares; should they not be taken up by private investors, the Fund will undertake to purchase them. If none of the new stock is taken up, this would give the Government an overall holding of 60% of the Royal Bank of Scotland, with 40% of the merged HBOS-Lloyds, held as a mixture of preference and ordinary stock.<10>
link Saturday, March 28 01:01 pm
"It's conceivable," Soros said in an interview with The Times. "You have a problem that the banking system is bigger than the economy... so for Britain to absorb it alone would really pile up the debt."
Soros said that "if the banking system continued to collapse, it's (an IMF bailout) a possibility but it's not a likelihood."
The man who made one billion dollars on short-selling sterling on 'Black Wednesday' in 1992 described the current recession as a "once-in-a-lifetime event", particularly in Britain.
"This is a crisis unlike any other. It's a total collapse of the financial system with tremendous implications for everyday life.
"On previous occasions when you had a crisis that was threatening the system the authorities intervened and did whatever was necessary to protect the system. This time they failed."
He said he feared the problem in Britain, with its huge financial and banking interests, could be greater than in the United States.
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