‘Keep it simple, stupid’ applies to bail-outs, too
An opposition politician has described the UK government’s bail-out plan as consisting of “stunts and wheezes”. This may be unfair but it highlights a tendency among governments battling with defective banks to be over-complex and to play politics rather than focus on simple financial solutions.
UK prime minister Gordon Brown claimed to be leading the world with the recapitalisation of the UK banking sector last October, and the move was indeed laudable for its boldness. But three months later, with bank shares still in freefall and lending stalled, there was clearly a need for more action.
Same old trap
Yet this time, the Labour government fell into a trap that has plagued it ever since it came to power in 1997 – that of making things much more complex than necessary and so taking away the effectiveness of simple and bold actions.
As part of the government’s earlier measures, there were already several insurance and guarantee schemes in play for politically crucial sectors such as homeowners and small businesses. Now with the new package, it has gone further along the insurance and guarantee route, adding in corporate loans and toxic assets.
These schemes are flawed for several reasons. The first is that government involvement in who gets credit is bound to be a backward step. The process will be bureaucratic and possibly political, and the banks (or government) are likely to end up with more bad loans.
Second, it becomes difficult for the government to withdraw from the market. Third, and most importantly, the new initiative of insuring against losses on toxic assets is less effective that taking these bad assets off the balance sheet entirely and placing them in a ‘hospital’ bank.
The government is surely staving off the inevitable on this one. It may just as well go the whole way and let the banks take the hit so they can start lending again.
Tied in knots
As this crisis is virtually unprecedented, it is not surprising that governments are feeling their way – the US government has equally got itself tied up in knots even before it handed over to a new administration.
First it was going to be asset purchases through the Troubled Asset Relief Programme, then it switched to recapitalisation (with a little bit of help for homeowners, automakers and Bank of America) and finally the plan moved back to a mixture of asset purchases and further guarantees.
It’s all too complex. Governments should stick to recapitalisation and creating bad banks for toxic assets and leave credit decisions to the market. This is the straightforward, effective way out of the crisis.
