YouGov Founder's Blog

The post below is copied from John Humphrys’ YouGov blog.

‘Ever since the banking crisis broke two years ago the figures involved have seemed off the scale of normal economic calculation. The talk has been not of millions or even billions but tens of billions or more. Now the government is pouring around £30 billion more of taxpayers’ money into the banking system. Is our money being well spent?

On the face of it this new handout may seem to many people evidence that previous bail-outs have not worked and that the banks have an unlimited appetite for our money which the government has an unlimited willingness to satisfy. But that is not how the government sees it. In its view the new money offers a better deal for the taxpayer and is in any case less than it previously indicated might have to be found.

The fact that the government has had to revisit bank funding should surprise no-one. Its initial emergency measures, first to take over Northern Rock and then to take large stakes in the Royal Bank of Scotland and in Lloyds TSB, were always going to have to come under the scrutiny of the EU’s competition rules. Now the competition commissioner, Neelie Kroes, has come back with instructions of what needs to change in order for the banks to comply with the rules. This week’s announcements on extra government funding are at least in part a response to this and to the restructuring which is being required.

The bald facts are these. Northern Rock is being split into two banks, a “good” bank and a “bad” bank. The good bank will be sold off to the private sector and the government will keep hold of the bad bank, hoping that in time its toxic assets, which no one wants at the moment, will prove not to be so toxic and so be sold in turn. The government has not written off the possibility that it will lose no money in the long run through its entanglement with Northern Rock.

Another £5.9bn will be invested in Lloyds and £25.5bn in RBS, taking its share in the Scottish bank up from 70% to 84%. But these headline figures conceal changes which the government claims will end up giving the taxpayer a better deal.

In the case of Lloyds, most of the new capital the bank is raising will come from the private sector. It wants £13.5bn in total of which the government will provide £5.9bn, keeping its share in the bank at 43%. But perhaps the most important aspect of the new arrangements is that Lloyds will now not have to join the government’s toxic asset insurance scheme.

This was a scheme set up by the government earlier this year in the depths of the gloom about the banking system. The fundamental worry about the banking system was that the banks were carrying on their books an essentially unquantifiable but huge quantity of assets (that’s to say, loans to other parties) which could well turn out ‘bad’ (i.e. they would never be repaid). The sheer scale of these ‘toxic’ assets threatened to bring down the system. So the government set up an insurance system, whereby the banks paid the government a premium and the government took on the risk. If all these assets had indeed gone bad, then the government would have been liable for hundreds of billions of pounds.

In the case of Lloyds the value of the toxic assets being insured was £260bn. Under the new arrangements, however, Lloyds has avoided joining the insurance scheme. Instead, the bank’s shareholders (including, of course, the government) retain the risk. The bank is to pay the government £2.5bn as a premium for the implicit cover it enjoyed since earlier this year so that, net, the government is injecting only £3.4bn into the bank. But it keeps its 43% share and instead of being liable for all of the £260bn of Lloyds’ potentially toxic assets, it is now liable for only 43% of them. That’s why the government is claiming it is a good deal.

By contrast RBS is staying in the insurance scheme but in conditions the government claims are more favourable to the taxpayer. RBS’ s estimated toxic assets have been reduced from £325bn to around £260bn and it will have to find the first £60bn (rather than the initially proposed £40bn) of any assets that go bad. The government hopes that its injection of £25.5bn of new capital will make it more secure, but it also putting on standby a further £7bn should the bank get into trouble.

As for the EU’s concerns that these largely government-owned banks have too much competitive advantage, the solution is that they must sell off some of their assets. RBS is being required to sell its insurance businesses and 312 branches. With sell-offs in Northern Rock and Lloyds too, to new entrants to the banking sector, such as Tesco and Virgin, it is estimated that 10% of Britain’s banking sector will be up for sale and it is hoped that the new entrants will make banking more competitive in Britain.

But the new arrangements also require the banks to cut their costs which is why RBS announced 3,700 job cuts earlier this week. The unions strongly objected, not least because they argued that government funding ought to be protecting jobs not destroying them.

Government funding for the banks has been objected to on another ground. If the government is pouring all this money into the banks, it is asked, why are the banks in turn not increasing their borrowing to firms and individuals? After all, so the argument goes, the justification initially given for claiming that the banking system was a special case and needed government support even when other industries were allowed to go to the wall, was that banks provide the fuel of the whole economy and that fuel is bank-lending. Yet bank-lending is continuing to fall.

The government’s answer to this is that in a recession bank-lending always falls but that the availability of credit has in fact increased as a result of all the measures the government has taken to keep the banking sector going. That increased availability will be welcome once the economy starts to grow again. This answer, however, concerns a greater worry for the government and ultimately for the taxpayer.

Britain’s economy alone among major industrialised countries is continuing to contract. In the third quarter of this year it shrank by 0.4%, a figure that shocked many commentators. So long as we go on shrinking then demand in the economy will remain constrained and bank-lending will continue to stagnate no matter how available credit may be.

The government forecasts that there will be a return to growth at the turn of the year, but others think that so long as levels of debt in both the personal and corporate sectors remain as high as they are, demand will not increase. Furthermore, it’s feared by some that once the government’s emergency measures, such as the VAT cut and the stamp duty freeze, end early next year the economy could be kicked back into a ‘double-dip’ recession.

Should that happen the banks could find themselves in new trouble. The assets they had hoped would not turn bad might then do so and the banks’ capital might prove insufficient. In that event the government might have to put its hand in its pocket yet again. As Vince Cable, the Liberal Democrats’ treasury spokesman, put it: “It’s all very precarious. If there is a double dip recession we could be back in trouble again.”

What’s your view? Do you think the government has been right to bail out the banks in the way it has? Do you think this week’s measures offer a better deal for the taxpayer or not? Do you think the government could still end up making money for all its investments in the banking sector or do you the taxpayer will end up losing money? Do you think it is a good thing or not that the banks receiving state aid are broken up to some extent and more competition created in the banking sector? Do you think RBS’ s redundancies are justified or not? And do you think this will be the end of the bailing out of the banks or do you think there’s still more to come.

Let us know what you think.’