Open Ended Taxpayer Bank Guarantee

Chancellor Darling has just announced that for the first time in British financial history the taxpayer is giving a 100% guarantee to depositors at a commercial bank. Having failed spectacularly to reassure Northern Rock depositors that he had things under control, he's hit the panic button.

We taxpayers stand to lose some serious money here. But despite that, the authorities have given hardly any information on what they've actually agreed to. As our friend Prof Buiter said this morning:

"We know that the chancellor authorised the Bank to support Northern Rock. But is the support uncapped and open-ended, as Northern Rock informs us? What is the premium? Exactly what collateral will be offered and how will it be priced? Taxpayers’ money is at risk. The chancellor should make public this information and if he does not, parliament should insist."

All good points, and what should bother us even more is what happens if this isn't simply a liquidity issue. What happens if NR's assets turn out to be what the trade describes as "impaired"- ie they're not actually worth what they claim to be worth? How much would we lose?

In an attempt to get some feel for this, I've taken a quick look at NR's balance sheet (see latest annual report here). I rather wish I hadn't.

As at end-2006, NR's assets were valued at £101.1bn, of which £87.3bn comprised loans to customers. The rest largely comprised so-called treasury assets, including its share of exposure to those notorious CDOs (see their emergency trading statement here).

In the event those assets are not worth what they claim, the first losers will be NR's equity investors. The balance sheet tells us that total equity amounts to £3.1bn, so that's our cushion: as long as NR's loans and other assets remain worth at least 97% of their end-2006 valuation, then the bank's creditors- now including us taxpayers- can all get repaid in full. Equity investors are wiped out, but taxpayers remain whole.

But in a world of rising interest rates and falling house prices, how lucky do we feel? A 3% safety margin isn't really very much at all.

Suppose instead those assets suffered an impairment of say 10%. What would happen then? Yup, you've got it- we taxpayers take a 7% loss. A 20% impairment means a 17% loss, etc etc.

Could be very expensive.

And does it end there?

Alliance and Leicester shares have been whacked today, because they are also heavily dependent on wholesale market funding. What if they get into the same difficulties? Will Darling use taxpayers' funds to guarantee their depositors as well?

And what about the other high street banks? These are uncertain and dangerous days- if another bank got into trouble, would Darling act in the same way? Put another way- could he refuse, having now given this unprecedented support to NR depositors?

On the 15th anniversary of Black Wednesday, having specatcularly failed to reassure depositors that things were under control, Darling has been panicked into writing the biggest blank cheque in the history of British banking.

And it's our money.