Vericool Finance

At last, the Governments is showing some urgency in deciding how to unblock bank lending to businesses. The £20bn loan scheme unveiled by Business Secretary Lord Mandelson is unlikely to do all that the Government claims for it - and the Tories may be right that their own plan for a £50bn loan scheme is a bigger and better-value version of what ministers intend.

But with a third of all small businesses reported to be struggling to get credit, the situation is urgent. A jump-start is needed and a modest start now is better than a grand plan that takes even longer to launch.

Under the terms of the plan - aimed at businesses turning over less than £500m - the Government will pledge £10bn of taxpayers’ money to underwrite loans. The money will attract a further £10bn of lending from banks, who will share the risk 50:50 with the Government. Since the banks will decide who qualifies for the loans, ministers will not find themselves in the tricky position of having to pick winners.

The scheme is a useful contribution but it won’t fix the problem. The £20bn is small beer in the context of the vast quantities of credit that have been removed from the economy as a whole, and ministers have no control over whether banks simultaneously cut their lending to households or big businesses.

This scheme will certainly release capital, but some of it may just be sat on. If the Government wants the banks to lend more, it will have to do more.

Some observers, including the Lib Dem Treasury Spokesman Vince Cable, prefer the stick: the Government should simply demand more lending from the banks in which it holds a majority stake. But that is to assume a degree of health that may be lacking.

Indeed, there appears to be a deep concern among the financial authorities that the banking sector is heading towards a fresh crisis and that a big policy response is needed. US Fed chief Ben Bernanke hinted as much in his speech at the London School of Economics.

The most radical suggestion being considered is the establishment of a bad bank that would buy up the nastiest and most illiquid assets and cleanse the banks’ balance sheets. It would be controversial and difficult to hammer out, but, short of full-scale nationalisation, it is the best shot we have of ensuring that Britain’s banks emerge from this crisis and start lending again.

Three cheers for the Chancellor. He has come out with an extraordinary list of good intentions to support companies through the recession, and has even roped in the dear old taxman to help.

The Government isn’t messing around: it is determined to prevent the collapse of the critical small- to medium-sized sector at all costs. The worry, though, is that the malaise is already too far advanced to be halted. Certainly for the 60 or so small businesses now going to the wall every day, Darling’s push has come too late.

It’s not just small business that is threatened. For some big firms – the investment banks, say, or the Detroit cark makers – the struggle for cash is already a very public affair; elsewhere, however, most of the panic is still hidden.

Don’t be fooled though: even solid corporate giants are finding it harder to roll over routine loans. Some face a desperate scramble to find money to meet such basic obligations as paying their staff. Nervous accountants, meanwhile, want to see more proof that businesses are “going concerns” before they sign off year-end accounts.

The mood among chief executives has taken a discernable turn for the worst. Some are now concerned that the very infrastructure of trade could break down if business customers are unable to obtain letters of credit to buy goods, or if credit insurers continue withdrawing cover from the suppliers of firms deemed at risk of failure.

The corporate credit squeeze is now evident on a global scale, fuelling the fear that recession could spill over into depression. The next few weeks look critical.

Businesses of every sort are lobbying the US authorities for aid, but don’t expect any such succour here. The PM has already ruled out a bailout for the beleaguered motor industry, and the director-general of the CBI, Richard Lambert, endorses him. He’s right. A bailout would set a terrible precedent.

If businesses deserve cash, the Government must exert its influence through the banks, in which it has staked taxpayers‘ money, to provide it.

Everyone agrees that the banks are perfect pantomime baddies: when audiences shout the traditional warning, “he’s behind you”, companies pushed to the brink by their lenders have a stock response: “Oh no he isn’t!”

The banks strenuously defend their lending records, but if they continue to sit on their capital, the Government and the Bank of England are threatening full-scale nationalisation. Extraordinary times demand extraordinary measures.

Barack Obama had always planned to make the US economy his priority on winning office, just not this economy. Sure, things were far from perfect when he addressed he concerns of voters earlier this year. But problems such as high energy and health costs, stagnant incomes and rising foreclosures pale beside the eruptions since August.

America’s housing crisis has become a global financial panic; the economy, muddling along as recently as July, may be in its deepest recession in decades. With tax revenues falling, a deficit that could double to $1trn, and continued fallout from the housing and banking crises, the challenges facing Obama are momentous.

Obama may be lacking economic capital, but he has political capital aplenty. This election was a genuine mandate for economic change, with voters emphatically rejecting the Republicans’ focus on low taxes and small government.

With luck he will quickly appoint a team of experienced officials. Obama has yet to name the treasury secretary who’ll replace Hank Paulson, but he has a star-studded cast of advisers, including the respected former Fed chairman, Paul Volcker, investor Warren Buffett and former treasury secretary Larry Summers.

And there’s every sign that he intends to hit the road running. Obama has already promised to review the Bush administration’s $700bn financial-sector bailout and called on Congress to pass a second fiscal stimulus package to aid the rapidly deteriorating economy. He has also announced plans to push a “big bang” social reform package, believing the financial meltdown presents a historic opportunity to deliver the large-scale investments that Democrats had promised for years.

Even so, Obama must move fast. The transition period between US presidencies usually offers plenty of time to mull over strategies. Not this time. As recent events have demonstrated, 11 weeks is a lifetime in the financial markets, and it’s imperative that Obama’s team get into the rooms where decisions are being made – now.

But despite his long list of domestic woes, Obama is also under pressure to deliver better news globally. His arrival at the White House doesn’t guarantee and economic revival, nor a geopolitical dividend: he doesn’t possess a potion to magic away eight years of debt-fuelled profligacy.

But in the same way the damage caused by Bush’s bombastic foreign policy was both subtle and long lasting, any Obama geopolitical dividend could be equally profound.

Barclays was cheered for its bravery in turning down government money to pursue its own cash-raising agenda. But the price of independence looks to be a heavy one indeed.

The bank is handing a 31% stake to the royal families of Qatar and Abu Dhabi, in exchange for some £7bn. “We negotiated hard,” remarked Amanda Staveley, the British go-between whose firm, PCP Capital, brokered the deal on behalf of Sheikh Mansour of Abu Dhabi.

You bet she did: the timing was perfect. After thumbing its nose at the Government’s offer of cash, failure was unthinkable for Barclays, and the Gulf rulers made the most of their bargaining position.

Staveley and the sheikh celebrated their coup by whooping it up in Annabel’s; but the deal went down like a lead balloon in the City. Barclay’s apparent preference for unaccountable sheikhs over the UK taxpayer is explained only by the perhaps naive belief that divide-and-rule will enable the board to treat the sovereign wealth funds as essentially passive shareholders who won’t meddle in its affairs.

Whether that will prove true in practice is anyone’s guess, but it’s already clear that the financial terms Barclays has agreed – including the obligation to pay 14% interest until 2019 on the £3bn of securities it has issued – are far harsher than those imposed on rival banks who took up the Government’s offer.

Barclays visibly bristles at the suggestion that its decision had anything to do with the famously generous bonus it pays to Barclays Capital chief Bob Diamond, but that’s probably at least part of the story. Had the bank accepted the Darling shilling, it would have been goodbye to any future as a risk-prone, whiz-bang investment bank.

For a business that has already bolted on bits of the collapsed Lehman Brothers, this was clearly unacceptable. Moreover, this deal opens the way for commercial links in the Middle East, which Barclays now has the opportunity to exploit.

It isn’t perfect, but it is infinitely preferable to raise cash from foreign investors than to rely on state handouts. Yet if Barclays thinks having this freedom enhances its investment case, it had better think again.

Investors have already made up their minds. The 18% fall in Barclays’ share price recently signals that, in its quest to go it alone, it has already given away far too much.

There are many striking parallels between the events described in John Kenneth Galbraith’s classic The Great Crash of 1929 and the current crisis – not least his observations about the ensuing humiliation of bankers. He recalls they were made “to suffer all available indignities. For the next decade they were fair game for congress, courts, the press and comedians.

To that we might now add, the clunking fist of Gordon Brown. It was a dark day for the City when the Government seized effective control of two of Britain’s largest banks. This is capitalism more akin to China than Britain. Welcome to Brown’s Britain.

This bailout was the ultimate exception to the principle that it is wrong to shoot first and ask questions later. But the enforced re-capitalisation of Britain’s banks is bound to have some potentially unpleasant consequences.

The chief worry is how the UK will cope with having a two-speed banking system, as nobody knows how it will work in practice. The freewheeling banks will be led by HSBC and Santander-owned Abbey, with Barclays (which daringly turned down the Government cash to raise its own) pedalling desperately to join them.

This crowd can set their own dividend policies, appoint their own boards and concentrate on stealing the cream in the UK lending market. The nationalised banks of RBS and HBOS/Lloyds, by contrast, risk becoming grey outposts of a 1950s-style Department of Loans.

There are big questions about how they’ll fulfil the Government’s demands to continue lending to homeowners and small businesses at 2007 levels – you might argue it was that sort of lending binge that landed us in the current mess. But it is the ban on paying dividends to ordinary shareholders that has become the first big flashpoint.

The markets are already meting out punishment: shares in the free-wheelers have risen sharply, while those involved in the bailout have plummeted. This is particularly galling for Lloyds TSB, whose chief attraction to investors has long been its generous dividend policy. But the loss of dividends may also have a big impact on pension funds. Hence the growing revolt in the City.

The Government has signalled it’s prepared to play hardball with the banks. But it could face a rocky ride. As the nationalisation of Northern Rock demonstrated, taking control is the easy part; reconciling conflicting public policy and shareholder value objectives is far more difficult.

First the good news: Labour is getting better at bailouts. The Bradford & Bingley solution was rather more elegant than the Government’s first stumbling effort with Northern Rock. Even so, we should see Gordon Brown’s decisive action to restore confidence in the banking system for what it really is: a number of unrelated knee-jerk reactions that have so far failed to work.

The ban on short-selling financial stocks hasn’t stopped share prices tumbling: and the Bank of England’s co-ordinated action with other central banks to pump hundreds of billions into the money markets hasn’t tempted banks to start lending to each other again. Hence the call for a concerted government plan to restore stability.

Banks, it is said, are only as safe as the ability of home governments to bail them out. Markets have deemed Ireland’s banks so unsafe that the government there has had to guarantee their deposits. Might Britain be forced to follow suit?

In the aftermath of Northern Rock, the Government gave an implicit assurance savers in all British banks could rest easy, even if their deposits exceeded the £35,000 guaranteed by the Financial Services Compensation Scheme. But that is a long way short of the explicit guarantee now provided in Ireland – and the recent move to raise the figure to £50,000 doesn’t alter that.

Britain’s retail banks will certainly put pressure on the Government to follow Ireland, not least because they rightly complain that the Irish guarantee puts them at a competitive disadvantage.

And a guarantee would prevent the sort of run on the bank that forced the Government to act to rescue B&B. It would also reduce the risk that a fall in a bank’s share price could trigger a self-fulfilling crisis of confidence.

Perhaps the most radical idea to be floated is that the Government should underwrite substantial rights issues to recapitalise the banking sector – a move that could easily lead to partial nationalisation.

The idea has the advantage of directly addressing the shortfall in banks’ capital. Its disadvantage is that it would oblige the Government to make tough choices about which banks are worth supporting and which are not – although there’s a certain Darwinian appeal in ensuring that the strong survive while the weak are allowed to die.

Whatever happens, it’s crucial the Government leaves the market enough room to decide for itself who the eventual winners and losers will be.