UK bail-out deal announced – and FTSE 100 drops sharply

The actions just announced by Chancellor, Alastair Darling, include:

• Response to the liquidity problem – making available £200 billion from the Bank of England for immediate short term borrowing by banks and building societies. Half of this is new money, as the existing Special Liquidity Scheme – allowing banks to exchange their mortgages for Treasury bills (like cash) will be raised from its 100 billion limit to the new £200 million limit. This provision reassures banks on their funding for the next two years.
• The bail-out – making funds available (about £50 billion) for state investment in the UK’s eight largest banks and building societies – Abbey, Barclays, HBOS, HSBC, Lloyds TSB, Nationwide Building Society, Royal Bank of Scotland and Standard Chartered. The government has made it clear that other banks and building societies may apply for inclusion in the scheme. In return, banks in receipt of the funds will accept restrictions on executive pay and dividends for shareholders.
• The taxpayer stake – receiving preference shares in those institution in return for funding – this is the partial nationalisation we’ve talked about before
• Freeing up the ‘wholesale’ money market – applying a £250 billion fund to guarantee the money that banks borrow from other banks and financial institutions – for up to three years and for a fee. This is a crucial part of the deal as it lets banks refinance their bonds and borrowings over their remaining maturity period of two to three years

For Scotland, the guarantee of bank-to-bank lending is particularly good news for HBOS – and should smooth the way for its takeover by Lloyds TSB. It’s not been clear how HBOS was going to repay holders of its mortgage-backed bonds.

Possibly crucially, there has been no mention of a cut in interest rates or a full guarantee for bank deposits. A noticeable feature of Gordon Brown’s actions, both as Chancellor and now as First Lord of the Treasury, has been to claw back as much as possible in every move. While this may be careful housekeeping it may limit – dangerously – the positive impact of the headline actions taken.

If this is the case and further announcements introducing these measures are forced from the Government by later events it will open to serious question the strategic judgment of the Prime Minister and the Chancellor, undermining the impact of any additional measures announced.

The package announced is a big one but neither as big as it seems nor a complete one. The next period of time, both in immediate reactions on the stock exchange and in market behaviour over the next week, will tell if it has been enough.

(09.00) The immediate news is not good. The FTSE 100 has fallen sharply – 4.05% – since the Chancellor’s announcement. (10.00) The FTSE is continuing to fall – it has been down to 6% – but banking shares are up.

(09.50) At the ongoing Downing Street Press Conference, the Prime Minister and the Chancellor have just been asked:

• ‘Is it a condition of the state investment in the Royal Bank of Scotland (RBS) that there will be changes to the RBS Board of management, now seen as a discredited?’ Mr Darling’s answer was that such changes would be a matter for the bank. The Government, while taking preference shares in the eight named banks, is not seeking to control the banks.
• ‘What’s Plan B? if this doesn’t work?’ There was no answer from either Gordon Brown or Alastair Darling.
• ‘What sort of limits will you impose on bank executive’s pay?’ The Chancellor’s answer that it would be ridiculous for the Government to decide on the pay of individual executives suggested that this part of the Treasury statement may have teeth more apparent than real – and may not have been intended to be anything else.
• ‘Why has this taken so long? Why didn’t you make this sort of announcement on Monday?’ The Chancellor’s response was that he had always said he would make announcements when he was ready.