The Banking Crisis

 This is a bit less tongue in cheek, or even opinionated, than some of my other posts. The Banking Crisis was without a doubt one of the defining events of the first decade of the 21^st century. Its shadow still falls across discussions on politics, regulation, the role of the state, and economic theory. But despite that little evidence is publicly presented as to the causes of the crisis, or the long run costs it has incurred.  This is therefore an attempt to put some numbers on the costs to the taxpayers of ‘bailing out the banks’.

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A Note on Figures; The majority of this post is sourced from reports completed by the National Audit Office and the Treasury Select Committee, however, as a result of the this some of the figures are based around 2009-10 rather than 2010-11 or more recent.

Indirect and Cash

Stability was returned to the UK banking sector through two main mechanisms – direct (or cash) and indirect. Cash injections were used to buy shares and provide loans to (amongst others) Lloyds TSB, RBS, Northern Rock and Bradford & Bingley. These ‘direct’ interventions cost real money in the here-and-now, and, assuming no more major impacts to the system, it is predominately these costs which will need to recovered or written off by H.M. Government.

Indirect costs took the form of guarantees and indemnities provided through three special purpose vehicles (The Asset Protection Scheme, Credit Guarantee Scheme and Special Liquidity Scheme). Although significantly larger than the cash costs to the Treasury, these ‘indirect’ costs are only crystallised in the event of further default or difficulty in the Banking sector.  Peaking at a potential exposure of nearly £1 trillion (Maintaining the financial stability of UK banks; update on the support schemes. National Audit Office, Dec 2010, reference 676, Key findings) the possible costs of these guarantees have fallen to an estimated £512 as at the end of 2010.

I’m largely going to ignore indirect costs from now on.  Reports from the Treasury and NAO seem to suggest these guarantees are not going to be required, and many of the schemes are looking to wind down by 2014 (et al). This reflects a wider truth that the banking sector suffered from a lack of liquidity and confidence, rather than necessarily a paper bankruptcy (this is especially true for Northern Rock which was in a stable position on paper, but a loss of confidence caused it to fail due to a cash flow problem). The government stepping in with the ‘big guns’ of unlimited asset guarantees restored confidence, reduced the need for immediate liquidity, and ended the problem.

Cash Costs

The total cash cost of the bank bailout was around £133 billion (et al, Summary (2)) this covered the purchase of shares in RBS and Lloyds, and cash loaned to banks wholly owned by the government at this point (predominately Northern Rock and Bradford & Bingley). It also covers loans to various compensation schemes to cover client withdrawals.

These funds were not taken from other governmental budgets, but rather borrowed in their entirety. The National Audit Office puts the cost of servicing this debt at approximately £5 billion / year (or an annual interest rate of 3.76%). This on-going cost will exist as long as the loans and shareholdings remain outstanding.

From a practical perspective the bank bailout has therefore incurred a cash-flow cost of £5 billion per year, with the caveat that a future loss may be crystallised when the various share holdings are sold. This £5 billion forms approximately 11% of an annual interest bill of £46 billion (2012 Budget Executive Summary) or 0.7% of total government spending.

The likely losses incurred by a sell-off of the shares in RBS and Lloyds will depend entirely on the prevailing share price, and any pricing arrangements put in place to secure a buyer.  So, where does that leave us at present?

RBS

The calculation of the current value of the government’s holding in RBS is slightly complicated by the introduction of “B” shares in 2009. In addition to its holding of 65% of the ordinary shares in RBS, the Government also owns 39 billion “B” shares, created to allow a further injection of cash into the Bank without further ordinary share purchases. These B shares are valued at 50p each, receive a 250% preference dividend, and do not allow voting rights.

These “B” shares were issued at a value of 50p, which conveniently ties in with an approximate ‘buy in’ price for the government’s ordinary RBS shares of around 50p as well. All this means that while a line by line analysis of the government’s holdings is out of the scope of this post, we can get a reasonable estimate of the current position by comparing the current ordinary share price to 50p. Anything above would equate to gains come a sale, anything below a loss.

(Note; RBS had a 10:1 corporate action after the bailout, this means the ‘buy in’ prices for the government need to be multiplied by 10 if you want to compare to current prices).

At the current market price of £3.39, the government is facing a loss of 32%, or £17bn.

Lloyds

Luckily the Lloyds figures don’t seem quite so convoluted. The government bought a 41% stake in Lloyds for £21billion. This was entirely in ordinary shares, and therefore the published market capitalisation figure can be used to determine the value of a 41% stake. Using this approach a current value of £15.2billion, or a paper loss of just under £7bn is reached.

Options

The government seems to have several avenues on how to proceed with regards to its shareholdings. Although I’m going to provide some commentary on these, I’d highlight these are my own opinions, not quotes or paraphrasing from official sources.

1. SELL IT ALL!!
There is always the option for the government to just drop their holdings and get out now.  What this would actually do to the share price is troublesome, since it would almost inevitably precipitate a complete collapse in the already struggling shares, even assuming a buyer could be found. In practice this probably isn’t a realistic option.

2. Bit now, bit later

I’m putting this in for the sake of completeness, though it smacks more of a political move than an economic one. Selling off some of the holdings in the two banks would reduce the spectre of ‘state ownership’ and raise a bit of cash, but it would also lock in losses with comparably few tangible benefits.

3. Public-ize RBS

A rather radical move that was floated at one point was to just give the government’s shares to the taxpaying public. Probably a nice voter winner, but I have to agree with Vince Cable’s recent comments that this was unlikely to happen. Not only would this crystallise the full value of the bail out as a loss to the government, it would potentially hammer the share price when the markets become flooded with shares being sold by private investors.

4. Do nothing

Unless a single, large, buyer (such as a sovereign wealth fund) can be found, this is probably what’s going to happen. There is always the long run chance that the share price will recover, and once Lloyds and RBS find their feet they will begin paying dividends, which will largely go straight into the Treasury.  This is also what I’d personally advocate. Although both Lloyds and RBS have currently suspended paying a dividend while they repair their balance sheets and pay down liabilities, in the long run (it is an oft-quoted truth that shares should be held for at least 5-10 years), a return to dividend payments of around 4.6% (HSBC’s average yield), would both cover the costs of servicing the underlying debts incurred in purchasing the shares, and even offer a gradual net profit on the deal.

To Re-Cap

Just to bring all of these points together, and to provide a quick summary for use against the ranks of “Argh the government is collapsing because of the costs of propping up the banks,”

·         The Government provide around £133bn in cash to the banking sector.

·         That £133 billion was borrowed at an effective rate of around 3.75% per annum, incurring a servicing charge of £5 billion per annum.

·         For that investment the government got a stake in RBS and Lloyds which is currently worth around £24billion less than was paid for it.

·         That loss isn’t going to be crystallised any time soon since it looks improbable that a major sale of RBS or Lloyds will take place. As such the £24 billion is only a ‘paper’ loss.

If Today Were Year ZERO

Much is made, both in the media, and by people in general, about how the current social/economic predicament is caused by having to bail out the banks. What I hope the above has shown is that the actual, real, cash cost, of the banking crisis is currently around £5 billion a year. A fairly irrelevant figure compared to the £638 billion a year annual budget.

Another way of looking at this is that if all historic data, opinions and knowledge were wiped today, and then the government’s figures re-calculated based on outgoings and incomings today, the costs of the financial sector bailout would account for 11% of the national debt. While I would not try and claim 11% is immaterial, it means that 89% of the nation’s accumulated debt has to do with decisions unrelated to the bank bailout.

Seven Fat Cows, Seven Thin Cows

The concept of saving when things are good, to cover you when things go wrong has been around so long its spawned innumerable clichés. Never-the-less it’s a view which is largely ignored with regards to the financial sector. I’m going to wrap this analysis up by providing some figures to show that the financial sector provided far more in tax receipts than it eventually claimed in bail outs.

Unfortunately the readily available information available on the taxes paid by the financial sector only goes back to 2005/6. However, using this as a starting year, the tax receipts from PAYE and Corporation Tax (including the banking levy), as provided by HMRC (Pay-As-You-Earn and corporate tax receipts from the banking sector, august 2012, table 1), stand at £147 billion.

This figure alone covers the £133 billion cash bail out required, and that’s excluding the ‘boom years’ from the beginning of the 2000s through to 2005. While I don’t expect any government to simply sequester away huge parts of its tax take for the express purpose of then bailing out the economy when things turn sour, I do expect an acknowledgement that the government earned vast receipts from the financial industry throughout the boom years, and is still in a net position with regards to the banks.

Conclusion

In conclusion I’m going to reiterate a point that has run throughout this post. Financial costs can always be broken down into direct and indirect costs. However, much of commentary on the banking sector compares the theoretical ‘worst case’ scenario where all of the indirect costs materialise, with the immediate direct benefits (the £20 billion a year in tax the sector currently pays). Not only is this grossly unfair, it’s also completely misleading. Considering only the direct cash costs to the economy the bank bailout cost £5 billion a year. This is a trivial cost compared to the £120 billion a year spending deficit the current and previous government’s social and welfare policies have necessitated. Should the further £500 billion of contingent indirect costs be incurred we are envisaging a society where two huge corporations have been wiped out of existence taking all of their assets and holdings with them, where tens of thousands of business have gone bankrupt overnight, again without leaving behind any assets, and where entire cities worth of housing has vanished into holes in the ground. If we ever end up in that situation the problems of macro-economic government spending are going to be very, very, far down our list of priorities.

/Z