Another round of government bailouts is on the way from the UK government. The latest move comes after a week of panic in UK banks, when the supposedly healthy Barclays saw its shares drop 25%.
The Wall Street Journal reports that the Brits are rushing out new additions to their financial rescue plan, and may well formally announce something in the next few hours. They’ve apparently been working on it all weekend—the usual weekend rush to rescue that has become standard around the world.
Here are some of the expected features of the new bailout.
- Loss insurance for banks. The government will provide so called “insurance” on bank assets, offering to pay for any losses beyond a certain level. This is intended to place a floor on how low the value of so-called toxic assets on the balance sheets of banks can fall. This puts UK taxpayers on the hook for the mistakes of bankers. The hope is that this will restore confidence in the banks.
- Loss insurance for debt securities. Mortgage bonds and other debt securities will be directly insured by the government. This will hopefully create some liquidity in the markets for the securities, since investors will know that they can fob off to the government any losses beyond a certain level.
- Extending the guarantee of bank debt. One of the key moves that helped bring down LIBOR was the guarantee of bank issued debt, making banks more willing to lend to each other. This was scheduled to expire in April. As that deadline has approached, investors have worried that banks may have liquidity problems. Tonight’s bailout would extend the guarantees to the end of the year.
- Guarantees of non-bank debts. As in the US, the bailout is going to expand beyond banks. Now auto-loan companies, mortgage companies, insurance companies and other pseudo-financial firms will be eligible to have their debts backed by the government.
- Bank of England buyouts. This will be similar to the US’s Federal Reserve’s program to purchase debt products from banks in exchange for Treasuries and cash. The Bank of England will allow financial institutions to trade in their junk paper for government bonds.
- Easing bailout terms. The UK government dealt out the first $740 billion of its bailout under terms that banks now want eased. The government equity stakes and promised dividends are now viewed by banks as driving away other private investors. So the government is now planning to ease the conditions. Think about the ever-easing terms of AIG’s bailout and you’ll understand what’s happening.
Here’s the biggest challenge for this newest bailout: it rests on the idea that the problems of the banks can be fixed with price-fixing. But as long as the government continues to permit, or even encourage, banks to over-value loans—and the loss-guarantees do exactly this—investors will remain sceptical about their financial health. What’s more, the bank guarantees could actually make the markets in the securities on their balance sheets less liquid by keeping them above a market clearing price.
In short, banks will still avoid writing down bad debts or selling assets at market prices. This means that the junk will remain in the system, creating the risk that the crisis will simply be extended rather than resolved.