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  1. Wealth
December 24, 2008

Beyond the balance sheet

By Spear's

Brown’s much-vaunted ’500,000,000,000 bank bail-out is bust.

Brown’s much-vaunted £500,000,000,000 bank bail-out is as bust as the braggart’s claim that his “plan had saved the world”. And it’s official, according to the Bank of England, as Brown the Banker announces he’s now working on Plan B.

Under Plan A, Brown stuffed £37 billion into the banks’ capital so that they could comply with the new FSA requirement for Tier 1 Capital of 9% of lending, up from the previous level of 7%.

This clumsy approach assumed rather too much about the carrying value of bank’s assets: in the case of LloydsTSB, which has a sound balance sheet, this bank was forced to take on £1.9 billion of Brown’s expensive largesse it didn’t even need!

The other two recipients, RBS and HBOS, needed the rest of the bail-out, £35 billion, just to prevent them going bust. In fact no one argues that stopping the banks going bust was and is an absolute necessity and at least Brown has achieved that, at least for the time being…

The government’s requirement that bank’s immediately resume lending, however, especially to more vulnerable smaller companies, to mortgagors buying houses in a declining market, and to individuals as massive unemployment looms, was simply to strain at a gnat while swallowing a camel. There are many reasons why this part of Plan A was never going to work, as follows:

• the banks are suffering from over-leverage, meaning their balance sheet totals are just too extended, and so deleverage, or reducing assets, and therefore loans, is the priority before taking on new loans;

• deleveraging during a recession is harder and takes much longer than during a boom, especially when capital markets are frozen as they are now;

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• the banks have to allow time for the recession to reveal all the bad debts so that they can truly assess their position and capital availability or requirements;

• there is no point in banks adding to their woes for the future by taking on new loans in risky sectors during a recession which is only just starting and threatens to be both longer and deeper than originally foreseen.

So what is Plan B going to be all about? If Brown thinks he is going to kick-start lending at this point in the recessionary cycle, then he is just going to waste taxpayers’ money and achieve nothing except more inflation in the future.

There is simply no quick answer to the credit crunch, other than to let the recession work its course and prevent the banks from going bust in the meantime. Lending can only revive when all the bad debts are out of the system and when confidence begins to revive.

The trouble for Brown is that he has to face the electorate in May 2010: just pumping more and more capital into the banking cow until something flows back into the land of milk and money is going to end up with the nationalisation of the banking system.

This may bring a wistful tear or two to the eyes of Tony Benn, but the rest of us will end up crying in Brown’s super souped-up mess of potage for a long time to come.

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