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June 10, 2011 10:11 pm

Banks, bills and bail-outs

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How much of the deficit is the result of bailing out the banks? It turns out that the answer is simple – none of it

I’ve been getting a few e-mails and tweets recently asking how much of the deficit is the result of bailing out the banks. It turns out that the answer is simple: none of it.

Let’s look at the situation in the UK. The bail-out – if that is the word – came in a number of forms, including the nationalisation of Northern Rock, compensation for depositors who lost money in Icelandic banks, capital injections into the likes of RBS and Lloyds, and extensive guarantees of bank debt designed to reassure investors and so make it easier for banks to raise money and keep on doing business.

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    Hundreds of billions of pounds were ostensibly on the line, but such figures were always somewhat deceptive: they described the maximum possible losses on the government’s guarantees and capital investments. What were the actual losses?

    The final bill is not yet in, and won’t be until the government successfully divests itself of its shares in banks. But you can get a rough idea of the trajectory by looking at Budget statements in recent years. Alistair Darling’s 2009 Budget estimated that total cost of the Treasury’s interventions would eventually add up to £20bn-£50bn, a hefty sum indeed – but still not enough to explain a deficit of around £150bn two years running. Darling’s 2010 Budget revised the figure to a much-less-frightening £6bn, as the price of bank shares recovered and guarantees expired without being used. George Osborne’s emergency budget a few months later offered a figure of £2bn.

    Now the Office for Budget Responsibility has the job of calculating these figures. Its estimate at the time of the last Budget: a profit of £3.4bn.

    No sooner had these figures emerged than the US Treasury published its own estimate of the costs of its bail-out operations. The result: a profit of $24bn.

    One reader writes to point out the so-called “bail-outs” were in fact successful investments by governments operating as vulture funds. That may be putting it a little too strongly – but it is a far more accurate view of the situation than the view summed up by the advertising slogans of a new film on US cable TV, Too Big to Fail: “Main Street took the fall. Wall Street got the cheque.”

    Are we fussing about nothing, then? Not at all. The “bail-outs” might easily have cost money: just because an insurance policy has no claims on it, does not mean the policy was free to offer. In other circumstances – smaller states, more incompetent banks, cruder interventions – support for the banks has brought governments to their knees. Anyone reading this in Ireland will know exactly what I mean. There is no reason to believe that a future bail-out will not be ruinous.

    So why does this discussion matter? It alters the debate about what we want to do to the banks. If you take the perfectly understandable – but wrong – view that the banks have swallowed a huge public subsidy and have delivered little in return, you should be delighted at their threats to move to Switzerland or Singapore. If you recognise that well-functioning banks are vital to the economy, the policy problem becomes far harder: keep them, discipline them, make them more robust and far less likely to risk public money next time. All of which is a far harder problem than cheerily waving them goodbye.

    And yet it is a problem that must be solved. The banking crisis did appalling damage to the economy as weak banks hoarded capital, leaving ordinary businesses and consumers gasping for credit. Andrew Haldane of the Bank of England has estimated that the cumulative loss of output in the UK economy, in net present value, could be several trillion pounds. So by all means, let us blame the banks – but not the bail-out.

    Tim Harford’s new book, ‘Adapt: Why Success Always Starts with Failure’ is published by Little, Brown.

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