Friday 16 January 2009

"UK 'bad bank' plan to boost loans"

More numptiness that won't work:

Ministers are understood to be considering creating a state-owned "bad bank" as part of government plans to stimulate the UK economy. It would accept "toxic assets" - risky loans on many banks' balance sheets - easing the pain of the credit crunch.

It is one of a number of options the prime minister and chancellor are expected to discuss during talks in the coming days with the banking sector. The government is looking at measures to get banks lending again.

However, the BBC's business editor Robert Peston says that the "bad bank" envisaged "may yet fail to be born", because "there are huge difficulties in valuing the assets to be placed in them and in defining the assets that may be placed in them".


Of course, there is a much better way - just create a few new 'good banks' (see also CityUnslicker, who credited AC1 with the idea, who in turn credited me).

All that happens is savers shift their cash to New Banks (thus old banks owe New Banks money for assuming this liability). When mortgages with old banks come up for renewal, New Banks skim off the best mortgage risks (say, < 70% LTV; loan < three times joint salary, no history of arrears etc) and lends to them, these borrowers then repay old banks, who in turn repay New Banks.

Instead of transferring out the bad stuff, which is, as Peston points out, very difficult to value, you leave the bad stuff where it is and transfer out the good stuff, which is easy to value.

Old banks thus becomes 'closed funds' that make no new loans, they merely collect mortgage repayments and redemptions, do the repossessions etc. The liabilities to New Banks get repaid first; once they've been paid off, bond holders get paid next in the order that they would have fallen due - if the money runs out before the ten and twenty year bonds are redeemed in full, well hey, the loss lies where it falls, if by a miracle there's still some money left over after that, then the shareholders get it of course.

This requires minimal government involvement, zero taxpayer exposure and is the closest thing to a truly free market solution.

That's that fixed. Next.

6 comments:

Lola said...

...which is of course what would happen if they had been allowed to go bust and been put into orderly liquidation.

Capitalism. Creative destruction. Don't you just love it.

Mark Wadsworth said...

I do love capitalism. But it's the government and the home-owners who hate free markets, and they have the whip hand here.

AntiCitizenOne said...

How about "UK govt to piss lots of taxpayer cash against fiscal wall"?

Anton Howes said...

What happens to shares in the old banks?

Would the rate between new and old banks have to be 0%?

It sounds good - but what are the downsides or potential problems? Out of interest ;)

P.S. you still haven't answered my last comment reply to yours about taxing banks.

Mark Wadsworth said...

a) The shares in old banks are still shares in the old banks, they continue as a business. it's just that all the depositors and 'good' mortgage borrowers go the New Bank.

b) The old banks would have to pay New Banks the normal interbank interest rate on the money that they owe them in the intervening period (until the good borrowers have all moved). What other rate would you suggest?

c) There are none. This is a debt-for-equity swap with a tweak. The only downside is political - somebody somewhere is going to make a loss, but even they won't find out how much until old banks are finally wound up in ten or fifteen years' time.

d) I have no grudge against banks generally, they should pay the same flat income/corporation tax as everybody else. BUT banks don't pay VAT (which gives them a relative advantage and hence distorts the economy) and I'd rather reduce tax burden on non-banks by scrapping VAT altogether than make banks pay VAT as well.

Anton Howes said...

a) I assumed that the old banks's shares would become worthless when it became apparent that they're bad. The company itself would go bust.

b) Ah no - have re-read the article and misunderstood it first time. Yes, this makes sense.

c) Cool. Not quite convinced though, especially as someone is making a loss - isn't that still a downside?

d) Ah, I meant about the bank-lending stimulation measure that was a few articles back. - "To every action an equal and opposite reaction" I think it was called.