Gold News

Competitive Bail-Outs

Anything the US Treasury can do, Ireland can do better. And London, Brussels, Luxembourg...

AS A CASH-RAISING STRATEGY GOES, it certainly beats trying to secure an inter-bank loan or raising cash from the stock market right now.

   "After one of the worst days of trading on the Irish stock market, Ireland's Government granted a sweeping unlimited guarantee on all bank deposits at its six main banks for the next two years," reports The Times here in London.

   "Brian Lenihan, Ireland's finance minister, said he had taken the unprecedented action, which starts immediately, to maintain financial stability after Irish banks' shares collapsed."

   Think of this €400 billion insurance ($560bn) as a "competitive re-capitalization", more akin than you might guess to those "competitive devaluations" that swept the world when global finance last suffered a Great Depression during the early 1930s.

   Back then, national governments fought to squash the exchange-rate value of their own citizen's money, bidding to grab export share and revive their home manufacturing.

   Today, and not quite in contrast, national governments are fighting to squish the risk of collapse amongst their domestic savings and loans – the industry that now matters most – by pumping money into local banks and guaranteeing the security of cash savers.

   The competitive bit? It comes in the cross-border flows that tax-funded bail-outs invite.

   "The Irish pledge to underwrite the country's banking system triggered a flood of cash from British businesses to Irish banks," a senior Irish stockbroker told The Irish Times in Dublin on Wednesday.

   "A spokeswoman for the [UK] Post Office – where savings products are backed by the Bank of Ireland – said there had been an increase in customers since the Irish government's announcement" that it now guarantees all €400 billion ($560bn) of Ireland's bank deposits, reports the BBC.

   Smart move, you'll agree. Monday saw the Irish Stock Exchange drop a massive 12.7% of its value in the market's worst ever one-session plunge. Since guaranteed by the Taoiseach, the capital value of Anglo Irish Bank sank by almost one-half. But then, in poured the savings...and up went the ISEQ, jumping by 8% the next day.

   "We just want the Irish government to look quite closely at the arrangements they are putting in place to make sure they comply with EU competition law," said a British government spokesman on Wednesday. He picked his words as carefully as any man should before throwing stones inside his own glass-house.

   The UK administration was the first to leap in and seize a failed bank when this global crisis first hit in September last year. Saving Northern Rock from itself, finance minister and Westminster-village idiot Alistair Darling also guaranteed the cash savings of every man, woman and child in the nation during what he laughably called the then "current instability in the financial markets."

   Not that the British nation has a great deal on deposit, of course. As BullionVault has noted before, private-sector debts now outweigh the sum total of all cash, bank savings and short-term near-money bonds in the UK economy (the M4 money supply) by a massive 43%. All too literally, the UK Cannot Pay What It Owes; there simply aren't enough pounds in the world, neither as paper or photons.

   But no matter; because in the new global race to bail out biggest and better, government-backed banks provide just the security which frightened cash savers need. Hence the headlines in London.

   "Banks protest at Northern Rock's unfair advantage," reported the Evening Standard in February. "Northern Rock rivals complain of unfair competition," said The Times one month later. Now "Northern Rock cuts mortgage rates as rivals go up," reports the Daily Mail. But why ever not? Cheap mortgages have been government policy since the Tech Stock Crash on both sides of the Anglo-Atlantic. Higher Home-Ownership Rates became a target and tenet of faith just as much in Whitehall as it did in the White House.

   And with interbank lending once again ground to a halt – but with the full weight of tax-payers' funds stood behind them – what's to stop Fannie, Freddie, Northern Rock and all the other government-owned lenders from dominating their markets...pumping out tax-funded loans at politically-friendly rates of interest?

   Never mind the preferred stock owners in Asia and Arabia, now cursing their part in the $200 billion cash raising somehow pulled off by the world's major banks between July 2007 and June '08. Citigroup alone managed to raise $41.7bn amid the frenzy of rights issues, so-called "hybrid" debt (it comes with equity-like rights and thus losses), and sovereign wealth fund injections. Its stock lost two-thirds of its value in the year to mid-summer.

   But even after selling $130bn of its assets over that time, Lehmans Bros still collapsed eight weeks later, taking a big chunk of the $8bn in fresh capital it also raised from investors with it. Once bitten, and no doubt needing to re-capitalize financial firms closer to home, all that Korean, Japanese and petro-fund money will now steer clear of Western banking investments for as long as it takes bankruptcy, bail-outs and state nationalization to stop trumping risk capital.

   In the absence of new financing, then, let's apply this week's Irish Sea cash-flows, along with the UK's domestic inter-bank squabbling, to the very big picture. For isn't such a swift transfer of depositors' cash the best hope for Hank Paulson's $700 billion bail-out of Wall Street...assuring foreign capital that it's safe to return to the States, if only as cash-on-deposit rather than equity, because Uncle Sam is underwriting the banks? Doesn't that risk setting the whole world alight with Irish-style promises, all chasing the same depositors' funds?

   "Everyone knows that a policy of bailouts will increase their number," as former St.Louis Fed president William Poole said in a speech of late 2006. Calamity Poole, however, was only thinking this moral hazard applied inside the domestic United States.

   "Every [US] company, financial or otherwise, knows that if it gets into trouble it is at least worth a major effort to attempt to secure a bailout because there is always a significant probability of success," he explained, as if looking ahead (without seeing) to the $25bn bail-out of Chrysler, Ford and GM.

   The race to rescue, however, has spread far beyond Detroit. Competitive bail-outs are now a globalized game, with tax-payers and savers both set to keep paying.

Adrian Ash

Adrian Ash, BullionVault Gold News

Adrian Ash is director of research at BullionVault, the world-leading physical gold, silver and platinum market for private investors online. Formerly head of editorial at London's top publisher of private-investment advice, he was City correspondent for The Daily Reckoning from 2003 to 2008, and he has now been researching and writing daily analysis of precious metals and the wider financial markets for over 20 years. A frequent guest on BBC radio and television, Adrian is regularly quoted by the Financial Times, MarketWatch and many other respected news outlets, and his views from inside the bullion market have been sought by the Economist magazine, CNBC, Bloomberg, Germany's Handelsblatt and FAZ, plus Italy's Il Sole 24 Ore.

See the full archive of Adrian Ash articles on GoldNews.

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