Manish Singh: Setting up "Bad Bank" would have been a better solution

Manish Singh is an Investment Director at SG Hambros Bank Limited (part of Société Générale Group). He is also the Head of the Conservative City Future Research Group. Manish is a graduate of Indian Institute of Technology in Mumbai (IIT) andan  associate member of the CFA Society of the UK.

After talking up the idea of a ‘bad bank’ last weekend, the Government decided to create an insurance scheme that exposes taxpayers to all the downsides and no upside.

In my opinion, insuring the banks against potential losses from toxic debt is a solution but not an optimal one for Britain.

I have long argued that setting up a 'bad bank' on lines of Swedish experience is the correct way to directly deal with toxic assets and still believe so. That is why I am surprised this Government gave up on the ‘Bad Bank’ idea after talking it up last weekend. I hope there is a very good reason; however the reason seems only political.

The political opportunism is ignoring the right response. The reason the Government is not setting up a 'bad bank' is because 'price discovery' will blow some of the banks away, and the Government will have to commit huge sums of additional taxpayer's money up front -  an outcome which is not politically favourable to the Government given that the PM has already claimed to have  ‘...saved the world...'

However, if we face up to size of these losses now, then solution will be near - or else we are just prolonging the inevitable.

Maybe the Treasury thinks pricing the assets, a precondition for buying them, is too difficult. But evaluation of assets will also be necessary to set insurance premiums and also when the Treasury has to make payouts in the event of losses.

The scheme has resulted in the banks' toxic assets being insured by the Government. Unlike other insurance ideas (e.g. from George Osborne) which take into account both good and bad assets and premiums from them, Labour’s scheme exposes taxpayers to only downside risk. What this means is that instead of having premiums paid from good assets to offset any losses from the defaulting assets, we are now going to have steadily reduced premiums from defaulting assets and more and more outlays in insurance claims by the banks.

No insurance company in the world would do this deal because it is a guaranteed massive loss-maker. The Government, scared of the lack of lending, decided to do what no rational individual would and insure against certain losses. This is more charity than genuine insurance.

It leaves taxpayers open to the downside without any participation in the upside that comes with holding and selling the assets at a later stage as was done by Sweden.

By not setting up a ‘Bad Bank’, the Treasury seems to have forfeited this opportunity of 'price discovery'. Taxpayers are on the hook. The banks must come clean so that taxpayers know what the value of these ‘toxic assets’ are now.

The Treasury press release states:

"In setting the terms under which protection will be offered, the Treasury and its advisers will take into account their estimation of the performance of the assets of the institution to be included in the Scheme."

Does this not amount to evaluating the assets, and if so why give up on the 'bad bank' solution?

The real winners are going to be asset managers/ buyers who buy and hold these 'bad assets' in the event of the banks offloading them. They will be buying assets at 10 or 20 pence on the pound. When the upturn happens, they will reap potentially very large profits.

The other winners will be the bank bosses who will now be able to offload the risk that they took to the taxpayer. They get the upside in profit… but none of the downside. This is what happens when a Government panics and interferes. Poor decisions are made by Whitehall and Downing Street but we taxpayers will have to bear the brunt of those decisions.

Therefore, the Tory response should include opposition to any sale of these 'bad assets' by the banks to third parties other than the Government without prior consent.

By preventing the sale of these assets at heavily discounted values; the assets will remain on books of the banks and any upward revaluation will immediately benefit the taxpayer through higher share price values. Government will act as both shareholder and insurer with losses announced resulting in lower share values and higher payouts by the Government.

If the Government is going into these banks and placing the taxpayer’s money at risk (as they have already) then they must look at any and all opportunities to obtain an upside.

The three most exposed U.K. banks have £900 billion of exposure to commercial and residential property and structured credit, of which £100 billion is particularly toxic, according to Merrill Lynch. You can run the numbers to see the size of potential losses. No wonder Jim Rogers is saying: “I would urge you to sell any sterling you might have. It’s finished. I hate to say it, but I would not put any money in the U.K.”.