Outlook Will the "asset protection scheme" due to be outlined by the Treasury and two of the big high street banks over the next few days work? The answer to this question is that it had better do, for if it doesn't the next port of call is outright nationalisation for both Royal Bank of Scotland and Lloyds Banking Group.
Both share prices have already pretty much discounted this possibility, despite the Government's repeated insistence that it doesn't want to nationalise, nor does it think it necessary. Bond prices in these two banks have also begun to reflect the possibility that senior debt holders could be wiped out alongside equity holders in a full-scale nationalisation.
The Government has indicated it may not pay either coupon or principal on subordinated bonds in the already nationalised Bradford & Bingley. The capital reorganisation promised by Northern Rock this week has alerted investors to the possibility of the same fate befalling £12bn of Northern Rock bonds. The consequent uncertainty is causing mayhem in markets.
If bondholders are wiped out, or even mildly interfered with, banks can kiss goodbye to ever being able to raise capital through subordinated debt instruments again. It would also profoundly interfere with the solvency of life insurance and pension funds that have invested heavily in the bonds of British banks. As a matter of urgency, the Government must bring clarity to these issues. It's one thing to wipe out shareholders through national-isation (though even this is highly undesirable), quite another to annihilate the bondholders too. The knock-on consequences for valuations and confidence would be profound.
Like some newly constructed supertanker, the "asset protection scheme" is meanwhile rolling ineloquently down the slipway. Nobody yet knows whether it will float. Somewhat crucial issues – such as precisely what is going to be insured, in what quantities, at what price, how it's all going to be paid for, and the attached conditions on exec-utive pay and lending – are still being negotiated. More than a month after being announced, the asset protection scheme remains a work in progress.
In the end, however, neither Lloyds nor RBS have any option but to accept whatever is on offer. John Kingman, chief executive of UK Financial Investments, the organisation through which the Government holds its stakes in British banks, will do his best to ensure that the banks are not completely rolled over, but they've got few cards left to play.
As I say, if it doesn't work, outright nationalisation beckons. The idea is that the Government restores confidence in bank balance sheets by insuring losses on bad debt over and above a yet to be determined level.
This ought to put a floor under asset values, thereby giving banks the confidence to stop hoarding cap-ital and start lending again. Yet as is apparent, it's incredibly complicated, and you have to wonder whether it is really worth the candle. It may prove cleaner, cheaper and more efficient simply to carry out the necessary restructuring under full public ownership. Quite who is to blame for all this scarcely seems to matter any more, but what a terrible mess everyone has conspired to get us into.Reuse content