We may still be headed for recession. There may still be plenty of bank loans ‘go bad’. But the risk of systemic failure has been eliminated by the largest government bailout in the history of financial markets.
Europe’s governments, including the UK, yesterday committed the astonishing sum of €1.9 trillion to shore up their banking system. Between 10% and 20% is earmarked for direct investment in new capital, mostly in the form of preference shares (the UK’s deal with Royal Bank of Scotland could leave it with 60% of the bank’s capital).
The remainder of the funds, more importantly, provide credit guarantees for inter-bank lending. Governments around the world have already protected depositors. Now they’re protecting banks from each other as well.
If that doesn’t kick-start the inter-bank lending market, nothing will. Banks have been refusing to lend to each other because they’ve been worried about counterparty risk. Now, with government guarantees, there really is nothing to worry about – apart from the solvency of the governments themselves.
For the world’s financial markets, this is undoubtedly good news. For those banks that need to sign up for a rescue package, selling cheap equity and agreeing to have the government as your master won’t mean wonderful returns for existing shareholders. But it’s better than going broke.
And for those, like Macquarie Group, that are well capitalised and have managed to steer clear of the disastrous investments causing their peers so many troubles, the return of functioning credit markets is a godsend. As it is for the thousands of well-managed, conservatively financed businesses dependent on credit markets for their day-to-day operations. Finance directors around the world should sleep a little better tonight.
The rest of us, however, have a little more to worry about. Nothing good is free, so my mother tells me, and the cost of this stupendous bailout will be borne by taxpayers. The main countries involved were already running large budget deficits and the cost of these measures will push them out to truly concerning percentages of GDP – the Financial Times expects UK public sector debt to rise to levels not seen since 1977 when the then Labour Government was forced to borrow from the IMF. Consumers will have to live with higher inflation and we’ll all have to live with the stifling impact of unprecedented government influence in financial markets.
Those, however, are tomorrow’s problems. Today, financial markets will rejoice.
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Forager Funds is a boutique fund manager specialising in a value investing approach. We offer an ASX listed Australian Shares Fund as well as an International Shares Fund both aimed at delivering returns for long term investors.