Is the British government on the right path with its recent package of measures to help the banking sector or, as Mervyn King, governor of the Bank of England, put it this week, “to protect the economy from the banks”? The question, in truth, is not only whether the measures will work, but whether the UK can afford them.
Here are two frightening statistics: over the past five years, the balance sheets of many of the world’s largest banks more than doubled; and, according to the Bank, the median ratio of debt to equity in big UK banks is more than 30 to one.
The government faces two challenges: it must eliminate the consequences of these past errors and prevent new ones. These errors go in opposite directions: the past one was lending too much; the present one is lending too little. The legacy of the former is destroyed balance sheets; that of the latter is collapsing lending.
So what should the government be doing in dealing with the legacy of past excesses? The first action must be a brutal worst-case evaluation of balance sheets. The government cannot safely guarantee any conceivable losses. The big banks are deemed too big, too interconnected and too important to fail. Yet might they not also be too big to rescue?
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