Banks bailout: Bonds tumble as Government admits no cap on taxpayer risk

Bank shares plunged and Government bonds tumbled after Gordon Brown announced plans to insure lenders for losses on bad loans which could amount to billions of pounds.

The Prime Minister announced a scheme to allow banks to exchange cash or shares for a Government guarantee on their “toxic” debts, transferring any losses they suffer from the banks to the taxpayer.

But the Government has conceded that it can’t estimate how much taxpayers’ money will be on the line in the latest bank assistance package.

UK bond prices fell sharply as the financial markets digested the prospect of further Government borrowing. Bank stocks also tumbled with shares of Royal Bank of Scotland losing more than half their value. Lloyds, Barclays and HSBC also fell.

Ministers say the new package, which comes only three months after another £500 billion bailout, is vital to restore bank lending and help companies get credit and stay in business.

At a press conference in Downing Street to announce the package Mr Brown said that “people are right to be angry” about what he called irresponsible lending by banks.

Mr Brown also reacted angrily to suggestions that he was handing a “blank cheque” to the banks by offering to protect them against the consequences of that lending.

He said: “You are completely misunderstanding this to suggest this is a blank cheque. Quite the opposite. It is for the Treasury to decide, after an analysis, what the insurance will be.”

But he admitted that ministers have not yet set any upper limit on the value of loans they support or the level of risk taxpayers will bear.

As part of the rescue package, the taxpayer has taken an even bigger stake in Royal Bank of Scotland, which has today announced losses of over £20 billion – the biggest loss in British corporate history.

The Government is also offering to increase its stake in Lloyds Banking Group. The state could even take shares in Barclays and HSBC in exchange for insuring their loans in its new Asset Protection Scheme.

HSBC said that it had not sought capital support from the UK Government “and cannot envisage circumstances where such action would be necessary”.

It is the second rescue package in three months, which is aimed at getting the banks to lend to businesses and homeowners.

If it fails, banking experts say the only option left for Mr Brown will be full nationalisation of the banking system.

In a statement to the City, the Treasury said the Asset Protection Scheme scheme is expected to operate for “not less than 5 years.”

“To increase confidence and capacity to lend, and in turn to support the recovery of the economy the Government is today announcing its intention to offer protection on those assets most affected by the current economic conditions,” the Treasury statement said.

In the first instance it will be open to the major British banks, but the Treasury said it was possible that insurance will ultimately be extended to the British subsidiaries of foreign banks.

The Government also announced:

A plan to make government bonds available to banks to support £100? million of loans for some home owners and small businesses, as recommended by Sir James Crosby, former HBOS chief executive;

An extension until the end of this year of the Government’s £250? billion Credit Guarantee Scheme to support lending between banks;

An expansion of the Bank of England’s £200?billion Special Liquidity Scheme. The Bank will now accept consumers’ car loans in exchange for Government bonds, a move intended to support the failing motor industry;

Northern Rock, the state-owned bank, will be told to offer more home loans, reversing previous instructions for it to get rid of mortgage customers by charging punitive rates of interest.

Despite £500 billion having been pledged for a rescue package in October, the banks are not lending at the levels ministers and business groups say are needed for the economy to function normally. As a result, the country is mired in a recession which experts are forecasting could be the worst for generations.

The Chancellor, Alistair Darling, also suggested that the bailout would be accompanied by new measures to control the banks’ behaviour

He said: “It’s quite clear in the world we’re living in just now we do need to look again at the way we supervise and regulate these banks.”

George Osborne, the Tory shadow chancellor, said the Government had no choice but to help the banks again because the October package had “failed.”

He said: “I don’t like the idea but it’s a question of what options there are.”

Mr Osborne added that strict scrutiny must be applied to bank assets to protect taxpayers’ interests. “We need to know exactly what the Government is proposing to insure. We need a full audit, an independent audit,” he said.

The centrepiece of today’s package is to provide Government guarantees against losses that the banks might incur on loans that have now turned sour amid collapsing house prices and a shrinking global economy.

The banks will pay a “significant” fee to the Government for each loan they insure.

They will be able to pay that fee in either cash or shares. That could open the way to the state holding stakes in all of Britain’s four biggest banks for the first time.

Shares in Barclays fell by more than 20 per cent on Friday amid City speculation that the bank is exposed to huge losses. It tried to calm that speculation by pre-announcing significant profits, but its shares are likely to come under fresh pressure.

In the October package, ministers offered Barclays billions of pounds in new capital, but – unlike RBS and Lloyds – Barclays rejected the offer and chose to raise new funds from Gulf investors.

Treasury sources said the proposal to insure Barclays’s loans in exchange for shares would effectively repeat that offer. Some believe that the bank will find it almost impossible to reject state help this time.

Despite raising the prospect of increased government holdings in the banks, ministers insist that outright nationalisation remains a last resort.

The loan insurance scheme is being proposed as an alternative to the creation of a state-controlled “bad bank” to house the toxic assets.

Officials say the insurance plan avoids some of the complexity and delay involved in valuing and buying the assets from the banks.

But it means the Government cannot know exactly what losses it would incur if the loans it insures go bad.

As well as paying substantial fees in cash and shares for the loan insurance, banks will also have to sign “contractual agreements” with the Treasury about their future lending, committing them to increase lending and focus new credit on British customers ahead of foreign borrowers.

Separately, the Government could increase its stake in RBS and the Lloyds Banking Group, potentially making the taxpayer the majority shareholder in Lloyds.

In October, some of the state’s holding in RBS and Lloyds was taken in the form of preference shares, holdings that committed them to paying hundreds of millions of pounds to the taxpayer before they did anything else.

The banks say those obligations have shackled them and forced them to divert money that could otherwise have been used to lend.

In exchange for reducing what it takes from the preference shares, the Government wants more normal shares, effectively diluting the value of private investors’ holdings and increasing state influence over RBS and Lloyds.

RBS has accepted the deal, taking the state’s ownership to 70 per cent.

Lloyds is more reluctant to accept the offer, which could see the Government share exceed 50 per cent.

By James Kirkup
Last Updated: 2:07PM GMT 19 Jan 2009

Source: The Telegraph