Is The Rescue Package Working ?

Last month the government unveiled a substantial range of measures to support the UK banking system. These included significant extra support for the Bank of England's 'special liquidity scheme', and an extra £50bn of funds to be made available to banks in exchange for shares - but is it working, and will it work ?

Before judging whether this bail-out has been, or will be, a success, it is important to consider the objectives of these measures, both stated and unstated, and not to set our sights too high.

Unfortunately in simple monetary terms, the size of the problem in the UK alone is truly astronomical, and it would be foolish to think that the government would be able to correct the situation using only financial brute force. The UK simply does not have the resources to do so. In addition, many of the measures that have been taken will take some time to have their full effect.

This is partly because, in the present circumstances, in attempting to rescue the banks the government is effectively pitting itself against the markets, which are almost universally pessimistic about the prospects of the banking sector. When panicked, as they are now, the markets are often irrational, and act in ways which cannot be justified on the basis of fundamentals alone.

A Disturbing Quote Attributed To Keynes

Within the UK Treasury, there will no doubt be quite a few who will be familiar with the disturbingly relevant quote attributed to the Cambridge economist John Maynard Keynes, which is most certainly true under the present circumstances:

"The market can stay irrational longer than you can stay solvent."

The government's stated objectives for last month's bail-out included both addressing the market instability of the banks and the critical lack of inter-bank liquidity. If this is the yardstick by which we should judge them, then, although it is early days, we anticipate the prospects of success as being, at best, mixed.

However, in our view, given the state of the markets at that time, the primary (unstated) objective of October's bail-out might well have been to prevent the sudden disorderly collapse of the UK banking system. If this was the objective, then it probably has been achieved.

In addition, the overall long-term cost of these measures cannot yet be quantified. Apart from the cash put on the table by the government, it is likely that there will be a significant adverse impact on the value of Sterling - as the currency markets effectively 'downgrade' their perception of the UK.

There could also be an adverse impact on the government's ability to raise finances though the issuing of government bonds, especially if the market and/or rating agencies judge that the UK will be less able to pay its debts and obligations in the future. This could, in turn, have unpredictable consequences for inflation and UK interest rates.

This brings us back to whether or not these events herald the end of the capitalist system. In my opinion this conclusion is a misguided 'headline grabber', which is a result of somewhat loose thinking.

Exotic Banking Practices Are Not What Capitalism Is Really About

In the recent past, various forms of exotic banking do seem to have been elevated to a position of pre-eminence, exemplifying our capitalist market-based system. They have sometimes almost been seen as epitomising it, but they are not the same thing. Banking should primarily be a facilitator rather than a main player in such a market.

The Importance of Entrepreneurs

It is a good thing that Entrepreneurs should be willing and able to take significant risks to form companies, and to create wealth and jobs. It is also important that banks should help them in this process. The market provides a mechanism by which capital should be able to flow between investors and investees.

Risk-taking by such individuals is to be supported, and this is not at all the same thing as supporting risk taking by banks in the financial markets. It is such entrepreneurs who will ultimately provide the jobs that will inevitably be lost in the wake of the meltdown of the financial sector.

Whatever might happen, it is vital that the government ensure that such people continue to be supported.

It seems to us that the reckless incompetence of a relatively small number of individuals within the banking sector does not really change this logic. Changes clearly need to be made, but in our opinion these need to include fundamental structural changes, not just a predictable regulatory tightening.