Tuesday, 16 March 2010

The scandal deepens in the bizarre logic of the bank bailout

by Michael Burke

Sometimes financial journalists don’t have the background and skills to do a story justice. An experienced crime reporter would be better suited to the task.
The management of Royal Bank of Scotland, which is 86% owned by taxpayers, is considering a buy-back of its own debt, perhaps as much as £10bn.
According to the Financial Times, the plan is in ‘an attempt to boost its capital strength and its standing with bond investors’. But RBS’s capital strength, measured by its ratio of ‘core assets’ to total loans is already 11.6%, much higher than both Lloyds and Barclays, which are below 9%. It is argued that RBS’s loan book is much worse than its rivals and it will face higher levels of default. Perhaps. But, given the disastrous merger of Lloyds with HBoS, it is difficult to see how RBS could be qualitatively worse, certainly not so much worse as to require hugely better capital ratios.
The real reason seems to be contained in the FT’s final phrase; the desire of RBS to improve ‘”its standing with bond investors”. Under EU rules, RBS will be prevented from paying interest to its bondholders for 2 years, because it has received capital from the State. The ban starts at the end of April, hence the rush. But this is the flimsiest protection against taxpayers’ money being shovelled into private hands, as the value of the shares and bonds in virtually all Britain’s major banks would be worthless without the guarantees already provided by the State. The fact is that many institutions, RBS, Lloyds, Bradford & Bingley, Northern Rock, etc., were such basket-cases that they also received direct injections of capital in order to stay afloat.
But even this flimsy protection is too much for RBS’s management. They intend to buy back £10bn in bonds at above market prices in order to curry favour with bondholders, using taxpayer funds to do so. It’s as if the burglar who robbed your home is now being paid to drive the loot away.
In addition the management hopes to pay down at least part of one slug of debt owed to taxpayers by issuing new debt to private bondholders. This will certainly be at a higher rate of interest than the 4% currently being charged, set generously low by government officials.
Now, why would a commercial enterprise pay more than the market rate to buy back bonds? And swap low-interest debt owed to the government for higher-interest rate to private bondholders, who might take a more hands-on approach to how the bank is managed? Why, in fact, would management not take advantage of the 2-year interest holiday imposed by the EU and use it to restore the business?
In an ordinary business, managed in the interests of shareholders, a management team which engaged in any of these actions would be thrown out, if not investigated for corruption. But RBS is no ordinary business. The main shareholder is British taxpayers. RBS is not being run in their interests, but in the interests of the once and future owners, private capital. Meanwhile domestic lending by banks in January is below the level at the beginning of 2007 and continues to decline, and the total bank bailout has cost £126bn.

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