Saturday, 28 March 2009

Back to equilibrium?

A very reassuring sign from Barclays and the FSA (via Robert Peston) today - the FSA's evaluation that Barclays will not need to raise new capital or buy the Treasury's asset insurance (though it can voluntarily do so if it wishes).

Of course this is good news for Barclays itself and a good sign for the financial system. But it also heralds a more subtle improvement in the economic firmament: the possibility of a return to an equilibrium market in finance.

Over the last 18 months, contagion has ruled the markets. Any financial institution in danger created a concern for the viability of all others. When Lehman failed, lots of other banks (and insurers such as AIG) all suffered because they were trading with it. When there was even a sniff that Citigroup, or HBOS, or other banks might go under, everyone else suffered too.

This is not how normal markets work. If Alitalia were to collapse, Air France, British Airways and Ryanair would all benefit. If one of your local pubs closes down, the other will get a lot more business. This is a sign of a healthy economy - it has the resilience to cope with failure - and indeed a bankrupt company gives its people and resources the chance to renew themselves and find more productive uses (though with a little short-term pain).

The fact that Barclays is now likely to be able to lend profitably and may have decoupled itself from the problems of other banks is an excellent sign. If the banking market is now back in a competitive equilibrium there are a whole stream of positive consequences:
  1. Bank equity will have a meaningful and relatively stable value again
  2. Banks will therefore be able to raise private capital more easily
  3. Banks' non-equity assets will be able to find a market price
  4. The many government owned or insured financial assets acquired over the last year will achieve clearer values, helping to clarify the fiscal position of governments
  5. It will be possible to more clearly measure and predict asset prices and returns using well-understood economic theory
  6. Monetary policy may start to work more conventionally
In other words, most of the dreadful phenomena that have made the last 18 months so unpredictable and uncontrollable will move into reverse.

And the sun's coming out. What else could we need this weekend?

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