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Monday, 24 August 2009

Counting the cost of plugging the gap

One of the great myths surrounding black Wednesday is that the Conservative government lost tens of billions of pounds in the affair. Sure enough they sold tens of billions of foreign currency reserves, buying back sterling in an effort to support the currency to keep it within ERM limits. The government lossed money as the value of the sterling fell a few percent through the ERM limits, but the amounts actually lost were a few per cent on tens of billions, which puts the losses into the range of hundreds of millions. Arguably, most of the losses were made up in the next few weeks, although it depends at what point in time you start to measure the loss.

Compare that with the more recent performance of governments taking stakes in banks. We shall ignore the total privatisations of the likes of Bradford & Bingley and Northern Rock and look at where governments have taken less than 100% stakes to stabilise the banks.

In these cases, the banks were not necessarily at imminent risk of insolvency, but governments had stipulated that the banks needed to raise more Tier 1 equity to operate within prudential banking limits complying with Basel capital adequacy criteria, particularly in the light of expected write-offs, changes in accounting rules to bring securtised assets back on balance sheet and changes to Basel II criteria that would allocate higher risk to highly rated and structured assets.

All in all, buying bank equity in these circumstances would look like a favourable thing for governments. After all as regulator, they hold many of the cards and should have a good understanding of the remaining risks in the banks. And so it turned out in the main.

First of all we have the Swiss government, which sold its 9 per cent UBS stake for a SFr1.2 billion profit last week, no doubt helped by the resolution of UBS' dispute with the US government over the bank's assistance of US tax evasion, in which the Swiss government took a very active role.

In the same vein, the US government holds an unrealised profit of nearly $11 billion on a 34% interest in Citigroup.

In July the US government converted $25bn of preferred stock into 7 billion shares of common equity at $3.25 a share. The share price has increased by $1.55.

Elsewhere, total losses in the UK, Germany, Belgium, Luxembourg and France offset the US and Swiss gains. Germany is sitting on only a small loss on its stake in Commerzbank, and a much larger loss on its stake in Hypo Real Estate, while the Belgian, Luxembourg and French governments are sharing a $3.2 billion loss on their joint $9 billion investment in Dexia, which looks bad, but as most of the bank's borrowers are municipal entities in those countries, the loss is perhaps inevitable.

But the biggest losses, $5.5 billion, relate to the UK government’s 43% stake in Lloyds and 70% stake in RBS respectively, despite the rrecent rises in the stock market. At the end of June, the the government was sitting on a paper loss of $11 billion. That figure was the difference between the market price at the time and the lowest price that the government could extract six months earlier from the banks on behalf of the taxpayer, notwithstanding that the UK government held all the cards with a gun pointed at the heads of the bankers.

The $11 billion loss far outstrips anything that occurred on Black Wednesday, and if that doesn't sound incompetent, just remember that the US government managed to make a 50% profit on their stake in Citigroup in a few weeks.

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