Imagine for one moment that your friend owned a bank. He has made some really stupid loans and paid himself some silly ostentatious bonuses and has got into financial trouble. You think it is his own fault, but your trusted uncle persuades you to bail him out for the sake of the economy by buying a 70% stake in his bank for a few billion. In order to finance this purchase you borrow heavily secured against your future income. The next day you go to withdraw some money from what is now your bank and your friend refuses to serve you because he is worried that you might have over extended yourself. How would you feel?

This is the position that the average member of the Great British public perceives themselves to be in.

Fortunately being Britain, people are not reaching for their guns, but their pens. They are writing letters to Members of Parliament and to their newspapers. Who in turn are making noises about “holding the bankers feet to the fire” until they start lending again.

Having stumped up £37 billion of taxpayers’ cash to rescue the banks from their own folly, and offered guarantees worth a further £450 billion, the British tax paying public is surprised to be rewarded by the “ungrateful bankers” by lending limits that are being cut and interest rate margins being increased.

The public were told they were “bailing out the banks”. The truth was that the boat which is the british banking sector had such a big hole in it that all the £37bn did was plug the hole. The bail out of the water already in the boat (the excessive marginal lending that was financed by interbank deposits) will take the next 3 years.

How have we got here?

The Financial Stability Report, published by the Bank of England, gives a surprisingly readable and clear explanation. It includes the Bank’s new estimate that losses on securitised credit instruments and corporate bonds since the start of 2007 are now $2.8 trillion, (£1,700 billion), equivalent to more than Britain’s annual gross domestic product, or 85% of the banks’ pre-crisis Tier 1 capital.

Not all these losses will be realised, though a good half are likely to be, and not all of them will be borne by the banks. But these are big numbers.
Seven years ago, Britain’s banks funded lending almost entirely out of customer deposits. By the first half of this year they had a funding “gap” — the amount they funded mainly from international wholesale money markets — of £740 billion.

The Bank does not expect this gap to close entirely, still believing there will be a place for wholesale funding in the long term, but it does suggest it needs to narrow to 2003 levels of about £265 billion.

Achieving that over a year, which the banks might have had to do without the government’s rescue package, would have required a sharp drop in lending and a very deep recession. Achieving it over three years will “smooth this slowing in lending”, the Bank says, but not prevent it. There will be no return, in other words, to past rates of growth of lending.

Meanwhile the politicians and the bankers are caught between reality and the public perception of reality.
Having told the public they had “rescued the banks” the politicians are blaming the bankers for not “playing fair”. Last week Peter Mandelson (Minister of Trade) declared: “It is completely unacceptable to the government and to business in this country for banks indefinitely to stop functioning as banks.”
MPs have called for the ministers to “hold the bankers feet to the fire” (such a colourful “Tom Browns School Days” sadomasochistic metaphor was worth repeating if only to prove that the values of a public school education are still very much to the fore in British public life 😉 and that was from a Labour MP)

The truth is that the lack of willingness to lend is more than a political issue. It is a self fulfilling economic paradox that without lending the economy wont recover and without an economic recovery the banks wont lend. The risk is that the Government is so over committed that borrowing and hence future taxation could spiral as the economy spirals downwards. This is the very real risk of a deflationary spiral that haunted the Japanese economy in the 1990s.

Mervyn King, governor of the Bank of England, called the lack of lending the “single most pressing challenge to domestic economic policy”.
He is not wrong.
The political question is having claimed to be the “hero” that “rescued the banks” how long will the UK public wait until they lose patience with Gordon Brown and demand firmer action. Gordon Brown has a lot of political capital invested in the rescue plan. The party he heads is socialist at its roots. He may not be able to just talk tough, he might actually have to act.

Most UK banks are nationalised in terms of ownership, it is only the degree of control being exercised that prevents this being called a “full nationalisation”.

Running a UK bank is going to be a tough job for the next 3 years… they’ll deserve a big bonus… 🙂