The judgement of markets can hardly be described as positive, but it seems to me that the UK authorities have belatedly got their response to the banking crisis broadly right with yesterday's wide-ranging package of measures. Dithering ministers and policy wonks have been swept aside. Treasury mandarins, the Sir Humphreys of this world if you like, seem to be firmly back in the driving seat. Measured and considered, this is exactly what the doctor ordered.
The might of the British taxpayer is being put fully behind the banks, and, perhaps more encouragingly still, there is now a sweeping inter-national response to the crisis, with central banks across the world slashing interest rates. Both these actions were an essential precursor to eventual resolution of the crisis.
Is it enough? Who knows. A nasty and prolonged recession now looks a done deal. It was that realisation, more than disappointment with the banking package, that drove the renewed plunge in share prices yesterday. The IMF's alarmist warnings about the state of the world and British economies was hardly the most conducive of backdrops for yesterday's attempt to restore confidence in the banking system.
But let's get one thing straight to begin with. This was not the partial nationalisation of the UK banks widely billed in yesterday morning's press. As a quid pro quo for the massive injection of liquidity and funding now promised, the banks have agreed to a significant, though small relative to the size of balance sheets, recapital-isation, amounting across the banking system as a whole to a 100 basis-point increase in tier one capital.
In most cases, the banks will offer this new capital to their own shareholders first by way of pre-emption rights. Only if investors fail to take up the stock will banks fall back on the Government's largesse. The taxpayer thus acts as underwriter to a recapitalisation that will end up making British banks some of the best capitalised in the world.
What's more, to the extent that the Treasury does end up a significant stakeholder, it will be through preference shares, which carry no votes and therefore no direct say in strategy, pay and asset allocation. Obviously, there is conditionality of some sort involved, on bankers' pay and on small business and mortgage lending.
The Government has learnt that much from the near failure of the Paulson plan in the US. Making taxpayers' money available to the wicked bankers of Wall Street and the City without conditions does not play well to the gallery. Taxpayers do not like bailing out bankers at all, let alone writing them a blank cheque. There is an implicit understanding that excessive pay and dividends will be curbed. This will eventually be given legal form through solvency rules which will require bankers taking greater risk to carry commensurately higher capital.
Yet this is not, as depicted in some quarters, about the state reclaiming the commanding heights of the econ-omy. Rather, it is just part of a package of measures designed to restore confidence in the banking system. In that respect, the old left is going to be sadly disappointed. The politicians are not about to take back control of credit allocation, thank goodness. The debate over what banks should be and how their business models might be transformed by the crisis is yet to come.
We await the crucial detail, but on the face of it the recapitalisation plan seems to have been sensitively and cleverly designed. Banks have lobbied hard and succeeded in persuading the Treasury against more extreme solutions. Wisely, policymakers have rowed back from the idea that shareholders need to be in some way punished for the crisis as an example to others. This is just as well, for in a world where there is no credit, where else is the money for investment in the economy going to come from other than private investors.
Being required to raise yet more capital having already raised so much is a profound embarrassment to the banks involved. The need is obviously greater with some bankers than others. Over the months ahead, a number of them will pay the penalty for the mess they are in by losing their jobs.
Yet the financial world has changed beyond recognition in the last three months, and, in circumstances where there is a serious recession coming on, more capital has become essential to the business of rebuilding confidence. The willingness of banks to put aside traditional rivalries and act together is indicative of just how urgent the situation had become. The crisis was threatening to sink well capitalised banks alongside the bad ones.
Use of non-convertible preference stock avoids the problem of dilution which so unnerved investors earlier this week when they first learnt of the plan to recapitalise banks with Government money. Ordinary equity holders are only diluted in so far as they now have to pay a substantial coupon on the preference stock and can expect curbs on dividends until this money is repaid. The devil is always in the detail, but as I say, on the face of it the recapitalisation has been quite cleverly designed.
Yet the more important part of yesterday's package is the measures taken on funding and liquidity. It is lack of funding, rather than lack of capital, that lies at the root of the present crisis. Dramatic action is now being taken to address the failure in wholesale markets to provide this liquidity. Where markets have failed, the taxpayer will now fill the void.
The existing special liquidity scheme is to be doubled in size to at least £200bn and the Government is to guarantee up to £250bn of banking term loans. Taken together with the further facilities that will be offered through the Bank of England, these measures ought in time to help ease the crisis in funding and allow the money markets to begin operating normally again. It looks like a massive gamble with taxpayers' money, but unless the whole banking system is about to go down the swanee, then the Government ought to get all its money back and some. If on the other hand the banking system does collapse, all consideration of taxpayer risk would become irrelevant. In the ensuing mayhem, the nation would return to lawlessness and the land.
This all should have been done six months ago. Hindsight is a wonderful thing, but things would all look a lot better today if it had. Some commercial bankers blame Mervyn King, Governor of the Bank of England, for this tardiness. He appeared blind to the gravity of the market failure until it was too late. It was only last week that he finally went on record to say that banks would get all the liquidity they needed to see them through the crisis. Previously, he seemed to take the view that bankers were only getting their just rewards, which may have been true but is an entirely worthless form of satisfaction if they end up taking everyone else down with them. Nobody likes to bail out bankers, but regrettably we are, in fact, only bailing out ourselves.
Yesterday's interest rate cut offers further evidence that governments are determined not to let the banking crisis degenerate into a repeat of the Great Depression. Nobody knows whether they will succeed, but at least they are now trying. If the markets won't lend, governments and central bankers have no option but to turn on the printing presses and lend themselves until confidence returns.
In this respect too, the British approach looks better than the Paulson plan in the US, where the Federal government proposes to nationalise the banking system's bad debts. In Britain, by contrast, the idea is to park the "assets" with taxpayers until wholesale markets return. If they don't, then again Britain has a major problem, for a banking system that is entirely funded by deposits is one that will be a whole lot smaller than the one we have today. The amount of available credit would shrink dramatically.
Ministers have wisely resisted following Ireland into guaranteeing all deposits. Legally, this is difficult territory, as the distinction between retail and wholesale deposits is, in practice, virtually impossible to make. By guaranteeing all the deposits of the British banking system, the Government would be taking on a massive liability equating to nearly double the annual GDP.
In extremis, this could collapse the currency and bankrupt the country, rather in the manner of Iceland, but on a much grander scale. The piecemeal approach adopted by the UK so far, where depositors in problem banks are individually bailed out, is on the face of it a better one.
I can't answer the question of whether it will work. To the doomsters, the authorities seem to be fast running out of ammunition. They've tried just about everything else. Now they are firing off their last cannon. Yet these are also the cannon that should have been fired in the first place. The policy response is now the correct one, and assuming the detail can swiftly be settled and applied to money markets there's no reason it should fail.