Tuesday, 16 December 2008

Making perfect sense

Robert Peston again - the government is now:

...excluding from the calculation of the risk premium payable to taxpayers the great surge in the perceived riskiness of banks that took place in September and October.

In effect, the Treasury has converted the Credit Guarantee Scheme from an insurance policy, which was designed to provide comfort to markets that banks wouldn't collapse for want of access to funding, into a new and substantial source of finance for banks, to replace the funds that have disappeared with the de facto closure of wholesale markets.

Well, kind of. There's a good argument that the banks are much less risky now - not least because they have been recapitalised by the taxpayer. This in turn justifies a lower premium.

Indeed, the most present risk to the banks was not that they would fundamentally become insolvent through writeoffs. It was that they would be unable to either refinance their short-term borrowings or call in their long-term loans. Securitisation used to allow them to sell the long-term loans if they needed money, but as Robert says that market is now closed.

But if the banks can get long-term borrowing from the government, this risk goes away. Once again that justifies a reduction in premiums.

Negatives of this:
  1. The short/long risk is transferred to the government - which in theory may have its own challenges in raising long-term debt. But in extremis, the government can print money to finance this - it should never have to default (the UK government is in the fortunate position of both borrowing and lending in pounds, at least for now).
  2. It creates an increase in the amount of short-term money available in the economy - wholesale lenders which would previously have lent to banks can now lend in the corporate or consumer markets instead. In theory this is a distortion to the normal structure of the money markets but with everything else that's happening, it just cancels out a distortion that's already happening.
And don't get the impression that the government is only displacing foreign lenders. Over 75% of debt owed by UK banks, companies and individuals is owed to others within the UK. About £309 billion is net foreign debt, but our foreign assets still make us more money than we pay out on the debt. Surprised?

1 comment:

Anonymous said...

Your comment and thrust assumes that the big UK banks are truly solvent, once the true write-downs of loans to commerce and industry and factored in.

I seriously doubt this is the case.