Some very murky corners

The devil is always in the detail, bank bailouts not excepted.  Now there is a row about the terms that illuminates some murky corners of government thinking.  BEWARE!  NEW STEALTH TAX COMING.

Under the current version of the plan most of the taxpayers’ money will be in the form of ordinary shares but some (£9bn out of £37bn) will be in the form of redeemable preference shares – effectively a loan with conditions.  Conditions include (a) interest set at a penal 12% and, (b) no dividends to be paid on ordinary shares until the preference shares are redeemed (i.e. until the loan is paid off).  The idea is allegedly to encourage the banks to pay back ASAP – which is fine as far as it goes, but …

Firstly, the larger object is to bail out the banks – not to punish them with a penal interest rate.  I don’t know what the govt’s cost of borrowing is currently, but I don’t think it’s anywhere near 12%.   I quite understand (and in fact agree with) the notion that someone should carry the can for this, but it’s spiv bankers that should be punished – not the institutions where they worked. 

The banks have been compared in recent days to the ‘financial plumbing’ of the economy.  Quite so, but if you are the victim of a cowboy plumber who wrecks your loo you don’t then go and take a sledge hammer to the boiler and pipework in a fit of rage.  Government should be mature about this.  The quickest way to ruin a bank is to increase the price it has to pay for its funding.

Secondly, it will be difficult for the banks to lend for mortgages or businesses if their marginal cost of capital is 12%.  Normally they would have to add a ‘retail markup’ onto their cost of capital so 12% wholesale becomes perhaps 16% retail.  How many will be able to afford this for their mortgage or business loan?  With inflation rates set to plummet on the back of falling commodity prices the real cost of loans will go through the roof.

Thirdly, bank dividends are very important to pension funds as a source of cash flow out of which to pay current pensioners.  If there is no dividend for up to five years pension funds will be decimated, probably doubly so.  If they keep their bank shares, the rest of their portfolio will have to take the strain at just the worst possible time; similarly if they sell, they do so at the worst possible time and make a massive capital loss.

It looks like Brown has homeowners, businesses and pensioners in his cross hairs for another whopping stealth tax.  And, as we all know, he has form on this; one of his first actions as Chancellor was a stealth tax on pension funds.  That the banks are the proximate target does not change the fact that the ordinary people are the ultimate victims.

Moreover, it turns out that the condition that preference share must be paid back before ordinary dividend payments are resumed was included at the instigation of the EU as confirmed on BBC R4’s ‘World at One’  (audio: the interview begins at approx 10.50 minutes in) today in an interview with Jonathan Todd, spokesman for the EU’s Competition Commissioner.

Apparently the Commission, “wanted to ensure that there was an incentive for the banks to repay the state as quickly as possible and we did not consider that applying a penal interest rate would be sufficient to achieve that“.  The UK government had considered it would be a sufficient incentive. 

This is all wrong – the Competition Commissioner should butt out.  I can concede than the EU has a role in ensuring that member countries don’t provide covert subsidies for national champions (or national basket cases) but it must be clear, even to them, that this is not the context here. This is the worst sort of bureaucracy – powerful, but without any ultimate responsibility or accountability when things screw up as a result of its intervention.

So what should the government do?

I suggest that the bailout: (a) should involve only preference shares (not ordinary shares – see this earlier post for reasons), (b) the interest rate should be as low as possible (e.g. 2% above the government’s own cost of capital),  (c) preference shareholders should get a deferred bonus at redemption of 1% for each year after the first two years that the shares remain outstanding (i.e. 1% on amounts redeemed in the third year, 2% in the fourth year, 3% in the fifth year etc.)  

This would mean that the banks could get healthy again ASAP, in the meantime they could make loans at affordable rates, they could pay dividends to pension funds and others that rely on them (although there seems to be general agreement that, this year at least, there will be no dividends anyway), and last but by no means least it is quite possible that private investors will put up much of the capital if the government gets its numbers right (those I’ve used above are purely illustrative).

After all, it is increasingly obvious that the government needs to keep its powder dry for the firestorm ahead.

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One response to this post.

  1. This is an excellent analysis and a good suggestion. However, I truly believe that the members of parliament in general and the prime minister in particular, really do not understand the problem. It is very complex and needs unraveling. This means that they must take and heed advice from of the very same people that caused the problems.

    This is akin to driving on the raod blindfolded, with an experienced driver in the passengers seat, you just wouldn’t do it, because of the serious consequences of getting it wrong. Yet, this is exactly what is going on now and the affects could devastate a country of 65m people for decades to come. I don’t know about the bankers being reckless, but this is certainly a charge that could be levelled at ministers.

    Reply

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