Britain's 'TARP': Taxpayers Locked in to Potential Upside

It appears our British Cousins (okay MY cousins) have decided to execute their own version of TARP in response to the global banking crisis:

(From the FT): "Britain’s largest banks will be part-nationalised on Wednesday morning after Gordon Brown took the momentous decision to pump tens of billions of pounds of public money into the sector to avert a banking collapse.

The massive public bail-out comes after a day of turmoil on the London stock exchange, where shares in banking group RBS fell 39 per cent to add to a 20 per cent tumble the day before. Rival HBOS fell 41 per cent.

Faced with an intensifying banking crisis, the prime minister sanctioned moves for the taxpayer to recapitalise Britain’s leading banks in an effort to restore confidence in the system and to allow them to start lending again. The total cost of the scheme was estimated at £35bn-£50bn – roughly equal to £1,400-£2,000 per taxpayer – although final details were being hammered out overnight before a statement by Alistair Darling, chancellor, this morning.

Royal Bank of Scotland, Barclays and Lloyds TSB – which is in the midst of a takeover of HBOS – are expected to be the main recipients of the capital. It was unclear whether HSBC, which already has stronger capital reserves, would participate in the plan, although if it does it is likely to take a smaller amount.

The bail-out is likely to be executed through the government acquiring preferred shares guaranteeing a fixed rate of interest, although it was unclear last night if the banks could issue such securities without offering existing shareholders an opportunity to participate.

The rescue will be presented as part of a wider attempt to reform markets and is expected to include a call to the banks to show responsibility over remuneration for bosses, now that the taxpayer has a direct stake.

Mr. Darling, who will make a Commons statement on Wednesday, wanted more time to form a full package but was forced to act by the market chaos and by circulated reports that banks wanted an injection of public money. At £50bn, the recapitalisation of Britain’s banks would more than double planned public borrowing this year, pushing public sector net borrowing close to £100bn and more than 6 per cent of national income, worse than any year since 1994-95.

The recapitalisation will deliver a huge boost to the banks’ core Tier One capital – the preferred measure of balance-sheet strength. This is expected to give the market greater confidence about the banks’ ability to absorb future losses.

However, the government’s move has a broader significance because it will also send a strong signal to the banks’ creditors that they are, in effect, protected from future losses. Concerns about losses among creditors, triggered by the collapse of Lehman Brothers, the Wall Street bank, are the main reason why banks have recently struggled to access the funding markets."

As all well know I'm not especially fond of the idea of handing over taxpayer money to private enterprises when they get into trouble, but at least this is an infusion of cash in exchange for preferred shares (and possibly dividends, profit sharing, etc), meaning that the banks are now effectively in debt to the taxpayer.

E.g. if you're going to do something like this have the taxpayer "locked in" to receive the upside due to having ownership in the companies being bailed out, instead of letting the companies being bailed out get off scot free via dumping their bad assets on taxpayers. 

Still it's a bad harbinger for the future when it appears that the governments of many of the world's strongest economies are going to have to execute some sort of de facto nationalization program in order to save their banking systems. At this juncture the bailout plans being executed via various governments aren't so much injecting life into the banking sector, as they're trying to keep the fire from spreading/putting a floor on the damage.

I.e. small cataclysms instead of gargantuan ones.

Of course this also begs the question: were their economies ever that strong in the first place, if their banks were overleveraged to the point of not being strong enough to survive a downturn/if their economies were largely built on debt and over-leverage?

You can read more on the subject here [FT], here [BBC News], and here [FT].

Sources

The Financial Times:"Massive rescue plan for banks" -- George Parker, Chris Giles, Tony Barber, October 7, 2008.

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.

Comments

[Diane Ritter:]

And in the United States, Congress enacted a bill that will allow the Bush Administration to buy any security they want, at any price they want, from anyone they want, with as little downside protection against further loss to the taxpayer that they want. This has to be the most poorly designed, irresponsible piece of legislation ever passed into law. The Bailout Bill seems DESIGNED to allow corruption and fraud, pay-off's and insider deals. Paulson has already said that he plans to pay far above market prices for the toxic assets he is going to buy. And the legislation gives him complete liberty to decide who to buy the assets from, and the kind and amount of downside protection to require. 100% of the $700 Billion dollars could be used to pay off political pals and cronies of the Bush Administration. We shouldn't be calling this the Bailout Bil, we should be calling it the $700 Billion Dollar Rip-Off Bill. It's the biggest slush fund in history.

.

2008 Oct 08 05:54 AM

[Zyx007:]

Agree with dlr. This was rushed through on the back of collapsing world market, but lacks any transparency or semblence of fairness.

2008 Oct 08 08:13 AM

[Rhunzzz:]

The British plan is so much better than TARP. A quick, instant injection of capital that allows for the taxpayer the potential for upside. TARP has taken long enough to pass, and now, while the Treasury has to figure out on a CASE BY CASE basis how much to pay for EACH toxic asset, it's taking way too long for the money to get where it's needed.

2008 Oct 08 09:12 AM