Blank Cheque

So just what are we taxpayers on the hook for? What exactly has the government's panic bank deposit guarantee announcement exposed us to (see this blog)?

Having trawled through the papers and official websites this morning, it's entirely unclear what's actually been agreed. The official HM Treasury merely repeats Darling's TV announcement:

"Should it be necessary, we, with the Bank of England, would put in place arrangements that would guarantee all the existing deposits in Northern Rock during the current instability in the financial markets."

"Put in place arrangements". Like what? Will all deposits be covered? Retail and wholesale? What about say a roll-over facility - is that a new deposit? The reality is probably that they have no idea.

Also, which institutions are covered by the broader guarantee? We only found out about that after Darling had spoken, when Treasury officials briefed journalists that "the same guarantee would extend to any other bank in a situation similar to Northern Rock, which asked the Bank of England for help after experiencing cash flow problems following the worldwide squeeze on credit." Had Darling simply forgotten to mention that huge extension, or hadn't it occurred to them until they were later asked?

The message - strongly reinforced by the bumbling performance of the FSA's chief executive on this morning's Today programme - is that they are making this up as they go along. All they know is that they will do whatever it takes to stop the nightly TV reports of Weimar Republic style panic in the streets.

But it's our money they're chucking around. We need to know what it will cost, even if they're beyond caring.

Let's assume the guarantee will only apply to UK bank deposits held by UK private sector residents. At present, they amount to around £2 trillion. So straight off the bat, Darling has signed us up to guarantee £2 trillion of deposits. That's a big Big Liability- even bigger than the £1.7 trillion debt mountain this government has already built up (see this blog).

But of course, they might argue the actual cost is not this total potential liability, but the value of the free insurance cover they're handing out.

In the absence of detail it's rather difficult to tell what this amounts to, but one indication might be the US deposit insurance scheme, which is being widely trawled as the model for us.

That's operated by the Federal Deposit Insurance Corporation (FDIC), and guarantees most deposits up to $100,000 (£50,000), some up to $250,000. It's funded by insurance premia paid by the participating banks themselves.

Looking at the FDIC's latest report, we find that in 2006 it insured $4.1 trillion of deposits on a premium income of only $32m (a mere 0.0008% of deposits). Which sounds like a knock-down bargain- until you recognise the FDIC has been going since 1933 and has built up huge reserves over that time. They now stand at $50bn, still only 1.2% of deposits, but a pretty chunky war chest compared to the zero we have in the UK.

So what might that imply for us?

A straight read across from the US says taxpayers would need to put aside an immediate reserve of £25bn and an annual premium of £16m pa. Well, that's not too bad you think- why didn't we do it before?

But given all those panicking queues, and NR alone with twenty odd billion of retail deposits, that doesn't sound right, does it. Not nearly enough.

And of course, it isn't.

In reality, the FDIC's premium rates go up and down depending on recent loss experience. During the recent boom, losses have been minimal (zero actually). But back in the late eighties and early nineties recession, the losses racked up ($15bn in the worst year). The premia then went much higher. A read across from that experience suggests the implied premia costs here would currently be of the order of £4-5bn pa (equals 0.2%- 0.25% pa of £2trn).

Remember too that the FDIC guarantee is capped - Darling has given an open-ended guarantee no matter how big the individual deposit.

The bottom line is that we can't really tell how much of a blank cheque the government has written, because as per they haven't worked out what their "plan" actually entails in the real world. But as of now, he's increased public sector liabilities by around £2 trillion, and he's committed taxpayers to providing free insurance cover costing perhaps £5bn pa.

This morning's press says Bank Governor King will take the rap for this and will shortly be removed. But the real culprit has been keeping a very low profile in No 10. He's the one who split responsibility for managing bank stability between the Bank and the FSA, and he's the one who presided over Britain's debt explosion.

But we're the ones who will have to pay for it all.
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