Thursday, 9 October 2008

Iceland - private bankruptcy's relation to public disaster

The crisis caused for many UK local authorities, police authorities, charities, individuals and other institutions by Iceland's suspension of payments, and potential default, on its bank debt illustrates clearly the inadequacy of the overall proposed package for UK banks proposed on Tuesday.
At the time of writing (6 30pm on Wednesday 9 October) reported exposure to losses of UK public sector bodies to failed Icelandic banks was already above £700 million - creating significant financial problems for them. If there is a default, or less than 100 per cent payment is made by Iceland, there will be substantial losses to the UK taxpayer and/or reduction in important public services.
If the UK government agrees to indemnify local councils, and other institutions, for any loss then the national taxpayer will pay out. If the government refuses to indemnify local and other institutions then local taxpayers, charities and others will have to pay - or significant cuts in services will take place.
This £700 million exposure is however extremely small, only just over one per cent, compared to the £50 billion exposure that will be faced by the national taxpayer if shares are taken in the UK banks under the package proposed on Tuesday.
The distinction between the support which the government should give to individuals and propping up shareholders must be clearly understood as it has large financial implications for the tax payer.
The financial institutions in which it is proposed that this £50 billion be invested in shares, not supporting individuals and public authorities savings, have already suffered huge falls in their share prices - in some cases over 80 per cent. In the context of the current international financial crisis further severe falls in share prices are possible. The potential losses involved in the tax payer subsidising these shareholders would completely dwarf those now at risk with Iceland.
Hopefully the Iceland crisis will be resolved. But it shows clearly why the taxpayer must not be exposed to the risk of placing the purchase of £50 billion in private bank shares on the public balance sheet with the potential for loss involved.
Such a step, as the far smaller problem with Iceland shows, can turn private bankruptcy into a public disaster.

1 comment:

Alun Griffiths said...

Why were these public and quasi public auithorities investing public money in risky unsupported currency markets?. This crisis is a result of years and years of obfuscation between what is public and what is private. Moral Hazard, yes well then these authorities did not take on board this concept. In the same way that controls must be placed on bank employees' (because that is what they are) salaries and bonuses, the same should apply to these authorities. O'k. we'll try and bail you out this time but in the future there will be secure controls on your investment and accounting activity to ensure you understand the difference. HOW DO WE ENSURE THAT MORALITY ETHICS AND "RIGHT LIVELEHOOD" to borrow a buddist term are central in our economic relations.