3 Nov 2009

Government bailout 3.0: Lloyds and RBS

Just over a year ago we thought that the £37bn injection of equity by the government into Lloyds and RBS was the landmark, never-to-be-repeated event. Bailout 1.0 literally saved the banking system from collapse, and was copied around the world.

Then, in January, came Bailout 2.0, which we were told would be a bailout not of the banks, but of the economy. That bailout was to enable the banks to continue lending to prospective homeowners and to businesses.

And now we have Bailout 3.0.* Incredibly, the extent of actual taxpayer funding into these two banking giants will be larger than the first bailout, which rescued them from collapse. £40bn more.
This will be spent on banking shares that have fallen in price since the last tranche was bought. RBS, two years ago the sixth biggest bank in the world on some measures, will now be 84 per cent owned by the state.

To be fair to the Treasury, this outcome was indicated back in January, though it had not been expected that all the £25.5bn would be needed up front. There’s also an incredible tax break, worth billions for RBS, which reflects their ability to charge losses against future tax bills. It must have caused the government accountants a headache.

What really has changed is that the extent of the guarantees: the so-called contingent liabilities have been reduced markedly. Lloyds have sidestepped the government’s toxic waste guarantee scheme, so £260bn of HBOS’s rotting commercial property and mortgage assets will now be dealt with by the private sector. The process of due diligence has also shrunk the RBS guarantee from £325bn to £282bn.

I had previously pointed out that the APS was seen internally as the biggest government contract signed since the Lend Lease arrangements with US forces during world war two. As Lloyds exits, this may no longer be the case. Indeed having gained £2.5bn for a nine-month insurance policy that did not pay out a penny, Lord Myners may wish to start up shop as an insurer if he leaves government next year.

So arguably the situation is better than the worst-case scenario envisaged by Bailout 2.0. The taxpayer no longer has to worry about HBOS’s toxic waste dump. But more money more quickly appears to be seeping into RBS.

The crucial difference is that this happening at a time when we are told there is no money for anything else. No money for public sector pay. No money for other industrial or consumer stimuli. Small wonder that the government shot George Osborne’s fox by banning cash bonuses to anyone at these two banks earning above £39,000.

*The biggest hedge fund in Britain, is how Robert Peston referred to this deal. The government is borrowing money at 3 per cent to buy shares in banks. It’s the classic story of leverage that funded the champagne lifestyle in Mayfair.

Of course, the next leg of this analogy is to point out that the Treasury’s deficits are actually being funded by the Bank of England, which in turn is creating the money out of thin air. No hedge fund has those powers.

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