Toxic debt boon - UK

By Ian Fraser
Published: The Sunday Times
Date: May 10th, 2009
THE UK government should be able to claw back at least of half its forecast budget deficits in 2010-12because of higher-than-expected returns from its ownership of shares in troubled banks and profits from bank bailouts, according to an Edinburgh-based economist.
Robert McDowell, a banking economist and risk-management consultant, said: “The UK and US Treasuries are charging substantial fees and exerting 25-30% haircuts, leaving themselves with more than adequate headroom to generate substantial medium-term profit which, I calculate, will finance both their bank recapitalisations and pay off half of medium term government budget deficits, thus relieving taxpayers of the risk of sharply higher future tax rates.”
The British and American treasuries have been widely slammed for their programmes to purchase or swap billions of pounds of “toxic waste” or “legacy assets” from the banks – including impaired mortgage-backed securities, collateralised debt obligations, credit card bonds and student loans.
However McDowell, who advises banks and sometimes governments and is a contributor to the high-profile www.asymptotix.eu financial risk management blogging site, indicated such criticisms are unjustified.
He believes that, while asset-backed securities (such as RMBS and CMBS) were arguably the cause of the credit crunch, they are also going to play a major part in bringing it to an end.
McDowell has worked out that the government various support schemes for the banking sector – including the special liquidity scheme and the asset protection scheme – will generate a net profit for the UK government of about £185bn, and very possibly more than £200bn, “which is a substantial three-year gain from off-budget financing worth about £900bn currently.”
He said the benefit may all be used as part of the Bank of England’s £150bn quantitative easing scheme authorization for buying in government bonds. This would be the same as paying off a major part of government fiscal borrowing, said McDowell.
He said that if the government is able to book his higher expected profit of £200bn, then it would be able to eradicate some 45% of future budget deficits, on the assumption that these will limb to £175bn in 2009 before falling to £160bn in 2010 and £125bn in 2011.
McDowell added: “Given that long-term interbank funding that UK banks require to finance their funding gaps remains so hard to obtain from private sector sources, we can expect the Bank of England to add several £100bn more to the asset protection scheme during the remainder of this year, which means we can be confident there will be a £200bn three-year gain or more - sufficient to cover half of government budget deficits.”
In his recent budget report Chancellor Alistair Darling said: “Reflecting the principle of transparency, the fiscal forecasts include a provisional estimate for the high end of a range for the net impact of unrealised losses on financial sector interventions, equal to 3½ per cent of GDP.”
The Treasury has forecast the UK’s budget deficit will be 12.4% of GDP in 2009/10, 11.9% in 2010/11 and 9.1% in 2011/12. McDowell said the Chancellor was signaling that about half of the forecast deficit is required to compensate the economy for the banks’ plight and will not need to be spent if the government’s financial sector interventions pay off.
“I know it is hard for taxpayers to understand that their money is not what the government is playing with in its liquidity windows and treasury bills for bank asset swaps,” said McDowell.
“They readily confuse government budget deficits with bank bailouts. The two things are not the same. Government budget deficits are almost entirely fiscal responses merely to recover economic growth, not to recapitalise or restructure the banks directly.”
He said the spate of government bond issuance in recent weeks has been entirely sensible. “There is too much absurd doom-mongering in financial markets,” he added.
An version of this article was published in The Sunday Times under the headline “Toxic debt boon” on May 10th, 2009.