Laughing all the way to the Bank of England

So the banking sector is getting a bail out from the UK taxpayer. 50 big ones – billions of pounds that is.

Now consider the following scenarios:

1) The mortgage debt that the banks are being allowed to exchange for government bonds is not ‘damaged goods’ in any way. It is, and always was, worth substantially all of its value in the banks’ balance sheets before the credit crunch.

2) The mortgage debt that the banks are being allowed to exchange for government bonds is ‘damaged goods’. It is worth substantially less than its value in the banks’ balance sheets before the credit crunch.

Choose a scenario, any scenario. OK, you picked 1). Does the fact that these mortgage assets are unimpaired tell you that in reality the credit crunch was, and is, largely an illusion – in the UK at least? When the banks stopped lending to each other for fear that they wouldn’t get their money back (because the collateral was in danger of disappearing), were they just deluding themselves – and the rest of us paying higher and higher rates to borrow money? And will mortgage rates really come down now that the treasury has stepped in with such an unprecedentedly large slice of public lending?

Right, so scenario 2) looks possible. The mortgage debts really were losing value, widespread negative equity and house repossessions amass were just around the corner (although neither seems to have happened yet, and if they do then we have a chicken and egg situation). So if the banks have bad assets, what does the government think it is doing swapping taxpayers’ money for them? £50bn of taxpayers money. It’s like a ‘get out of jail free’ card for the banks. Invest in poor assets, get bailed out by Mr & Mrs Taxpayer when you have to write them down and no-one will lend you money as a result.

Northern Rock was a shock to the system and the government does not want any more financial blood on its hands (heaven knows it has enough trouble trying to convince people they’re better off now the 10p tax rate has gone). But I fear it has lead to an over-reaction and a rush to intervention in the market place where time, and the return of good old capitalistic common sense, would ultimately have prevailed. The government wants to be seen as the saviour of the lowly mortgage borrower, but its rescue vehicle is a big truck full of dosh from the national coffers.

Somebody’s laughing, and I bet they work in banking.