The case for a Bad Bank

The Government's asset purchase scheme has 'spent' £375bn buying up gilts (UK Government Bonds) from our distressed banking sector, what they call Quantitative Easing (QE). The scheme was meant to be self financing but this week The Bank of England stressed that although likely deliver a £17bn profit, its possible that losses made on the sale of the gilts would rise to £75bn, producing a net loss of £8bn to the public finances in 2020.  As well as pointing out some long term risks they also confirmed that more QE is unlikely to beneficial, what a surprise!

QE - keeping the lights on!

In a parallel universe within the Bank the Deputy Governor, a Mr Bailey, confirmed that despite this massive commitment to asset purchasing our 'too big to fail' banks may still need a further injection of Capital, he said “I agree there is a need to strengthen the capital position,” he told MPs.  .  He hinted that the extra Capital might be necessary before Lloyds and RBS are returned to the private sector.  Some 'experts' suggest the figure could be as high as £50bn

The Bank of England and the Labour Government missed a big opportunity to resolve our banking crisis back in 2009 when they decided to prop up the banks rather than buy up the distressed assets to create a Nationalised 'Bad Bank'.  The coalition Government have also kept their heads firmly in the sand on this since 2010.  The result is that after four years on and with £375 billion spent on QE we still have a broken banking sector. 

If the Government had broaden the asset types for the QE programme we could now be in a situation where Lloyds, RBS and Barclays could be providing the credit and lending services that our economy so desperately needs.  Meanwhile the Bank of England could be managing the run-off of asset sales from 'Bad Bank'.  It's now emerging that this 'Bad Bank' construct maybe needed to bail-out the UK's over-blown and poorly regulated Private Equity business. When it rains ......!

Yet another Bank of England study (my they have been busy) has confirmed that many UK businesses have been left “fragile and susceptible to default” by private equity’s leveraged buy out (LBO) model.  In the first decade of this century Private Equity sector used leveraged finance to 'buy' many of our best UK companies, actually what they did was to borrow a load of money and then pass these debts on to the balance sheet of the acquired business.  Companies like Boots, Manchester United, Saga, Debenhams and all suffered the same fate.  These businesses are now loaded with the debt estimated at £160bn. See the chart on the left.

When people think of Zombie business we image small run down family companies hardly able to meet the pay-role, the reality is much more serious.  We now have some of our best business over loaded with debts that they will take years to pay off.  This is killing productivity and we are losing the opportunities to expand exports and employment at home because of the greed in our financial service industry.  This may is some way explain the UK's terrible productivity performance sine 2008.

But setting up a 'Bad Bank' the government could free both our banks and our leading businesses from the effect of the credit boom and bust setting the economy on a course of recovery.  The next question will be how do we get our money back from the Private Equity millionaires who have done their bit to wreck our economy.