Liquidity crisis: Stopping the rot

Last Friday’s protest of the government’s bank bailout plan throws into sharp relief a very legitimate question: why is it that irresponsible banks are receiving tens of billions from the government when ordinary citizens are bearing the brunt of this financial crisis? If you had asked one of the Socialist Party members protesting outside the HBOS headquarters on the Mound, you would have undoubtedly received an answer about how the government should be protecting people’s jobs and homes instead of supporting City fat cats and their corporate greed.

Class warfare aside, this is certainly a question that should be asked in the name of both fiscal responsibility and the welfare of the nation. The economic crisis we face now is unlike anything we have seen in our lifetimes, and the actions we take to resolve it will reverberate for decades. Even those with no interest in finance will have heard about the causes and effects of the sub-prime mortgage crisis and the credit crunch, so I will refrain from repeating the lurid details. In the most concise terms, what we are facing is a rapidly deteriorating lending system that could potentially freeze up without swift and substantial intervention.

The plan put forward by the government consists of three parts: £50 billion for equity stakes in troubled banks, £200 billion for a Special Liquidity Scheme that will help money markets and a further £250 billion that will be available to banks to secure medium-term debt. Out of this potential £500 billion expenditure, only the equity stakes in banks will be financed through taxation, with the rest coming from the Bank of England. The per capita tax bill of this bailout is just over £800.

Why shouldn’t the government let us keep £800 in taxes and use the Treasury’s £450 billion to protect people’s homes and jobs? Though it may sound harsh, the short-term financial difficulties of the citizenry come a distant second to the importance of preserving our banking system. Assume HBOS and RBS are allowed to fail, and the government gives each of us £8,000 with which to pay our mortgages, credit card debt, and so on.

Without these banks, people will be hard-pressed to get loans, mortgages, and credit cards. Foreign companies will leave Britain for countries that were bold enough to ensure the survival of their financial system. British businesses will not be able to get loans; jobs will be cut, homes will be lost. Young people should be especially concerned about preserving the financial system because, as they leave university, the next serious steps in life, such as home ownership, depend entirely on their ability to borrow money.

Proposing that a government handout to individuals is the solution to this financial crisis is both short sighted and dangerous. Like it or not, the foundation of our economic system depends on the ability to borrow money. Without banks, or with severely damaged banks, growth will come to a standstill. Socialist critics might riposte that economic growth is not a necessity; jobs and housing are what people need. Need to survive, yes, but the social and environmental challenges that will arise in the coming years will depend exclusively on the ability of this country to innovate. We must give those with the knowledge and talent to solve these problems the incentive and opportunity to do so.

The short-term rise in welfare from subsidising personal debt pales in comparison to the increase in welfare provided by ensuring the future of the financial system. Worries of moral hazard must be addressed: regulators must ensure the markets are watched with a careful eye, banks must take the responsibility of ensuring their investments are both viable and intelligent and executives must not be enriched with the government’s money. Slowly and surely, the financial system will coalesce. By taking the initiative to bail out banks now, a larger and much more devastating crisis has been avoided.

In the best case, taxpayers might see an increase in the value of their investment. When the United States bailed out banks in the Savings and Loan crisis of the late 1980s, the assets it nationalised returned 80% of the government’s investment when those assets were sold. With any luck, the equity stakes the United Kingdom has taken in its banks will eventually see a similar rise in value.

It is undoubtedly frustrating that the banks that hold much of the responsibility for the current crisis are receiving an injection of government money at a time when ordinary people are losing their jobs and struggling to pay their bills. However, as exasperating as it is, putting our future prosperity and security at stake in the name of teaching the City a lesson is one risk we cannot afford to take.