What Today's Bailout Means For You And Me

by Stuart J Watson on 19 January 2009  |  56 comments
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It's taxpayers to the rescue again as yet more of our money is pledged to unglue the banking system. Will it work?

As Bruce Jackson outlined in this article, the second banking bailout is now upon us. We've also seen a raft of other news from our major banks in the last few days. So how does it tie together and what impact will it have on us all?

Whereas the first bailout was about avoiding a full-scale banking collapse, this one is about getting lending flowing again. Many people have derided the government's calls for `lending at 2007 levels' saying lending at such levels is what caused the mess in the first place. That's true - but my view is that this excessive debt is like an addiction. We need to wean ourselves off it slowly to mitigate the damage to the economy.

Exactly how slowly is a matter for debate, but I think that turning off the lending taps altogether would result in too many otherwise viable businesses going bust, with the loss of even more jobs. We also have the situation that many international lenders are no longer lending in the UK (they are quite naturally concentrating on their own domestic markets) so total new lending will fall even if our own banks maintain the levels of credit they're offering.

Royal Bank of Scotland

Let's run through the banks' news first. Royal Bank of Scotland (LSE: RBS) is truly the sick man of the sector. It's now expecting to make a loss of between £7bn and £8bn for 2008 plus take a further £15bn to £20bn hit from writing down its investment in Dutch Bank ABN Amro, which it bought in 2007. (Oops!)

The government is converting the £5bn of preference shares it signed up last year into ordinary shares. So no new public money is being spent doing this but it could take the taxpayer's stake in RBS from just under 60% to almost 70%.

As part of this deal, RBS has pledged to increase its UK lending by £6bn over 2007 levels. At the end of 2007, RBS had lent £324bn to UK individuals and corporates, so an £6bn increase represents just 2% of its pre-credit crunch lending total. Therefore this is small beer, but beer that's flowing in the right direction.

Northern Rock

The government-owned Northern Rock has been criticised in the past (including here at The Fool) for ramping up its rates for mortgage customers when they came to the end of their introductory deals -in order to encourage them to remortgage with other lenders. The Rock was also slated by my fellow Fool Donna Werbner for being the most aggressive lender for using the courts to pursue repossessions. This was all done in order to clear its books and pay back its loans from the government as quickly as possible. But of course this strategy is now the opposite of what the government wants every other bank to do!

So, to enable the Rock to make a sharp U-turn in its lending policy, the government has now said Northern Rock will be allowed to pay back its debts more slowly. This means Northern Rock mortgage customers are arguably the biggest winners from today's news - but the full details of this are yet to be published.

HBOS

As of today, HBOS is no longer a separate listed company. It is now part of Lloyds Banking Group (LSE: LLOY) which issued its own trading update this morning saying nothing much had changed since its last statement. That's good news, if a little vague.

(By the way, we taxpayers own just over 43% of this company as a result of the first bailout.)

Government guarantees

So that's what's going on with the bailed-out banks.

But what else has the government announced?

The Bank of England starts investing

A special fund is to be set up which will buy high-quality private sector assets. Up to £50bn will be spent initially, which will effectively see the Bank of England providing credit to the private sector through buying bonds and other corporate loans.

This will be funded by issuing more government debt and the Bank of England will be able to use this facility in conjunction with setting the base rate in order to meet its inflation target.

Insuring banks' losses

The government will also protect banks against future bad debts with what is, in effect, a huge insurance scheme. Only bank assets deemed most at risk from the current crisis will be included in this scheme and it will last for at least five years. It will cover 90% of losses over a certain amount, which will vary according to an initial assessment of the risk of the asset in question. A fee will also be payable for each asset insured.

Just how much this will cost us taxpayers is impossible to say. We don't know what assets will be included, what the level of the first losses will be or how much the fees are. And the government says it doesn't expect to release any further details on any of this until the end of February.

Summing it all up

With so much of the detail on this bailout yet to be provided, it's pretty difficult to come to any firm conclusions! While some of the actions should help more or less immediately, others are going to take a few months to get up to full speed. Once again this means that it will some time before we know whether this package is working and it will also be very difficult to separate its impact from everything else that takes place.

However I like the fact it's taking a two-pronged approach providing additional lending from the Bank of England on one side but also partly insuring the banks' losses made on previous loans. While the insurance element looks like a blank cheque, the government has a lot of leeway regarding what it can include and the extent of the loss we will bear.

Looking at the share prices of the banks today, the market has obviously decided it is not good news for them in that they are not getting off scot free. HSBC and Barclays are down 10% as I write, while Lloyds is down 25% and RBS is 40% lower. However, the UK taxpayer invested £29bn in RBS and Lloyds' shares just over two months ago. As things stand, we've lost about two-thirds of that money.

As for the pound, it's down slightly against the dollar and the euro and the market is also demanding a higher rate of interest for UK government debt. In other words, the markets are taking the view that today's announcement is a negative development for the UK economy, but not significantly so.

It would be nice to think that this second bailout can draw a line under this whole situation. But in reality, it's just a small piece of the puzzle compared to what taxpayers are already on the hook for.

On the positive side, it's more targeted than previous measures. So, pound for pound, it should have a more visible impact for the man on the street.

Eventually..