“The last… piece of the global rescue plan is now in place,” said Hugo Dixon on Breakingviews. Over the past few days the major Western economies have followed Britain’s lead in bailing out the financial sector, by injecting capital into banks and guaranteeing medium-term borrowing. Banks’ fears that it was too risky to lend to each other for more than very short periods had virtually shut down wholesale markets, threatening banks and non-financial companies alike. Globally, over $3trn has been set aside for capital injections and bank borrowing, noted Dixon.
What America is doing
The US plan is “the most sweeping government intervention in the financial sector since the Great Depression”, said Krishna Guha in the FT. The authorities will guarantee unsecured borrowing by banks for maturities of up to three-and-a-half years and inject up to $250bn into banks. Half the sum will initially go to nine big institutions, including Goldman Sachs, Citigroup and Bank of America.
The terms look less onerous than in Britain, noted Dwight Cass and Anthony Currie on Breakingviews. The Government’s injection comes in the form of preference shares with a dividend of just 5%; British banks are paying 12% and Warren Buffett grabbed a 10% coupon from Goldman Sachs. The curbs on compensation also “have more teeth” in the British version. I know we’re all supposed to have stopped worrying about moral hazard, said Jeremy Warner in The Independent, but this scheme is “amazingly generous”.
Will it boost lending?
Still, a return to risky practices looks unlikely. The key issue is whether the plan can stimulate lending and give the economy a boost, and here the outlook is hardly encouraging. Banks are in the process of shrinking their balance sheets as the economic outlook darkens. They’re also set to lose another $250bn over the next two years, estimates Capital Economics, as defaults on various types of loans mount up: “plummeting house prices, sliding corporate profits and rising unemployment are a lethal cocktail”. The Treasury’s money will merely offset future likely losses. Loan portfolios are likely to shrink by 10% over the next two years, further dampening growth.
On a global scale, government action may have averted systemic collapse, but a “painful global recession is now unavoidable”, said Nouriel Roubini of New York University. Interbank rates have eased (helped also by central banks making unlimited dollars available), but stockmarkets weakened again mid-week as investors worldwide refocused on the real economy and remembered that “we have much more to go in terms of earnings deterioration”, as Christian Gattiker of Bank Julis Baer told Bloomberg.com. The fire may be out, but the building is hardly in good shape.