The UK Government is according to the BBC about to take up to £500bn of toxic assets from RBS and Lloyds into an asset protection scheme.

Effectively the UK Taxpayer will become ultimately liable for £500bn worth of loans and investments made by Royal Bank of Scotland and Lloyds Banking Group should they turn bad. The £500bn are the most marginal loans they may not all turn out to be bad in the end, but this policy effectively acts as an insurance.

The good news for RBS and Lloyds going forward is frankly their balance sheets would be pretty bomb proof.

The bad news for existing shareholders is that the price is more non voting preference shares making this an economic nationalisation – if not a formal one. They are being diluted to the point of irrelevence.

The cost to the UK tax payer of all of the combined bank rescue schemes to date is £1.3tn in bank debts now secured by the taxpayer. To put that in perspective that is about the size of UK GNP. The Government would argue that scary as that might sound the picture is not that black for the taxpayer. The underwriting would be contingent on the loans going bad but most wont and the ordinary shares bought in the banks may one day be sold potentially at a profit.

The problems are
1. Timing: even though UK Banking in normal times is very, very profitable business it could take a very long time indeed for them to be able to lift the assets out of the asset protection scheme (presumably as a result of repayment or taking the hit through provisions in a controlled sustainable manner).
2. Other banks: what does this say about the other banks? Will for example Barclays be able to compete in the still recovering interbank finance market place against a bank whose balance sheets are underwritten by the government? What if this sparks a run against the other banks shares?
3. The impact on UK plc of this perceived level of borrowing and future tax liability

The BBC says “The idea is to draw a line under bad assets to free up cash that the banks can lend to companies and individuals.”

Personally I think it is a nice idea – but so are peace and love. I don’t see that bank lending will be restored until the economy is restored. You need people to be confident enough to want to borrow and that takes time. Banks ought to be cautious about lending in a recession. The horse has bolted and the Government is now intent on gilding the stables. Recessions are caused by people acting rationally on their expectations, they may be triggered by bank lending, but you can’t turn an economy round by restoring bank lending that just generates bad debt.

The RBS and Lloyds results were bad, very bad, but if two weeks later they are saying that £500bn needs to be provided for then I think a material misstatement has taken place. I’m not saying they don’t need more help… it just feels like too much.