The Chancellor and RBS: Osborne's failure to get a grip

The Telegraph carried an interesting article discussing how the Too Big to Fail banks have driven policy since the beginning of the credit crisis.

In particular, the article highlights the number of false assumptions that have dominated the discussion.

[It] points to a first-class crisis in government, created by the state purchase of two banks at the height of the 2008 financial crisis – RBS and Lloyds, the former now 84 per cent state-owned, the latter to the tune of around 40 per cent. 

Between them these banks account for an astonishing and quite terrifying £1.6 trillion in assets, roughly the same as GDP. 

If things go wrong, the British economy could capsize. Mr Redwood told me yesterday that you could easily lose a sum equal to the defence budget for a year if RBS investments caught so much as a cold.

The first assumption is that the state is at risk for losses incurred by RBS.  This assumption is false.

As Spain has just demonstrated, banks can recognize all the losses on their balance sheets today and restore their book capital through retention of future earnings.

Said another way.  Until the UK financial regulators close down a bank, it can continue to operate.  If the bank actually has a franchise of value, it will be able to earn the money to restore its book capital without government intervention.

Allies of the Chancellor insist that he made the decision to keep RBS under state control and as a single unit after the advice of two very persuasive men – Mr Hester and Sir Nicholas Macpherson, permanent secretary at the Treasury. 

Mr Osborne was reassured that RBS could be “floated off the reef”, kept intact and sold back to the public sector relatively quickly, thus delivering a return to taxpayers.

The second assumption is that there is a market for the common stock of a bank whose disclosures leave it as the Bank of England's Andrew Haldane says resembling a 'black box'.  Even Stephen Hester has said publicly that investors would be dumb to invest in banks.  He knows they do not have the necessary information to assess the risk of the bank.

Meanwhile, Sir Nicholas warned that it would be politically dangerous to intervene directly in the management of RBS and Lloyds.

It would be far better, the Chancellor was told by his top Treasury adviser, to allow RBS to be run by the clique of investment bankers who had been appointed by former chancellor Alistair Darling 18 months earlier....

The third assumption is that the choice for intervention is either no intervention or allow RBS to be run by the clique of investment bankers.  There is a middle ground.

From day one the UK Financial Investments should have been requiring the data that any investor would want if the investor was going to independently assess and monitor the risk of the two banks.

The data that an investor would want is the current asset, liability and off-balance sheet exposure details.

With this data, investors could independently assess and monitor the risk of each bank.  Without this data, investors are guessing at the contents of a black box.

With this data, investors could exert market discipline so that management does not increase the risk of these banks and try to gamble on redemption.  Without this data, investors are reliant on financial regulators  to properly assess and monitor the risk.

With this data, investors are not troubled by bonus payments as they can see that the bankers earned these bonuses for superior risk adjusted performance.  Without this data, investors assume the bonuses were earned as a result of all the financial market life support programs.

Others feel that [Mr. Osborne] is too much in awe of City bankers and, like his predecessor, Mr Darling, has been intimidated by their bullying and occasional hints at resignation.

The fourth assumption is that politicians and financial regulators will be able to control City bankers.

Its failure forever ends the discussion in favor of banks being required to provide ultra transparency.


Why?


Because the only player in the financial markets big enough to stare down City bankers is the financial market itself.  Frankly, it doesn't give a damn about the bankers tactics of bullying or hints at resignation.