In the 19th Century bank failures were almost a part of everyday life and yet the Victorian era was one of enormous growth.  Those banks that lent imprudently, or were slow to learn, or those who did not have the “Fear of God” went under.  There was a kind of Darwinian “survival of the fittest” that ensured that the smartest banks adapted, survived and prospered and the slow and the stupid did not.  Walter Bagehot, the great Victorian essayist, wrote that the Bank of England should lend unstintingly to solvent banks, against good collateral and at a high rate of interest.  Today, we have the Bank of England lending unstintingly to our insolvent banks against poor collateral and at a very low rate of interest.  Where have things gone wrong? 

We are now all majority shareholders in RBS plc, with the government owning 58% of this institution and nursing large losses on its holding.  Looking at RBS’s most recently published balance sheet there is little evidence of any fear whatsoever and it is this that led to its bail out.  RBS’s balance sheet totals an amazing £1.8 trillion.  Now, that is an awful lot of zeros and commas when written down, so for many of us it is difficult to appreciate just how big and bloated RBS has become.  The UK’s GDP is around £1.3 trillion, so RBS’s balance sheet is roughly 1.3 times GDP.  Supporting this mountainous balance sheet is “only” £53 billion of shareholders’ capital, or in other words, RBS management have levered their shareholders capital 34 times, making it very vulnerable to a vengeful God or the vagaries of Mr Market, as we have seen.  The other UK banks are not much better. 

The big banks have very little capital and despite government pressure and despite assertions to the contrary, little wish to expand their balance sheets further to irrigate the parched mortgage market or to lend to business.  The government is trying to keep to keep these zombie banks on life support at the taxpayers’ expense and endure a bank led repression that is likely to last many years.  The current process of letting the big banks merge has been likened to letting two drunks prop each other up.  If the old banks were “too large to fail” what use are even larger banks.  What is likely to emerge at the end of this process is a calcified oligopoly of a few large institutions that serve the public poorly.  With no lessons to learn they will almost inevitably have to be bailed out again in 5, 10 or 20 years, rather like a clown stepping repeatedly on a garden rake, and we again will foot the bill. 

Would it not be better to take these insolvent institutions into full public ownership, to protect the depositors, cleanse the bad debts, eliminate the bureaucratic structure and over-paid, fat and complacent bankers.  At the end of the process the banks could be broken-up and a series of small, more vibrant institutions that would have to compete for our custom and not regard their customers as unwelcome distractions.  They would be unencumbered by bad loans and able to lend freely again, hopefully to solvent borrowers against good collateral in the best Bagehot traditions. 

If the banks came into public ownership Gordon Brown may have trouble explaining to HRH The Queen why the royal estate just got bigger by £3 - £4 trillion, but it should be easier following on from Northern Rock and the Bradford & Bingley, which were also taken under the public wing.   

The French economist Jacques Rueff wrote that the “ever present threat of bankruptcy subjected all persons, even the most unwilling, to the harsh law of prices, and made short shrift of those who, through inability or dissipation, had not managed their own interests... to higher interests of the community”[i]. 

With the banks’ bonus culture there was a mentality of “heads I win, tails you lose” that encouraged reckless risk taking that has led to the present sorry state of affairs.  Whilst bankruptcy may be a step too far, wiping out the shareholders and holding the incompetent bankers accountable may go some way to re-instilling the Fear of God into the UK’s banks. 

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And finally... What is the last thing you would normally expect to find at a zebra crossing – a zebra! Well, apparently not if you live in the city of Augsburg in Germany. Police were forced to spend hours chasing four zebras across the streets after they escaped from a visiting circus. After two hours of pursuit, the last of the errant animals was shot with a tranquiliser dart so it could be transported back to the circus. Police stress that no zebra was harmed in the making of this news story.  

Have a good week, 

Peter Sleep

Senior Research Analyst

Seven Investment Management Limited