Alistair Darling’s New Insurance-Based Bailout Explained

After a couple of months of bailout cash stubbornly refusing to percolate down to the masses, here we are again – Alistair Darling has revealed the government’s new package of bank bailouts, designed to “reduce banks’ uncertainty” and “provide them with greater confidence”. Sounds like copy for an incontinence pad advertising campaign, but let’s move on. 

The trouble with the previous bailout package last October was that while it recapitalised the banks, i.e. gave them a buffer of cash to bolster confidence in providing credit, it didn’t bolster confidence enough against the bubbling green gloop of toxic assets (often mortgages and loans that are defaulted on). With a deteriorating economy, more and more assets could turn toxic, leading to lower and lower lending confidence; and thanks to complicated financial instruments like CDOs being traded on a worldwide scale, banks aren’t sure how much of their assets are toxic or not. With the new bailout, the government is insuring the banks against losses made on toxic assets; there isn’t a pot of cash, but a promise of cash should the banks suffer heavy losses. The banks haven’t revealed the extent of their toxic assets, but expect some eye-watering sums to be hitting headlines in the next few weeks.

Just as if you’re a boy racer with loads of licence points driving a souped-up Saxo, your car insurance is going to be more than most, so banks also must pay more cash or shares to the government if their exposure to toxic assets is higher. And just as if the boy racer has to pay an excess fee if he smashes said Saxo while doing donuts in an Aldi car park, the banks also have to pay excess if it does announce losses that need to be covered with government insurance. And under the terms of the plan, the banks are now legally bound to start lending to customers, rather than saying “shan’t” as having a huff in the corner as they’ve been doing up til now.

The hope is that once banks know they’ve got this money available if they do suffer big losses, they’ll have the confidence to start lending again. Once they start lending, and the economy starts moving, there’s every chance that there won’t be too many defaults on loans, and that potentially toxic assets will get detoxed. Therefore the banks won’t have to make insurance claims, and a golden circle will appear around Darling’s head in photographs.

In America, where everyone’s already defaulting on their subprime mortgage loans and toxic assets are more rife, they’re thinking of making a “bad bank” where all the toxicity gets chucked and absorbed by the Treasury at great cost to the taxpayer, though which would at least get banks lending again. Darling wants to avoid this.

Also, with investors wary of securities (bonds and other such investor bait) that are backed by mortgages or assets, thanks to the subprime crisis making them supremely uncertain in providing a payout, they’re not providing funds for lending like they used to. To solve this the government has issued £100bn of mortgage-backed securities with a guarantee, so that returns are assured and investors will start giving banks some money, thus bolstering the banks’ ability to lend all the more.

God, it’s complicated. Thanks to the FT then, for leavening the mood with a front page photo of RBS head Stephen Hester wearing a wonderful ensemble of a waistcoat-tabard amalgam that looks suited for protection against X-rays, alongside a collared shirt, jeans and carpet slippers. It’s a look that screams “Day release” rather than “My bank lost £28bn last year but it’s all under control”.

Posted by Ben Beaumont-Thomas in Hot Money | January 19, 2009 11:16AM |