Fighting the Meltdown Britain Announces Second Financial Bailout

Britain's second multi-billion pound bailout aims to get banks lending again by insuring toxic assets. But will it be enough?

By Mark Scott


Last year, British Prime Minister Gordon Brown won plaudits worldwide for a multi-billion package to recapitalize domestic banks in the hopes of staving off a financial meltdown. It took some by surprise, then, that on Jan. 19 Brown -- along with his finance minister, Alastair Darling -- was again outlining a multi-billion plan to prop up Britain's struggling financial services sector.

British Prime Minister Gordon Brown and his finance minister Alastair Darling have announced a second bailout.
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British Prime Minister Gordon Brown and his finance minister Alastair Darling have announced a second bailout.

Yet unlike the previous announcement, which focused on providing new capital to struggling banks, the Jan. 19 package had a broader goal: to shore up the British economy. Under the plan, the government will provide insurance -- for a fee -- against losses on banks' riskiest assets, the Bank of England will create a £50 billion ($73 billion) fund to buy high-quality securities from the corporate sector, and the central bank will swap British Treasury bonds for hard-to-move, but Triple-A rated assets.

The government also announced it would increase its stake in struggling bank RBS from 58 percent to 70 percent by converting £5 billion ($7.4 billion) of preference shares into ordinary shares. The British Treasury similarly revealed plans to maintain the loan book of nationalized mortgage lender Northern Rock, reversing an earlier proposal to run down the bank's lending.

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All this may sound pretty technical, but it all has one clear goal -- to get banks lending again.

Here's how it should work. By providing insurance for toxic assets, the British government hopes financial institutions will start to feel more confident about providing new capital to companies and/or homeowners. One of the biggest causes in the recent contraction in credit has been banks' fears that they are overexposed. By offering a safety net against further losses, Gordon Brown reckons banks will again open their wallets to new business, which then will jumpstart the economy as companies/consumers start to spend.

The Bank of England's move to buy/swap high-quality assets also is part of this plan. Since Lehman Brothers collapsed in September, 2008, the money markets have virtually shut down as investors have shied away from (possibly under threat) banks and companies. That's left institutions with a liquidity problem, meaning they've had to cut back on investments and slash workforces just to keep their heads above water. By exchanging these securities (which remain illiquid, but of high quality) for liquid British Treasury bills, the central bank hopes to inject much needed cash into the market, and consequently boost the domestic economy.

This plan has many advantages, but it does leave the British taxpayer with an even larger stake in the financial services sector, as well as increasing already-bloated government-debt. Gordon Brown says he will wind down state-owned assets as quickly as possible, although the prospects for the British economy look dire for at least the next twelve months.

And if any naysayer was looking for a reason to criticize the Jan. 19 plan, he/she would only have to look at struggling RBS. On the same day that the government increased its ownership of the bank to 70 percent, RBS announced it's expecting a £7 billion ($10.2 billion) to £8 billion ($11.7 billion) loss for 2008. The bank also said it also could write down between £15 billion ($21.9 billion) to £20 billion ($29.2 billion) of assets related to its acquisition of Dutch financial giant ABN Amro in 2007. All told, the figures could represent the largest ever loss reported by a British corporation. By early afternoon trading in London, the bank's share price had fallen almost 52 percent.

That's not the sort of news Brown would have wanted as he unveiled the latest attempt to stave off a long-term recession. RBS certainly has become a basket case. But the Jan. 19 plan is an attempt to stop such financial problems from spreading into the broader British economy.

Scott is a reporter in BusinessWeek's London bureau.

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