Cost Of Bank Bail-Outs

WEDNESDAY, DECEMBER 15, 2010

Cost Of Bank Bail-Outs

A very rocky road, and still a mountain to climb

This morning's National Audit Office report on the cost of bank bail-outs is being headlined as saying taxpayers will likely escape without loss. But it actually says nothing of the kind.

True, the NAO tells us taxpayer exposure to the special guarantee and indeminity schemes (the Asset Protection Scheme, the Special Liquidity Scheme, and the Credit Guarantee Scheme) has halved to around £500bn. But:

"The Treasury retains the unquantifiable ultimate risk of supporting banks should they threaten the stability of the overall financial system. The outstanding £512 billion is only on the explicit support already provided. Further intensification of financial instability may require additional intervention."

That massive implicit guarantee is one we've blogged many times. And let's be under no illusions - at a time when there are still huge uncertainties surrounding the creditworthimess of banks right across Europe, the market reckons our two big nationalised banks remain pretty risky.

As the NAO highlights, the market price for insuring against default by RBS or Lloyds has remained right at the top of the range for similarly sized European banks (NB a 5 year Credit Default Swap cost of 200 basis points paroughly means the market reckons there's at least a 2% chance of default within 1 year, implying at least a 1-in-10 chance of default within 5 years).

And with that level of risk, unsurprisingly our banks have underperformed other banks in the equity market:

In other words, we're still propping up two relatively high risk megabanks that the market doesn't much like the look of.

And there's another point the NAO highlights. In order to inject funds into the banks, the government has had to borrow more. And that costs. According to the NAO:

"...the Government is paying some £5 billion a year (£10 billion so far) in interest on the Government borrowing raised to finance the purchase of shares and loans to banks. This ongoing cost is material in terms of the overall public finances and deficit. This £5 billion a year was not included in the Treasury’s previous estimates of the loss to the taxpayer, because the Treasury does not consider them to be direct costs. The estimated £5 billion a year interest on this debt is 11 per cent of the total £44 billion forecast to be paid in interest on public sector debt in 2010-11."

Whatever it says in the headline, the bottom line is that we ain't out of jail yet. Not by a long chalk.

TUESDAY, DECEMBER 14, 2010

Proverbial Hawks

No Proverbial Hawks listed

So Deputy Governor Bean says that he and his colleagues at the Bank of England are watching inflation "like proverbial hawks".

Hmm. You have to wonder whether Proverbial Hawks watch the right bit of the field.

Because today's inflation figures have yet again surprised on the upside. CPI inflation has moved back up to 3.3%, and RPI inflation is back up to 4.7%. Inflation has been above the official 2% target for 39 out of the last 48 months, and with VAT going up to 20% in January that record is set to get even worse. Some hawk.

In Tyler's experience what actually happens is this: the economics establishment lock themselves into a particular world view and find it incredibly difficult to admit they've got it wrong. Even when the numbers start telling a different story, people cling on to their world view and explain away the numbers as a temporary aberration.

OK, the facts are these.

In the two years since Lehman blew up and we were told we faced the unfathomable horrors of deflation, the overall price level has increased by 5.2% (CPI). Prices have not fallen. We have not had deflation.

The impetus - as we've blogged many times - has come from import prices. The combination of weak sterling and soaring world commodity prices has pushed up the cost of our imports by 10%.

The Bank and others have argued that we can live with that, because it hasn't fed through into wage increases. In other words, there is no 70s style wage-price spiral in the making.

But wages have certainly not been flat. Despite the rise in unemployment and widespread concern about job security, average earnings have stillgone up by over 3%. And although the recovery has only just started, one-third of firms are already reporting skills shortages. As they say in labour market circles, watch this space.

Of course, there is that other explanation for the Bank's inaction - the not-so secret plan to inflate away the UK's debts.

Like we've said before - sell money.

PS A great shame that Mr Dale has pulled the plug on regular blogging. He was one of the original UK political bloggers and was always well worth worth reading. He'll be missed.