Toxic Assets Leave A Bad Taste

It is becoming increasingly obvious that a new, and potentially devastating, round of bank writedowns is just starting. This will increase the dramatic holes in the banks' balance sheets. Inevitably, it will also renew the calls for more government intervention to save the banks.

The main focus for rescue attempts this time round is based on the so-called 'toxic assets' the banks hold - essentially, the overly complicated derivatives of various loans that started the whole credit crunch. People stopped repaying the loans, and banks suddenly realised that, thanks to the way the derivatives were structured, they didn't know who was going to be effected. With no idea of who was losing out, it became impossible to exchange these derivatives, leading to a freezing up of the financial markets, and a drying up of credit. Now the call is for the government, the tax-payer, to buy up these assets. This would mean the banks lose the potential black hole on their balance sheet, and get the security of cash instead.

The reason we are told we need to do this is to get the banks lending again, to return to the 'normal' level of lending of the past few years. But is this really something we want? It is widely acknowledged that the problem we are facing was caused by too much easy credit being available, that we had all become accustomed to the magically increasing feeling of affluence that rising house prices gave us, house prices propelled ever upwards through a combination of lack of supply and ever greater credit given to those seeking mortgages. If we did return to that world, it is inevitable that all we would be doing is putting off the economic distress to a later date, and in fact perhaps making sure it will be much worse.

That is not to say that the lack of lending is a good thing. No, credit is a vital part of business for many perfectly sensible and staid companies. But they are being dragged down by the poor decisions made by banks to lend to people based solely on the assumption that house prices would magically rise forever, with nary a blip to worry us.

So what is to be done? Banks, not surprisingly, are calling for the tax-payer to take the toxic assets off their hands, to transfer the potentially massive liabilities from them to us. But if we did, how much should we pay for these assets, given that the reason the market in them froze up was that no-one could value them? It's a difficult question, and has many different aspects to it. On the one hand, if you take too negative a view, banks will not gain enough money to resume lending. If you are too generous, the tax-payer hands over too much money, and loses on the value of the assets.

There is an argument that the second case is, essentially, irrelevant. Tax-payers are already suffering from an economy that is dead in the water. Being overly generous to the banks may just help alleviate that situation, and they are more likely to start lending again.

This is not an argument I am totally convinced by. Anything which deliberately moves our tax money into private hands, and is, almost by deliberate design, overly generous doesn't exactly sit well with me.

So what is to be done? Bailing out the banks, and buying their toxic assets, and doing nothing else would serve only to reward them for their poor decisions (I've blogged about this before). The role of government in this banking crisis is not to act in the best interests of the banks. It is to act in the best interests of us, the voters and tax-payers who are going to have to fix all of this mess. Our needs and best interests are complex, and will not be served by simple solutions, by throwing money at the banks in the hope they will deign to start lending in the same reckless way they have in the past.

How about this for a way forward?

Use government money to invest in a large-scale and rapid expansion of social housing. This has the benefit of getting money directly into the economy, supporting an industry particularly badly hit by the downturn, and reducing the pressure on the housing market that caused it to overheat so dramatically.

Completely nationalise RBS (the bank we currently have a large and absolute majority shareholding in), and use it as a development bank. This bank, as well as continuing as a retail bank (though this arm could subsequently be sold off) will have as its aim to support British industry through providing loans to small and medium businesses with a long repayment time at low interest rates - in essence, allowing businesses to invest in themselves without risking the uncertainty of short term bank loans or braving a flotation or other form of external investment. One of the ways this could help is by enabling manufacturing businesses to invest in new machinery without being punished by shareholders.

However, while we need a strong and vibrant manufacturing sector (particularly considering the positive impact, now removed, that the financial markets in London had on our trade deficit), we cannot compete as simple metal-bashers - if we try to compete on cheapest cost only, we are doomed to failure. No, we must also target loans at supporting other industries, industries that use the wealth of graduates we are now producing in productive ways. Knowledge based businesses could receive loans to develop new technologies, new devices, new methods. Even intellectual properties need to be developed.

This is the type of lending that the economy needs, that society needs. This will enable Britain to rebuild its economy, and refocus it from being excessively biased towards the financial markets, and to become much more balanced. And happily, we already have some of the infrastructure in place to make the judgements on what lending is appropriate thanks to the various departments of Regional Development Agencies around the country, which already make judgements on grants on criteria including value to the wider economy and support for innovation.

Lending for larger companies would have to be looked at on a case by case basis. Large companies are, of course, important to the economy, not least through the web of companies they order from. But lending to these businesses would have to be done on much more stringent commercial lines.

As for the toxic assets, well, that's a tough one. It is appropriate for the government to intervene to assist home-owners (or rather, mortgage payers) in difficulty, and to try and reduce the over-inflation of the market through building. Is it appropriate to bail out those whose greed blinded them to the problems, who sought only to profit? I don't know.

What I do know, though, is that with one bank nationalised, the pressure from the stock market on the others over their toxic assets will be immense. Because of this, and to prevent their collapse and the situation of all banking in the UK being through state-owned banks, I can only suggest that the assets are indeed bought, but at a conservative price - paying too much would encourage reckless lending again, and important business lending will already be in place via the nationalised RBS. If the banks feel the need to batten down the hatches, then so be it.

Yes, this is likely to cause pain and hardship for some. But we have to face the fact that there is going to be pain and hardship. We got ourselves into an appalling position, and there is no magic wand to wave to make it all go away. We pay now, or we pay later, and perhaps pay more. All we can do is make sure support is there so that no-one suffers too much or for too long. And rebalancing the economy might just mean this kind of pain is avoided in the future.

(Thanks to Matthew Stratford for his help.)

Repossessions and Recession: A modest proposal

You will no doubt have seen the recent reports regarding home repossessions by Northern Rock. This has led to a wider debate on the repossessions all banks are making, especially those that have received substantial amounts of public money in the form of extra capital, and extra loans from the Bank of England. We can all see the heartache losing your home brings, and can imagine the sorrow and difficulties it would bring to us if it ever happened. Less easy to see is what it costs all of us, as taxpayers, when it happens. Families made newly homeless need to be housed and supported, while our neighbourhoods are blighted by empty homes, forlorn "For Sale" signs waiting for an answer.

In the first 6 months of this year, 19,000 homes were repossessed. In the second six months, 26,000 more are expected to be repossessed. The government tells us that they, and us, expect banks to be more lenient because of the support we, as taxpayers, have given them. But if the response of the bankers and shareholders (here and here also) to our help has shown us anything, it is that we cannot expect them to behave in anything but their own crass material self-interests. And their self-interest does not match the interests of society and taxpayers.

However, Labour ministers have repeatedly stressed that they will not be dictating policy to the banks we now own large stakes in. They are running scared from any possible accusation that this is anything but a part-nationalisation, anything other than support, silent support, for the banks and the economy. All they are willing to do is exhort from the sidelines, despite the legitimate interests of all of us, as taxpayers.

Meanwhile, the chancellor is talking about bringing forward massive investments in infrastructure, following the Keynesian route out of a recession. This is something that should be applauded, as injecting that money into the economy is the best hope we have of making the recession short and shallow.

So perhaps a way to put money into the economy at the same time as helping banks and mortgage payers is needed.

The idea is simple: Allow everyone who is paying a mortgage on their primary residence to apply for a two year mortgage holiday. This would involve them only paying the interest on their mortgage for those two years. However, because we don't want to be giving those who have taken on too much a free ride, this will involve a charge on the mortgage holder of a percentage of their mortgage cost. To ensure the banks aren't hit by this, the government will loan an amount equal to the expected repayments to the banks, which will be repaid, with interest, over the next 5 to 10 years.

This plan would ensure those who need help with their mortgage in the economic downturn get it, while the charge will discourage those who don't need it. The banks will, instead of having an uncertain revenue stream from struggling mortgage holders, have a guaranteed income from the government to support them. And the money freed up from mortgage payments will be put into the economy, either through direct spending, or by being deposited in the banks, encouraging them to begin lending to small businesses again.

Note, however, this is only for mortgages on primary residences - on people's homes. It does not cover commercial mortgages, or those houses bought as buy-to-let. Commercial property is a commercial venture, and must stand or fall on its own. The same is true for buy-to-let houses. However, in this case, we must also ensure we support the tenants.

To this end, I also propose that all banks must give first refusal on houses that are being repossessed to the local council. They will be supported with government money to purchase these homes as social housing, giving continuity to tenants. Of course, the price paid must be a fair one, found with reference to the local market.

Finally, when the two years are up, it is hoped that the economy will be moving out of recession. Wages should be rising, enabling those who were previously struggling to meet their repayments. And for those who still cannot afford to meet their commitments, they, or the banks, will face an economy better able to provide buyers for houses.

Originally, I thought this scheme could easily be introduced into the banks that have either been taken over or have received large injections of capital from the government. However, to prevent this from distorting the entire market, and to ensure assistance is provided for the mortgage holders in other banks, I now believe it would be best to ensure this is available across the industry. All banks should be able to benefit from a little more security, and all mortgage-payers in their own homes should be able to benefit from a little more breathing space. And all of us should be able to benefit from more money going into the economy.

This plan is essentially an extension of the mortgage rescue scheme announced at the start of September. Under that scheme, councils or housing associations could buy the home and rent back, buy part of the home, or simply loan money to the owner to allow them to keep up repayments. The version I have set out here, however, can be extended to help more people, forces a real charge on them to ensure reckless borrowing does not go unpunished, and has the benefit of giving a secure income stream to banks. The repayments from the bank to the government will make sure the taxpayer is not out of pocket. And finally, and most importantly, more money will be put into the economy through the spending of mortgage holders assisted, meaning this policy can help us come out of recession, as opposed to only alleviating repossessions. That truly helps every one of us.

Bank Nationalisation

"No longer is state ownership the unpalatable solution for wayward individuals like Northern Rock and Bradford & Bingley, but a logical fix for the whole industry."

So says Philip Aldrick in the Sunday Telegraph.

If even the Telegraph start saying things like this, why are the Labour government still running so scared from the prospect? Why not bite the bullet and nationalise, even if only for the medium-term? This level of control would allow the government greater tools to support the rest of the economy, and once stabilised, you could even privatise the banks again, should you want to.

Instead we have a bailout which is already beginning to look like it may not be enough, and could turn into a death by a thousand cuts, as the government slowly takes a bigger and bigger slice of each institution, all while the lack of confidence in the banks causes chaos in the real economy. Let's just nationalise them, and give ourselves a firm foundation to fight the rest of this crisis from.