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Tales From The Front Line

May 1, 2009

Tales From The Front Line

Few in the financial services industry will mourn the end of 2008, which will rank as its most tumultuous year certainly since 1974, or perhaps even 1931. Few wise men (or women) would dare predict how the year ahead will shape up.

One thing seems for sure, however. The gloss on the Prime Minister’s much-vaunted global recapitalisation of the banks is already wearing off.

As much as Gordon Brown has relished his portrayal as a grand Keynesian economic genius whose lead the United States and Europe follow, the political weather may be about to turn stormy for our Prime Minister. In his international showboating, he has sought to take the credit for the government’s display of apparently bold and swift action to save the nation’s economy. Household name banks have been provided with an injection of cash so colossal that the UK’s already spiralling levels of debt seem like small change, allowing the Prime Minister to continue the conceit that he has been a steady hand on the economic tiller for the past debt-laden decade. No doubt he will try to elaborate a similar fantasy when the wheels come off the recapitalisation plan. The banks will offer a ready scapegoat.

For now as fear stalks the land, people are understandably desperate to believe the government has the answers. Indeed back in November I wrote here that the broader economic crisis had not yet bitten and people viewed the implosion of the financial sector as a problem that had been contained. But sentiment is changing swiftly and in painting himself as an all-powerful global saviour, Gordon Brown will surely find it ever harder to escape blame when the fear turns to pain and then to anger. Now that the season of goodwill is behind us, harsh reality will assert itself. It will not be a pretty sight.

With a residential population of just under 70 000 but with a daily workforce close on one million, my constituency mailbag is filled every week with ever more letters from increasingly alarmed business folk. Most seem to boil down to the same question: given that the government has poured billions into propping up the banks, why will no one lend to my otherwise viable small business which is unable to access credit?

The first indication that the credit crunch would extend beyond inter-bank lending came a couple of months ago when a former lawyer at a leading international firm wrote to me outlining the problems he was having setting up a new solicitors’ practice in the constituency. Despite fulfilling the criteria, he found it impossible to get a quotation for professional indemnity insurance. He could only suppose it was due to a lack of available capital in the insurance market and wrote, ‘The Prime Minister has, to date, focused on the transparent costs of the credit crunch that fall on small businesses…it seems, however, little has been done to address the less transparent costs of the credit crunch on SMEs. I am told by my broker that the insurer has ‘lost its appetite’ for property-related risk. Very quickly, then, what was once a viable business could become unviable.’

Another company in the constituency informed me that under the DTI Small Firm Loan Guarantee Scheme they were given a loan of £50 000 of which they had spent £10 000. They requested that Lloyds TSB defer the capital repayments on the loan to maintain enough working capital for the business. The bank had refused, saying they were bound by the terms of the DTI guarantee. The letter concluded, ‘The rhetoric the government is feeding us is not backed by any support in reality despite the billions of taxpayers’ pounds served up to rescue the banks without our electoral consent’.

Another long-standing small business said ‘Despite the massive efforts by the government to refinance the banks and to encourage a return to normal commercial practice, the facts on the ground remain dire, putting the life of our company at risk. In the past months we have seen our overdraft facilities cancelled, all merchant services provided by our bank subjected to huge cost increases and a strict refusal to envisage new terms for short-term loans or overdraft facilities. Ours is a seasonal business – without some financial flexibility, our cashflow fluctuations can quickly lead to difficulties’.

I could provide further examples. In the meantime, rather curiously, a resident wrote to tell me that on going to his now partly-nationalised bank, he was offered a loan out of the blue and unsolicited of £27 000. He pondered whether the banks were seeking good risk customers to lend to in an attempt to appear to meet the government’s aims without involving themselves in intrinsically riskier loans to small business.

I suspect he is right and small wonder when one looks at the perverse incentives contained in the recapitalisation package. The banks are absolutely desperate to run down the capital they have been encouraged to take from the government as quickly as possible. Whereas the US Treasury has lent money to its banks at an interest rate of 5% and in Germany at between 5.5% and 8.5%, the British government demands a 12% coupon on its preference shares. As Eric Daniels, Chief Executive of Lloyds TSB said, ‘In the case of the UK, the recapitalisation was done on pretty punitive terms, and what that does is it can cause the wrong behaviours’.

As the banks see it, the quickest and simplest way of reducing the size of its balance sheet and repaying the government is to stop lending new money. In the meantime, the government demands that lending continues to SMEs at rates far more favourable than those it has imposed upon the banks. Simultaneously it orders them to shore up their own balance sheets and buy government bonds to equip themselves better for future crises (and, conveniently, to fund the swelling national debt). To accuse the government of sending out mixed messages is an understatement.

Unfortunately the banks, all too aware of their grim public profile, are wary of publicly saying anything of their reservations. Speaking to a representative of RBS recently, I was told that the banks are prepared to act as fall guys in the short-term, but they are not fools: they realise that this narrative enables the government to deflect criticism for its own policy failures. For UK Plc this can only end in tears. It is not simply that confidence in our financial institutions has been shaken to its core – in truth, trust has been shattered and this will take a long time to restore.

In the year ahead we may well discover that our bashful, activist government has conjured up a fantastical rescue plan that has not only come at colossal cost to future generations of taxpayers but may not work on the ground. For the time being, the public has placed a conditional trust in the Prime Minister as someone who can best make sense of a fast moving and bewildering financial catastrophe. But be in no doubt. Before this year gets much older the public’s fright and apprehension will turn to real pain and anger. The real question then will be whether trust will be corroded more in government or the workings of a free market economy. Neither outcome makes for a cheery prospect for the year ahead.