Wondering why HBOS, LLoyds TSB and RBS were in freefall on Monday - down 14, 12 and 11 per cent, respectively?
Tuck in to Willem Buiter’s Maverecon blog at FT.com - Could the UK face a sterling crisis, or are we in one already?
This particular epic is around 5,000 words, but here are the operative paragraphs:
Reduce the exposure of the state to the banking sector.
If one or more systemically important UK banks were to be at risk of failing imminently, the distribution of the associated financial losses becomes a key political issue, financial stability issue and macroeconomic stability issue. Because the UK does not yet have a proper special resolution regime (SSR) for banks, the only ways the state can safeguard systemically important bits of the large UK banks is either by guaranteeing the liabilities or by injecting capital. The strongest version of a capital injection is nationalisation. The British state has done this for Northern Rock and Bradford and Bingley, neither of which was systemically important. It is about to tie the knot with RBS, which is systemically important. It has guaranteed new medium-term debt issuance by UK banks. It has de facto guaranteed all deposits, retail or wholesale. It has exposed itself to residential mortgage-backed securities and other asset-backed securities through the Special Liquidity Scheme.
The problem with nationalisation of the banks is that when the state owns a bank and the bank goes broke, if the state does not make all creditors whole (ensures that their claims are met in full), a bank default becomes effectively a sovereign default. To avoid that, it is essential that banks be put into some form of receivership before the state takes a controlling ownership stake in them. When the bank is in receivership, all holders of the bank’s unsecured debt, even the senior debt holders, and all other creditors, including unsecured senior creditors, can be made to pay a charge (suffer a haircut).
The alternative is that the tax payers or the current beneficiaries of public spending compensate in full the holders of unsecured bank debt and the banks’ other unsecured creditors. That would be outrageously unfair. It would also constitute the mother of all moral hazard. The creditors of the bank and the holders of the unsecured debt were essential participants in the process that created the excessive leverage taken on by the banks. There can be no reckless lending and investment by banks unless the banks have reckless creditors and reckless purchasers of their debt. These creditors and debt holders must be made to suffer financial losses if we are not to encourage even more reckless lending and investment in the future.
The problem with the insolvency process for banks in the UK is that there is no special insolvency process and insolvency regime for banks. When a bank is put into receivership, its creditors (including the retail depositors) find that their claims on the bank are frozen. Also, by the time the conditions for putting a bank into involuntary insolvency have been met (effectively balance sheet insolvency or liquidity insolvency), most of the systemic damage has already been done - all counterparty risk will have materialised and clearing and settlement systems for interbank payments and for securities sales and purchases will have been crippled. Financial paralysis will spread - think Lehman Brothers, where the absence of a proper SRR for investment banks/broker-dealers led to what Mohamed El-Erian calls a counterparty risk ‘cardiac arrest condition’ when Lehman sought bankruptcy protection on September 15.
It is incomprehensible to me why, almost 16 months after the start of the financial crisis, the UK still does not have a special resolution regime for banks. The failure to make this a top priority must count as a major dereliction of duty by the government.
Shock summary - the UK’s banks are quite possibly bust, but to protect the tax-payer those banks must be seen to go bust before the state steps in with support.
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