Tuesday, 5 April 2011

The Myth Of An Alternative To The Bank Bail Out

Last month I was particularly angered by a comment from Defence Secretary Dr. Liam Fox when he said that the main reason for the cuts in defence expenditure was no fault of the coalition government rather it was the consequence of the sustained damage Dr. Gordon Brown had inflicted on the economy as prime minister 2007-10.  Among leading Conservative politicians, Fox has been one of the most vocal in attributing the blame for the UK's economic problems on the previous Labour governments, more so even than Prime Minister David Cameron and Chancellor of the Exchequer, George Osbourne.  Cameron and Osborne use the large deficit created by bailing out the banks at the onset of the recession as the excuse for their harsh public spending cuts, which would have been imposed even if the UK was in a boom because the current batch of Conservatives believe that the state is too large and needs to be culled as abruptly as possible.  Fox, however, takes it a step further and peddles the idea that for some reason Brown and his government deliberately 'wrecked' the economy for some unknown motive.  Fox, in many ways, is a throwback to the 1970s and 1980s seeing some Communist conspiracy at the heart of British government trying to do the worst for the decent British public.  The reality was that whilst governments do and pursue a particular agenda, and Brown less vigorously than the prime ministers that bracketed him, a lot of their activity is responsive rather than proactive, particularly in the age of the globalised economy when the demand from copper in China leads to thieves in the UK disabling electricity sub-stations and sections of railway in order to get the scrap copper.

All governments say that they could have done things better than their rivals.  There is an implication in everything that Cameron, Osborne, Fox, et al say, that if, for example, rather than Tony Blair handing the premiership to Gordon Brown in June 2007, there had been an election and David Cameron had come to power, then the banking crisis and the recession which came the following year, would have been handled so differently, so much 'better', if Fox is to be believed, that, in fact, we would not now be facing such a large deficit and the consequent 'need' to slash so much of public service.  So let us look at what the Conservatives might have done differently.

The first thing to establish is what would have happened if the government had done nothing.  Even before the global recession had started, in the UK, the Northern Rock bank ran into problems.  It lent 18.9% of all of the mortgages in the UK and handled deposits of £24 billion compared to loans and assets of £113 billion.  In the summer of 2007 it found it difficult to borrow money to cover its lending.  As the US sub-prime market began to stagger, lenders became reluctant to lend on any mortgages even though British lending was generally on a far more restricted basis.  I was not surprised that Northern Rock was struggling having had much anecdotal evidence of its poor customer care combined with its aggressive marketing of products including very high percentage mortgages; this has raised its market share from 14.6% in 2006.  Rapidly fading faith led to a 'run' on the bank with £1 billion in deposits being withdrawn on 14th September 2007. This was the first run on a British bank for more than a century.  To stop the bank from collapsing, the British 'lender of last resort', the Bank of England lent the company £27 billion and in 2008 bought up £3 billion of effectively worthless shares in the company.  In February 2008 the bank was de facto nationalised. 

At least ten other offers to buy the bank were rejected because these potential owners were unable to repay the public money loaned to the company.  Interestingly, the US company Lehman Brothers which was soon to collapse in a spectacular way was one of the bidders.  Others were equity funds such as Terra Firma Capital Partners, J.C. Flowers and Ceberus, investment companies like Olivant and other banks like Bradford & Bingley and Lloyds-TSB.  If Terra Firma's bid is anything to go buy, some of the equity fund purchases would have been de facto asset stripping processes.  Interestingly, before Northern Rock was effectively taken over by the state 40% of its best business accounts was transferred to a company called Granite based in the Channel Islands which have different tax laws.  Though Granite does not receive new business, this effectively meant the cream of the bank's business (and profit potential) remained free of state control.

Now, if the state had not stepped in, then we would have seen the run on the bank continue, reducing the amount of deposits even further than before in relation to its loan commitments. There was one incident in which one bank manager was barricaded in their office because two customers were unable to withdraw their £1 million after the online banking facility of Northern Rock collapsed.  It is likely that violent scenes would have continued as the bank would have found it impossible to cover all the withdrawals with the relative low level of reserves it kept. At this stage the bank would be compelled to foreclose on its mortgages, i.e. insisting lenders immediately repay their loans or lose their homes to the bank.  This would not have helped the bank much as they would have had to dispose of the property quickly to recoup funds and in many towns the housing market would have been utterly disrupted as numerous properties were auctioned off.  As it was some borrowers, including charities, accused Northern Rock of pursuing aggressive repossession especially in 2007-8.

Some borrowers could have transferred their mortgages to other banks but this would have brought pressure on to them as they would increasingly have faced the challenges Northern Rock had already faced to raise loans to cover the mortgages they lent.  Thus, even before the main recession started, not bailing out Northern Rock could have become a crash in the UK economy. The issue for many was that the total support to Northern Rock came to £100 billion which was added to the National Debt meaning it was equivalent to 37.5% of the GDP (Gross Domestic Product) close to what is seen as the highest permitted level of debt by a state. 

I suppose that the difference that the Conservatives would have done, is being so averse to nationalisation, they would have allowed Northern Rock to have been sold to another bank, with no guarantee that the public funds put into the bank would ever be returned.  Under the de facto nationalisation, by August 2008, the bank had already paid back £9.5 billion of what it had been given, so reducing its part of the National Debt.  It seems unlikely, given that so much Conservative support comes from property owners that they would have allowed Northern Rock to collapse, it held too large a market share.  Thus, there would have been addition to the National Debt just in the way the Conservatives complain about.  In addition, there approach would have meant that the government would not have had a chance of ever seeing the money it had provided returned at some date in the future. 

The key difference would have had to have occurred back in the 1990s when regulation of banks and The City financial bodies was far too lax.  The Blair government like the Major and Thatcher ones that had preceded it, seemed beholden to the financial institutions and was happy for them to act recklessly and earn big profits.  The 'invisible' trade of financial products has been Britain's strongest industry since the 1980s and no prime minister seemed to have the will or the wish to temper the behaviour of not only merchant banks but also high street banks too.  The conversion of mutual building societies into banks after 1986 and their focus on shareholders rather than customers did not help the situation in the mortgage sector, because they were prone to take more risks.  A lot of this could be foreseen, the Bank of England had apparently been working through scenarios of such difficulties as early as 2004 and like many others saw Northern Rock and Halifax/Bank of Scotland (popularly referred to these days as HBOS) as likely candidates.

The ongoing sub-prime mortgage crisis in the USA and the subsequent tightening of loans to banks meant that many UK banks beyond Northern Rock began to experience crises.  The Bank of England offered £4.4 billion in relief in September 2007 and it was drained by banks within hours. In October 2008, the Bank of England offered £37 billion to Royal Bank of Scotland (RBS), Lloyds TSB and HBOS who were struggling to cover their loans and certainly to grant new ones.  Would the Conservatives have refused to offer such funds to the banks and so, having avoided the collapse with Northern Rock, have seen even greater problems as these banks collapsed?  RBS had assets of £2.5 trillion in December 2008 and Lloyds Banking Group £1.195 trillion, thus the scale of their demise would have made that of Northern Rock seem minor.

RBS had had difficulty in raising funds from April 2008 and in the end first 60%, in March 2009 70% and in November 2009, 84% of the bank was taken over by the state.  RBS has been shedding assets since early in 2008 but did not close its tax avoidance department until March 2009 and in December 2009 stood by plans to pay £1.5 billion in bonuses to staff in its investment arm.  Lloyds-TSB already an amalgam of an old bank and a building society turned bank, took over HBOS in September 2008.  Like these other banks, through 2008 HBOS itself an amalgam of a bank and building society turned bank, saw rapid falls in its shares.  The government approved of the combination of Lloyds-TSB with HBOS even though it was effectively counter to competition as the 'super-bank' has 38 million customers, compared to a UK population of 61.8 million people.  This buy-out effectively relieved the government of having to take over HBOS itself.  However, the continued difficulty in banks raising funds meant that in 2009 the government bought 43% of the Lloyds Banking Group.  EU rules means that by 2013, it will have divested itself of the TSB brand and hundreds of branches of the retail group.  Now, it seems unlikely that the Conservatives would have overseen the nationalisation of any bank.  They certainly would have backed the buy-out of Lloyds-TSB of HBOS, but then in 2009 what would they have done with this super-bank running into difficulty given that so many people and businesses were dependent on its stability?  The likely solution from their view would have been to sell it to a consortium of equity funds.  Given equity funds' desire for fast profit, it is very likely that we would have seen even faster shedding of staff than the 15,000 made redundant by the company in 2010, a fifth of the total workforce.  By November 2009, RBS has similarly shed over 19,000 jobs.  Again, if the state had not stepped in and the only remaining source of support had been equity funds or perhaps foreign banks, then this figure is likely to have been higher. 

The Bradford & Bingley bank's mortgage book in was bought by the government in December 2008 whilst the savings and bank network was bought by Abbey National, itself owned by Spanish bank, Santander. Without UK state intervention, the only way to have avoid collapse of banks, many far bigger than Northern Rock would have been to hawk them to equity funds or to institutions from other countries.  Spain with its insistence on higher reserves being held by its banks almost inadvertently put its banks in a stronger position to weather the financial crises of 2007-9.

Aside from the state taking over banks, the British government, following the US model, but leading the way in Europe also provided funds that could be used by other banks, 'quantitative easing' to stand in for the lack of available funds on the commercial market. In October 2008 the government made available £500 billion but only RBS and Lloyds-TSB took any of these funds.  Barclays (with £2.3 trillion assets at the end of 2008) refused assistance and turned instead to the Qatari government for funds.  So, even though it would not accepted one government's funds it was happy to take them from another government.  This may have been a model that a Cameron government coming into power in 2007 would have promoted more widely for UK banks in the place of the British government nationalising or providing funds.  HSBC (with £1.736 trillion assets), the other key bank in the UK, was able to weather the financial crisis in the UK through share issues and that unlike the other banks discussed it was a multi-national bank on an already large scale.  A second package of another £50 billion in January 2009 and an increase of state ownership of Lloyds-TSB shares to 65% was announced due to the bank suffering from having taken on HBOS's losses. 

Now, the Conservatives may argue that there was no need to come forward with these funds, especially by 2009 when things seemed to be settling.  To them, no doubt, it all appears far too Keynesian in approach, stimulating the economy through state intervention.  However, much of what happens in the financial world depends on confidence.  A key problem for British banks was not that they had so many bad loans (though some did have a sizeable number) more that international lenders lost confidence in lending to any business engaged in lending mortgages no matter the quality of them.  Thus, the extra funds put forward in the latter stages were important in rebuilding this confidence, not only of lenders, but vitally of savers.  Banks have moved far from when they were dependent on depositors to provide the funds for their businesses, but what is saved cannot be ignored.  In fact, banks that weathered the situation were those who tended to have more deposits and reserves.

In total, the government paid out £131 billion in funds to keep banks from collapsing; including £107 million in fees for financial advice from companies from December 2007 to December 2009.  Other potential expenses such as borrowing support, money put into increase liquidity and protection for savings, brought the total costs to £850 billion, though of course with the easing of the situation not all these funds were called upon.  In addition, through nationalising banks, the government to some extent ensured they would get some of their money back; having them sold to private companies especially foreign ones would have meant that the government's investment to bring stabiliy, and, vitally, to try to increase the amount of lending needed by businesses and house buyers, would have never come back and in fact would have left the UK economy.

To blame the Labour government for the size of the National Debt resulting from the support it gave banks 2007-9 is false.  No government would have been able to allow Northern Rock let alone RBS or HBOS to collapse.  Even the folding of Bradford & Bingley would have had severe consequences beyond just those who saved with or borrowed from that bank.  The Conservatives, many of whom come from banking backgrounds, would not have let their friends go to the wall.  Thus, billions of pounds was needed and this would have gone on the National Debt.  I accept that rather than nationalising, the Conservatives most likely would have encouraged buy-outs by private equity companies and foreign companies.  Whilst this would have saved funds in the short-term, it would have meant that any money paid to banks most likely would never have come back, and, particularly with the private equity companies, the stability would be short lived as the banks would be broken up for what assets they could release.  The UK since the 1950s if not longer has had a real focus on privately-owned housing as a core element of its economic life, much more than any other country.  Instability in the housing market impinges widely in the UK economy and society.  Thus, the closure of banks, the foreclosure of loans, even just a greater restriction on lending than we see now, would all have dented this important sector of the economy, having a knock-on effect on purchasing and in turn jobs and economic activity.  Perhaps the Conservatives could have save a few billions by now bailing out the banks to the extent they were, but the cost would have been more instability and in turn falling tax returns, so reducing any saving they may have made.

The increase in the National Debt was a responsive policy not a proactive one as Fox and other Conservatives pretend.  If they had been in power they would have been compelled to do very much the same.  The alternatives would have only saved some small sums and at a cost to longer-term stability that many would have baulked at.  If seeking blame, one focus has to be on the freedom which financial institutions have had since the years of the Thatcher governments, though, of course, this has been a global trend, especially in the USA from where so often the UK takes its lead.  The Conservative governments of Margaret Thatcher and John Major, in line with other Conservative governments throughout the 20th century but boosted by New Right attitudes that appeared in the 1970s, believed in deregulation and the state standing back in many sectors of the economy, not least in the banking world.  Allowing building societies to become banks was one element in this trend building towards the UK aspect of the crisis of 2007-9.  However, on coming to power in 1997 under Tony Blair, Labour was beholden to the Thatcherite attitude.  Blair was a Thatcherite, making the Bank of England independent was an element of this.  Gordon Brown as Chancellor of the Exchequer was prudent, but in many ways was simply lucky.  No-one during the Blair years tried to rein in the behaviour of the banks and it was only sheer good fortune that meant the crisis did not hit in 1999 or 2003 or some other time in that period. 

Of course, the current government is a clear advocate of deregulation, unsurprisingly as it has been an unchallenged political trend of the last 30 years.  However, it means that the banks remain as free as ever to behave irresponsibily.  It is right that protestors from UK Uncut go into banks and turn them into libraries or woodland.  We could not let the banks collapse, it would have led to a social and economic crisis in the UK unlike anything we had seen.  The taxpayer provided the funds to bail them out after their mistakes, driven by pure greed for massive profits.  We have paid twice because now to fund that the government says it has to be taken out of public services with huge cuts, not by getting the banks to pay back what they received and in this I mean not only funds but also the steps to boost confidence and stop runs.  They do not even have the grace to curtail their vast earnings, they just behave as they did before, uncowed by what happened.  There is nothing to stop a similar crisis manifesting itself this year, next year, sometime soon and then where will be the funds to save the banks this time? It is not a scare story to recognise that in the life of this parliament we could see the end of a banking system that we have become familiar with in the last 40 years and a return to something very dated and very out of step with the rest of the world. 

It seems that, next time, UK banks will, in large part, stop being owned by British companies but by European and probably Chinese institutions.  A number will be asset stripped by equity funds, the only ones who have the money to afford to intervene.  Say goodbye to your savings, say goodbye to getting a mortgage unless you are already wealthy, say goodbye to free banking, say goodbye to even having a bank account if you do not have a well-paid job (especially once the Post Office accounts are privatised).  The current government panders to its banking friends and uses the myth that somehow Brown deliberately wrecked the economy as the excuse for their reverse social engineering and smashing up of the state.  It is a myth.  In the same position they would have done minimally different and like Blair and Brown, have done nothing to stop the chance that it will happen again, this time with no safety net.

No comments: