How America's Bailout Blew It

The British plan to salvage its banks is far better than Washington's.

With the Dow continuing to plunge downwards like a tart’s knickers on Navy Day at Annapolis, it’s dawning on Washington that the $700 billion Pauslon bank bailout might not be all it’s cracked up to be. So here’s a suggestion for US policy-makers from good old Blighty (aka Great Britain).

The aim of the Paulson plan is for the Feds to buy up all the toxic waste (ie bad loans) from the banks to clean up their balance sheets and encourage them to start lending to each other again. The problem is twofold: identifying the toxic waste (so much of the bad stuff is wrapped up with the good stuff and it’s almost impossible to disentangle); and then putting a price on it (expect much wrangling between the banks and the Feds).

London might be pointing the way and America’s recent financial track-record suggests it can’t afford to be too proud to learn from elsewhere.

Even if you could resolve both problems, it will take time and time is something we don’t have when the markets are in such an unforgiving mood. You can get an idea of just how serious the financial crisis is now becoming in the real economy (where things are made and non-financial services, like food and transport, are offered) by realizing that Mattel, the toy car maker, now has twice the market cap of General Motors after yesterday’s Dow collapse.

So here’s the suggestion: instead of the time-consuming and complicated process of buying up the banks’ toxic waste in the hope of freeing up inter-bank lending once more, the Feds should simply guarantee all inter-bank lending. The British government has just done this, to widespread plaudits.

The British plans are no panacea—the London stock market continued to fall after they were unveiled on Wednesday and continues to plummet as I write this Friday morning. But the London markets nearly always take their lead from New York and are simply following in the wake of the Dow.

It means the government taking on a whopping contingent liability—around $400 billion here in London, which means well over $1 trillion for it to work in America—but it’s a guarantee the government is giving, not a check it is writing. It would only have to dole out the dosh if things really went belly up—and the very existence of such a guarantee means they probably won’t.

Risky, I know, but maybe not as risky as doing nothing. The idea is that, with Uncle Sam guaranteeing inter-bank lending, the banks have no excuse not to start lending to each other again. Confidence in the wholesale credit markets is restored and the banks then start lending to us again too. With the government guarantee it doesn’t matter that the banks still have toxic waste on their books—they needn’t be afraid of lending to each other—and over, say, the three-year life of such a guarantee, the banks can sort the bad loans out themselves (they created the mess, after all, so they can clean it up).

That leaves the need for the banks to recapitalize their balance sheets and, given the state of investor sentiment towards financial institutions at the moment, the capital is unlikely to be raised in by the private sector by a rights’ issue. Here again the Brits are ahead of the curve: the government in London has agreed to pump $100 billion of taxpayers’ money into the banks to allow them to restructure and recapitalise in return for preference shares (ie non-voting so it’s not nationalisation) which will pay a high rate of interest and (hopefully) be redeemed at a profit.

Other European countries are now looking at Britain’s loan guarantees and recapitalizing schemes and planning to do the same for their banks. The International Monetary Fund, meeting in Washington today, is also keen on the idea. The Feds should have a look too.

The solution to the current financial turmoil doesn’t lie in London but in Washington and New York. But London might be pointing the way and America’s recent financial track-record suggests it can’t afford to be too proud to learn from elsewhere. Your pension, after all, probably depends on it.

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Andrew Neil

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