Plain Person's Guide to British Support For The Economy

I posted a brief note last night about an announcement made in the UK before the markets opened about the measures that are being taken to support the economy.

More details have been made available in Parliament and I continue to be reasonably pleased about about what is being proposed. Nothing can be guaranteed in this situation but, because it is comprehensive and does not only tackle one or two elements, it has every chance to succeed.

The difference between here and the USA is that the government wants to support the banking system, not just buy bad assets.

The massive funds that will be passed to banks to prevent their collapse will be very much like the Swedish model. It will be done in exchange for equity. Temporarily we, the tax payers, will have ownership of part of the City.

The word “Nationalisation” is not being used seriously here. It is mainly a Republican stick to instill fear in the USA. The Government in the UK will leave management of the banks to those who work in the industry - under scrutiny because of the equity interest - and is not itself becoming private bankers to the nation.

As soon as possible, the Government will release that equity back to private shareholders. It is expected that, in time, this will be at a profit to the tax payer.

This part of the package is designed to keep the banks in business. Another part is that, to ensure that funds are available for them to operate, additional billions are being made available to allow lending.

To help this to all filter down to business and the real economy, particularly small enterprises, certain other measures are being taken. These include the requirement to pay bills being reduced from 30 days to 15. This reduces the amount of capital required to be borrowed by these businesses.

Of course, supporting all of this is the co-ordinated announcement across Europe and the USA to reduce interest rates by 0.5%. This makes borrowing and mortgages cheaper for Main Street and businesses. Already a number of banks have announced that this cut will be passed directly to the consumer (the last two rate cuts were not passed on and banks used them to shore up their own financial position).

Executive pay has caused as much anger here as it has in the USA (although we have not seen anything as gross as the Lehman Brothers CEO). I have never been in favour of blanket capping. The approach being adopted is that not only those requiring direct support from government will be scrutinised but all financial institutions requiring government rating (which affects severely their business) will in future include a review, by the Financial Services Agency as a formal part of rating, of their reward systems to ensure that these do not give short-term rewards for short-term risk taking. This allows a case by case approach without artificially removing genuine reward for hard work and long-term achievement.

Although this is a summary, the package does attempt to create a broad solution that takes into account the need to do something about the real economy.

The Icelandic government has renegaded on its promise to secure depositors in its banks. The UK government has undertaken to pay in full UK depositors in these. This is a sensible move to quiet anxieties of ordinary people about their personal financial exposure to High Street banks.

The measures have had all-party support and the issues have been discussed responsibly. The government was criticised for not taking action at the beginning of the week - not least because they wanted a degree of consensus amongst leading financial players, European agreement and international action in terms of rate cuts. They are now generally being seen to have acted well and its has re-established some confidence in how it is responding.

Once again, the Stock Market declined rapidly this morning. The measures announced by the government caused it to rally but it has dropped again on worries about Wall Street. It is not behaving as part of the solution - but when has it?

No measures can guarantee that they will work in this unique and extraordinary situation. There is little left that the UK government can do after this package. Nor will the historically high and unprecedented government funding do much in the short-term to recover the economy. The IMF has just announced that the UK will take a big knock in this regard, although hopes are for signs of recovery at the back end of 2009. Meanwhile there will be pain.

Pain will also be felt because, of course, this money will prevent the government maintaining its current and proposed level of funding of public services. (One good thing. It will accelerate the desire to bring our troops home. We have over 8000 in Afghanistan alone). The UK Deficit has been strictly controlled at 40% of GDP. This target will almost certainly be exceeded. Other European countries are in a worse position.

Really it is now down to the bankers to get the system working again. If they don’t, pitchforks are in order! At the moment the financial systems are in deep freeze. It is essential that they are moved at least into the ‘fridge.

There is still a massive amount to do, not least through the meeting of the G7 in Washington this weekend.

Dammit it, Wall Street is misbehaving and is down at the opening. I hope it comes back and the volatility disappears.

I do feel more optimistic, however. It may take a few days for all of this to flow through and to de-stress the markets. Maybe it will involve another interest cut but the government is right to be concerned about not triggering inflation by this means.

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Comments

the magic bouncing ball has the DJIA up 78+ as of now (10:11 EST). I have no doubt the "market" will fluctuate wildly as the program/automated software packages kick in around the world.

Maybe the thing to do is make them use hand-carried paper orders - no electronic trades allowed. Kind of a "Luddite Solution Day". Dose until the hallucinations subside.

don't listen to you?

You have been saying for weeks... shut it down and take a market holiday.

you write:

Executive pay has caused as much anger here as it has in the USA (although we have not seen anything as gross as the Lehman Brothers CEO). I have never been in favour of blanket capping.

Could that be that in Britain, the ratio of CEO (maybe CFO is included in the data) to employer is in the neighborhood, I believe if I have read correctly... 46 to 1... whereas in the US since 2000 it has skyrocketed to something like 400 to 1?

It's truly obscene here, especially when many of these CEOs have driven their companies into the ditch.

Don't get me wrong, I think that the job of being CEO is so tough that job description demands the candidate for the position be amply rewarded, but what has happened in this country is truly porky the pig at the trough.

Another difference: over here they have to discuss everything with the population and do opinion polls and stuff, and get opinion lined up. Over there, a group of civil servants can put together a plan behind the scenes over months, and then someone can say "we had a meeting last night and here's what we're going to do," and that's it.

I'm glad you are kind of happy about what they did. I guess the plumbing metaphor still holds, put enough "Drano" down there and hope to clear the clog without busting the pipes. Save old kitchen sinks for political campaigns, and old bath tubs for post campaign clean ups.

The UK has an annual tax revenue of about 200 billion pounds. It borrows on top of that. So Brown's "partial Swedish model" is one quarter of the tax income of the UK. The 2 credit lines will together be, they say here, 500 billion pounds. Who or what will secure those lines? The tax revenues at 200 billion per year? RBS has liabilities of over 2 trillion pounds on its own. Barclays more than 1 trillion, and its deposits are twice the UK's tax base.

I wonder about the activities these banks will be pursuing which will turn this investment into a winner for the British government and people. Currency swaps, foreign exchange expertise, commodity market windfalls, other swaps, flops and plops?

I saw this morning that Pakistan is about to join Iceland on the sovereign bankrupt list. There is probably a whole swath of countries which have seen foreign equity investment evaporate over the last few weeks and are about to go down that path. Some of them would be in the middle rank with military and political ambitions to maintain but not the means, given their indebtedness. The UK seems to be a player in that league actually.

So now the financial risk is transferred, and becomes the liability of the sovereign. The country is now the stake not just the banks. Time will tell just how good the package is. It does seem though that issue of unclogging money markets will shortly be upstaged by the plight of indebted sovereigns. I wonder what position the UK will be playing in that game and whether the game will be craps or brag.

I haven't checked all your figures, Chris. but total annual tax revenue from taxation is double that indicated by you, for example.

An enlarged version is available here

You write: "Over there, a group of civil servants can put together a plan behind the scenes over months, and then someone can say "we had a meeting last night and here's what we're going to do," and that's it."

It is nowhere near as easy as that. There is such a thing as Parliamentary scrutiny, for example. And the strange, valuable anachronism of the House of Lords.

Iceland's problems are very peculiar to that country. They have been known for a long time, which is why they have not had acceptance into the EU.

Fortunately, the UK has the advantage of being outside the Eurozone , so has a higher degree of flexibility in fiscal policy than other European countries.

One of the interesting questions at the moment is that which queries whether or not the Euro can survive as a currency. With France certain to exceed the EU fiscal deficit limits again and other countries under pressure also, these are exciting times. The failure of France and Germany to reach agreement over the last five days is not a good omen for the Euro.

He thinks the rate cuts are too late and will have little effect at this point.

Policy rate cuts will have limited effects as they don’t resolve the fundamental problem in markets that is keeping money market spreads relative to safe rates so high, i.e massive counterparty risk. To resolve that triage of insolvent banks and recapitalization of solvent banks, together with massive injections of liquidity in non banks and the corporate sector are necessary; yesterday plan to support the commercial paper market – something I recommended last week - is a step in the right direction.

Back in February, he outlined a 12 step process to a systemic financial crisis. It appears we have entered step 10.

This morning, Roubini provides 4 steps he feels need to be taken immediately:

1. Public works - to get cash flowing again (fighting deflation)
2. Close insolvent banks and recapitalize solvent banks
3. Blanket guarantee on all deposits to stop bank runs
4. Modify TARP to inject capital into solvent banks, reduce the face value of mortgages for distressed home owners, and rapidly close capitalize banks

Roubini: Revisiting my February paper “The Risk of a Systemic Financial Meltdown: The 12 Steps to Financial Disaster”…And Some New Policy Recommendations to Avoid the Meltdown log in required

This is ugly.

Items 2, 3, & 4 are authorized in the EES Act ("Bailout"). Further actions are, and have been, taken by the FDIC which has primary jurisdiction over the banking industry, and of course the Fed.

Recommendations from interested parties will be accepted as the rulemaking process moves forward. Public input is encouraged, even from economics professors.

From what I've read in the last few days, (Brad DeLong, Paul Krugman, Nouriel Roubini, Paul Volcker, Dani Rodrick, etc) there's a bit of disagreement about what the bill authorizes. General agreement that there's an enormous need to recapitalize asap but that recapitalization is not spelled out in clear enough terms in the bill hence concern it won't happen. See Cho's link to Krugman below.

Edit: I just found this over at Calculated Risk Paulson and Capitalization

Maybe people are seeing what they want to see, but it'd be nice if the TARP was more oriented towards increasing capital.

So sorry, its an imported data service disaster!

But compared to the market for interest rate swaps...

Britain and Brown have it right... To do, Not to Do