Monday, January 19, 2009

Blankety Blank Cheque


Of course we'll insure your toxic onions -why not?

Watching the Brown/Darling news conference on their latest massive bank bailout, it was interesting to see how Brown reacted to the Blank Cheque charge. He growled menacingly at ITN's Tom Bradby that he should be "very cautious" about suggesting such things.

Why?

If it isn't true, surely Brown could have simply swatted Bradby away with some chapter and verse. But he couldn't, because the charge is spot on.

For taxpayers, the most worrying bit of of a worrying package is the insurance we'll be providing on the banks' existing holdings of toxic debt (eg see this blog).

We've been trying to access HMT's detailed release on how it's actually going to work, but as per, nothing has yet been made available to mere taxpayers, apart from this sketchy press notice. So we turned to the excellent FT Alphaville, which reproduces what HMT has put out to the people it considers important.

Key points are:

  • Pretty well any asset may be eligible for insurance, including assets denominated in foreign currency - which as we've blogged previously, loads a huge additional layer of risk onto us because our government does not have a foreign currency printing press
  • There is no stated upper limit on how much we'll be insuring
  • For each asset, HMT will somehow make "an assessment... for inclusion on a case-by-case basis... subject to appropriate investigation by the Treasury and its advisers in order to assess the probability of future loss" - bearing in mind that this will be tens of thousands of loans/investments, many of which are so complex nobody has been able to fathom them, and nobody has a clue what future losses may be
  • "In setting the terms under which protection will be offered, the Treasury and its advisers will take into account their estimation of the performance of the assets of the institution to be included in the Scheme. The fee, “first loss” amount to be borne by the institution and residual exposure will be set accordingly." - Translation: we have no idea how much we'll charge, what the "excess" levels will be, or how risk sharing will work

As Alphaville points out, taxpayers are now entering the very business that made mega US insurer AIG go bust:

"The new scheme will effectively do what AIG - and other insurers, like the monolines - did for the banks back in the heady days. That is, provide regulatory capital relief.

Under Basel, banks hold regulatory capital as a cushion against potential losses from their assets. The amount of capital which must be set aside against each asset varies according to those assets’ “risk weightings”: which are calculated according to a host of different models prescribed by the Basel accord. But risk-weightings can be offset by credit risk mitigants: insurance.

...a bank could thus own a security rated BBB but using sufficient hedging - with, in this case, HMT, (but previously, someone like AIG) - treat the security as if it was rated AAA. The difference in risk weightings implied are huge...

As with AIG’s business, in principle, the scheme could be very lucrative... The problem is that modelling the value of most structured credit products is extremely difficult. The Treasury intends to assess submissions on “a case-by-case basis”, which is plainly mad. The most qualified names in finance have had their fingers burned touching CDOs. There’s a danger that the Treasury’s scheme - just like AIG - could be rather a costly capital sump."

A costly capital sump or a blank cheque? In practice, taxpayers will find there's very little difference.

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