Government Prepares To Bail Out High Street Banks

The British government is preparing to do the once unthinkable. They’re going to directly bail out high street banks.

The good ship Finance is holed under the water. The scramble for life boats is on... women and HBOS first...

Actually it looks like Royal Bank of Scotland (RBS) may be first in the queue. Its shares were battered this morning. They tumbled 30% in early trading as rumours swirled that it had approached the state for emergency funding.

If you’ve followed our advice in these bulletins you’ll have stayed away from financial stocks. And a good thing too. Several investors — from sovereign wealth funds to the owner of Newcastle United Football Club — have burnt their fingers this year buying banks at what they (mistakenly) thought was the bottom.

We’re not at the bottom.

Remember two weeks ago I talked about Warren Buffett’s investment in Goldman Sachs? Buffett got a good deal when he bought into Goldman. He negotiated a 10% dividend, and warrants that showed an immediate paper profit. Not only that, Buffett got preference shares, rather than the ordinary kind bottom fishers would get. Should Goldman go bust, he’d be further up the queue for getting some of his money back.

Buffett got such a deal because of the strong position he was in. Here was an investor with a lot of money, negotiating with a bank that desperately needed some.

In many ways, the British government finds itself in a similarly strong position. Don’t laugh, it’s true. British banks — like banks everywhere — are desperately short of capital. Investors are unwilling to provide it (can you imagine anyone doing a rights issue now?) So the state is the only player with both the money and the will to provide the capital banks so sorely need.

But the parallel with Buffett only goes so far. Buffett is a private individual running a fund. His goal is plain and simple — to turn the sum of money he’s responsible for into a bigger sum of money. He could have walked away from the Goldman deal any time he liked.

Our government doesn’t have that luxury — and the banks know it. The risk now is that the banks play a bit of a game of chicken, hoping the terms of recapitalisation aren’t too onerous.

For its part, the government will be keen to strike the deal that appears to offer the best terms for the taxpayer. But it can’t just walk away if the deal looks wrong, so this could get tricky...

One thing is clear, though — the big losers will be those holding bank stocks. That’s why RBS plunged — if the government buys a stake, it will dilute the holdings of existing shareholders.

I can’t see a winner in all of this. The banks themselves, I suppose, although their prize will (we hope) be mere survival.

Much has been made of Sweden’s bank rescue in the 1990s, and how the Swedish taxpayer eventually made a profit from the bank shares the government bought. But this crisis is international. It’s bigger, it’s deeper and it’s messier.

So I don’t think you and I, the British taxpayers, will emerge victorious either. Let’s see this for what it is — a desperate, if necessary, measure at a desperate time. But while the government may have no other choice, that doesn’t change the fact that it puts a further strain on the public purse [for more information on the repercussions of this, and how you can protect yourself, read my special report here.]

If you take one thing away from this article, let it be this: don’t buy shares in banks. That may sound obvious, but the temptation will be there for someone to call a bottom — it always is. Don’t. A sector that needs state aid is not a moneymaker.

Of course, the turmoil is hitting even those businesses that are making money. The FTSE 100 suffered its biggest points drop ever yesterday. It was the biggest drop in percentage terms since 1987.

At times like this it’s important to remember that the strong companies will come back. That’s why we buy them in the first place. If the underlying business is still sound — and you’re in a position to stay the course — then there’s no need to be spooked by every up and down in the market. Even the big ones.

Until tomorrow

Ben Traynor
Editor
Fleet Street Daily

Selected article:

Tom Bulford on why every downswing breeds the seeds of revival.

The Daily Reckoning — The Big Sell off has arrived

"It’s pretty much all out war," said the chief financial economist at a large Japanese bank.

Yesterday, the battle was hot and heavy. By 8 PM last evening the financial media was in a panic. An attack of stock market panics was rolling over the world. Japan was down 5%. India was down 4%. In Russia, they stopped trading twice. In Iceland, they stopped trading in financial shares all together.

By the time the battle reached Manhattan, the London press expected the whole island to be pulverized. And for a while, it did look as though US stocks would be hammered to dust. The Dow fell 600 points at one point.

But by the end of the day, stocks were down...but not out. The Dow lost 363 points, to below 10,000. And this morning, there are signs of new life coming from Asia. One investor thought he saw a dove with a green twig in its beak.

What is going on?

You can read the Daily Reckoning in full here.

P.S. If you enjoyed this article then we encourage you to sign up for the free Fleet Street Daily eletter. Learn what you can expect from today's markets -- and how to prosper in the face of uncertainty. You won't find more thought provoking writing anywhere on the Internet.

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Government Prepares To Bail Out High Street Banks

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