So, panic over, apparently. Gordon Brown saved the world from imminent catastrophe with a £500bn plan to bail out the banks and the markets rallied in relief and admiration. Well, we'll see. It's hard to quibble with what Brown did last week. Faced with the complete collapse of the financial system, it was up to governments to act. And under the circumstances, the plan he came up with is pretty smart. The banks will get ample capital and access to liquidity, making further major bank collapses unlikely, but on sufficiently punitive terms that taxpayers get a degree of protection and shareholders don't get a completely free ride.
Even so, relief should not blind us to the realities of this deal. For a start, it may not end the crisis previous relief rallies have petered out after a few weeks, or even days. More importantly, the fact the state now has such a massive stake in the financial system raises worrying questions for the future. Brown may have bought some short-term stability, but at what long-term cost?
First, this bailout has done nothing to tackle the underlying cause of the crisis: the massive leverage that has built up in the financial system. All it has done is to shift that leverage off bank balance sheets and on to governments. A crisis that was until last week a question of the solvency of banks now becomes an issue of the solvency of governments. We have already seen, in the case of Iceland, what can happen when the markets lose faith in the solvency of states. Similar alarm bells are now sounding over a number of emerging markets, from South Korea to Eastern Europe. Britain itself has one of the highest ratios of bank liabilities to GDP in the world, making it particularly vulnerable to a crisis of confidence.
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The consensus for the moment is that the UK itself can withstand the vast increase in Government borrowing required to fund these bail-outs, even though it is likely to push public-sector debt to GDP up towards the 50% levels that forced the last Labour government go begging to the IMF.
But that presupposes the market has confidence in Britain's published national debt figures, which, due to Brown's financial chicanery are less transparent and more riddled with off-balance sheet liabilities than the most reckless investment bank. It also assumes the Government won't be forced to stump up yet more cash before this crisis is over, or that tax receipts won't fall off a cliff and social-security payments soar as a deep recession starts to bite. Finally, it presupposes that Britain won't be forced to help prevent a domino-effect of failing smaller countries whose collapse could have a devastating effect on UK banks. Britain itself is unlikely to go bust, but if international investors lose faith in sterling, the result will be higher inflation and interest rates and a deeper recession.
Second, all of us should be worried about how the Government will use its new-found influence over large parts of the banking system. I don't doubt the Chancellor, Alistair Darling, when he says he never wanted to take direct stakes in the banks. Nor do I think he is some Communist sleeper who has been waiting 25 years to implement the Labour party's 1983 manifesto commitment to nationalise the banks.
But I take with a pinch of salt Darling's assurances that the Government will let these banks to operate at arm's length. The Government has broken this commitment already with its demands over bonuses for bank bosses and insistence that banks maintain lending to small businesses and homeowners at 2007 levels. The idea that bank bosses, faced with two Government representatives on their board, won't be swayed by political considerations is absurd. So too is the notion that a weak,unpopular Government heading for an election won't make its political objectives known. Apart from the risk of corruption, any hint of political interference will undermine whatever value remains in the franchises.
The third troubling aspect is how this bailout will eventually be unwound. The fact that so many banks around the world are likely to end up in state control means there will need to be lots of international cooperation if they are returned to the private sector in an orderly way. The snag is that governments owe their first loyalty to taxpayers, rather than foreign investors and depositors, and will be tempted to try to engineer some domestic advantage.
We've already seen some nasty outbreaks of financial nationalism in this crisis. Look at the way Lehman Brothers repatriated $8bn from its London operations on the eve of its bankruptcy, leaving its UK creditors with no assets to claim against. Or the way the British Government invoked anti-terror laws to seize the assets of bankrupt Icelandic banks. The risk is that once governments become the leading players in the financial system, international trust will start to break down and globalisation will start to unwind. That would make us all poorer.
Simon Nixon is the author of Credit Crunch: How Safe is Your Money? Priced £5.99,
