The UK Has A Better Financial Bailout Plan Than The US

Following on yesterday’s (Tuesday) discussion of Britain’s TARP here is a look at the latest news on the plan, which provides more details than what were available yesterday:

From BBC News:

The UK government has announced a package of measures aimed at rescuing the banking system that makes available £400bn ($692bn) of fresh money.

It will initially make extra capital available to eight of the UK’s largest banks and building societies in return for preference shares in them.

It is “designed to put the British banking system on a sounder footing”, said Prime Minister Gordon Brown.

Some bank shares rose on the news although the main FTSE 100 index fell.

Shares in HBOS, the UK’s biggest mortgage lender, ended up 24.5%, and Royal Bank of Scotland was 0.8% higher - trimming earlier gains. Shares in Lloyds TSB fell 7% and Barclays was down 2.4%.

The fall on the FTSE 100, which ended down 5.18% at 4,366.69 points, also came despite co-ordinated interest rate cuts from the Bank of England, European Central Bank and Federal Reserve.

The key points of the plan are:

Banks will have to increase their capital by at least £25bn and can borrow from the government to do so.

An additional £25bn in extra capital will be available in exchange for preference shares.

£100bn will be available in short-term loans from the Bank of England, on top of an existing loan facility worth £100bn.

Up to £250bn in loan guarantees will be available at commercial rates to encourage banks to lend to each other.

To participate in the scheme banks will have to sign up to an FSA agreement on executive pay and dividends.

Falling Shares

BBC business editor Robert Peston said that it was understandable that shares had fallen following news of the government’s package.

“What Gordon Brown and central banks have done today should stave off economic Armageddon - but it’s probably too late to save us from months, or even years, of sluggish growth.”

He said that HBOS shares had risen strongly because it would be more likely to benefit from the plan than its peers.

Preference shares pay a fixed rate of interest instead of a dividend, which has to be paid before other shareholders receive anything, but they do not carry voting rights.

Taxpayers may even end up making a profit from the shares, but that is by no means guaranteed.

Robert Peston said there would be strings attached for banks that take the government money.

“Taking taxpayers’ money will not be a licence to trade as normal,” he said.

Negotiations will take place with each participating institution that will require them to extend normal credit lines to homeowners and small businesses, in addition to rules on executive pay and dividends to other shareholders.

The graphic below provides a high-level overview of the plan:

Graphic courtesy of the BBC

What a novel idea: instead of overpaying for the bank’s worst assets based on the idea that you “might” be able to sell them for a profit later, you instead  inject cash into the banks in exchange for interest payments and/or preferred shares, set capitalization standards, mandate behavior towards consumers, mandate standards around executive pay and dividends and (most importantly) effectively guarantee that the taxpayer gets to benefit from any upside. Furthermore the plan is relatively simple and can be enacted rather quickly, so you avoid issues around a slow ramp up time, administrative difficulties, it’s easier to shift course if new or different actions are needed, etc.

Perhaps the best part of the British bailout plan is the fact that the banks are being treated in the same manner that they would treat each other, or any other business that was desperately in need of cash and/or outside investment.

I.e. in the space of less than 24-hours the British Government has embarrassed our Government’s feeble attempt to bailout our banking system, especially since our plan took over a week to put together and is a pork-laden insult that will prove to be largely ineffective.

Mind you I don’t especially like bailouts because of the moral hazards introduced, the way the taxpayers are treated and the overall message it sends to a society, however in some cases bailouts are indeed necessary, and if you’re going to do a bailout, something like the current solution being put into action by the British is not a bad way to go.

At this juncture the American taxpayer needs to pose the following question to their representatives in Congress: “Why didn’t you display the leadership, courage and integrity to put forth a similar plan, especially when many critics of TARP suggested the very same thing and something like the British plan would be easier to implement?”

You can read more here.

Source:

BBC News: “Central banks cut interest rates” — October 8, 2008.

Disclosure: at the time of publishing the author didn’t own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn’t be viewed as financial or investment advice.

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Comment by victor baum

2008-10-23 12:11:49

Owning a lot of preferred stocks of international bank and insurance companies has me in a dilemma. If, under the UK plan, the banks have to omit their ordinary share dividends – does this mean that they will have to omit their preferred stock dividends (i.e. Royal Bank of Scotland, AEGON, ING, Barclays, etc.)?

Vic Baum

vhbaum@whummer.com

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