As an act of heart-stopping political drama, the Government's latest attempt to ease the banking crisis does not quite match last autumn's £37bn recapitalisation package, but its implications for the taxpayer are scarcely less serious. The Government's announcement that it is going to insure the toxic assets of the banks and allow the Bank of England to lend directly to businesses puts taxpayers on the hook for potentially hundreds of billions of pounds.
As with the recapitalisation package, it is galling to witness another colossal slice of taxpayer support being sent in the direction of the very institutions whose reckless lending precipitated this disaster in the first place. But we must be realistic. We are in the throes of an economic emergency. The banks are cutting off credit from the economy, increasing the risk that we will go into a prolonged and disastrous slump. The priority for the Government must be to get cash flowing to those firms and businesses that urgently need it, even if this means rescuing those financial institutions that have so grievously failed.
One of the Government's other announcements yesterday, that it is allowing the nationalised Northern Rock to wind down its mortgage business more slowly, is something of a red herring. There is little that the Government can (or should try to) do to put an artificial floor under house prices. The focus needs to be on supporting those perfectly viable and responsibly-run businesses that risk going under thanks to a sudden dearth of credit.
The Government hopes that by insuring the pile of toxic assets that the banks built up in the boom years, they will not feel the need now to hoard cash to cover future losses, and will instead begin lending on a normal scale to the rest of the economy. That is the theory. Whether it will happen in practice is impossible to argue with any confidence, even if the Government does extract promises from the banks to increase their lending in return for state help.
Some feel that the problem of the banks is not one of liquidity, but solvency; that no amount of government insurance, lending guarantees or even new capital will convince other banks and private investors that they represent a solid credit risk.
In this view of the world, the banks simply have too many bad assets on their books to raise funds freely from the financial markets themselves, and will therefore never be able to lend freely to their struggling customers. The logical conclusion here is that the Government needs to nationalise the banks now and begin to allocate credit to the wider economy directly.
That is the path Ireland set off down last week by taking Anglo-Irish bank into public ownership. And our own government's conversion of the Treasury's preference shares in the Royal Bank of Scotland into ordinary equity is also a significant step in that direction.
Full nationalisation may yet be necessary. But the Government surely needs to exhaust every possible alternative first. The problem with outright public ownership is that it is very hard to see an exit strategy for the Government when the recovery eventually begins. Civil servants and politicians are also unqualified to make decisions on credit allocation or risk. Many would doubtless counter that they could hardly make a worse job of it than the supposed professionals in the banking world. Nevertheless, the potential pitfalls of nationalisation are significant. In view of this, the latest insurance scheme ought at least to be given a chance to work. The American financial authorities are attempting something similar. The results on both sides of the Atlantic need to be closely monitored.
Yet the Government must be prepared to take the next step in case this package fails to unblock the credit markets. The planning should be in train now. Time is of the essence. Every day that our economy is starved of credit damages business and further undermines consumer confidence.
No room for error
This is a dangerous and uncertain moment for our economy. It is also a perilous moment for Gordon Brown. The Prime Minister's aides talked up last year's bank recapitalisation as the crucial intervention in the crisis (that is why Mr Brown's "save the world" slip of the tongue in the House of Commons was so damaging). And yet here we are three months later with another supposedly crucial intervention in the banking sector. There are only so many times Mr Brown can announce that he has solved the problem before his credibility starts to crumble.
The Prime Minister was thrown a political lifeline by the banking crisis and the bewildering speed of the downturn. It enabled him to present himself as a leader who, for all his past mistakes in charge of the nation's finances, was best placed to steer Britain through the churning waters of financial and economic turmoil. Yet it is a pitch that leaves Mr Brown no room for error. Neither he, nor the country, can afford it.