Notwithstanding the recent carnage in bank share prices, the Government is behaving in a logical & consistent manner.  Having decided on the eight banks which are to form the core of the UK banking business sector going forward, the Government, now owning listed equity stakes in two of them on behalf of the UK taxpayers, is now committed to defending its investments.  Wiping out shareholders via nationalisation at zero pence per share is not an option as this would destroy its existing £37 bln investment on our behalf and it would not be consistent with the Government’s stated policy of ”managing the Government’s shareholdings in the recapitalised institutions on a commercial arms-length basis and with the aim of realising value for the taxpayer”.  Vague promises about recouping the money upon eventual relisting would not wash with the electorate.  By allowing the companies to remain listed on the stockmarket, the Government can argue (with some justification) that the valuation of the companies is temporarily depressed, it is not a permanent investor in the banks and its investments will be sold when value has been recovered.  Note that the same 8.5% discount to the prior day’s close was used to decide the RBS rights price, just as in October 2008 with HBOS, LLOY & RBS.  The Government has also reiterated that it stands ready to inject equity into other banks, if asked to do so.  Never mind Gordon Brown being “angry” with RBS for losing so much money, he is just quickly learning what being a shareholder is all about – you invest in a company, the management mess up & then sting you with a rights issue to prevent the company from going bust (and to pay their severance)! 

The Government’s next logical step, after making sure the banks retain enough capital to remain in business by offering to insure their dodgier assets against unforeseen losses, is to support borrowing by companies & individuals.  Hence the guarantees for asset-backed securities and direct Government lending via the fund to purchase assets such as corporate bonds, commercial paper, syndicated loans and asset-backed securities (mortgages, credit cards & car loans).  Expect this fund to grow from its initial £50 bln, especially if the MPC take up their option to use it to implement quantitative easing in the UK.  The MPC’s purchases won’t be funded by issuing Treasury Bills, instead the cash will just be printed.

The FSA has now worked out & published its policy on bank capital ratios.  Banks will be expected to absorb losses by running down their Core Tier 1 capital ratios to a low of 4%.  The Government (via the FSA) eventually wants to move to a counter-cyclical bank capital regime whereby capital is built up by retaining profits in the good times so that banks are sufficiently well-capitalised to withstand future recessions.  It is a beautiful irony that this is exactly what Gordon Brown was supposed to have done when he was Chancellor – run Budget surpluses during the boom times so as to be in a strong position cometh the eventual recession.  But Gordon says “Do as I say, not as I do”.