Evercore Pan Asset

Many policy makers and commentators are looking for a magic bullet, a single package, a measure which will solve the crisis. They will look in vain.

We need to remember that the UK crises – and the US one – were born of over borrowing. Collectively British people and their government spent too much and earned too little. Collectively they borrowed huge sums from banks and from abroad, to pay for large quantities of imports. Now it is the time of reckoning.

You cannot solve a crisis of borrowing too much by borrowing more. The UK private sector needs more cash – more earnings, more turnover – more than it needs more borrowing. The UK government, borrowing too much when we were apparently doing well, now wishes to borrow unheard of amounts. That just delays the full reckoning a little, and means much higher taxes in the years ahead when the bonds have to be paid back.

The banks, too, were mightily over-borrowed and over-lent. You cannot solve a crisis of too many bad loans in private sector banks by simply transferring the loans or the risk on them to the public sector. In the case of the UK, the banks taken together are too large for the state to bail out comprehensively. Giving them new capital or subsidy merely delays the need to sort out their risky assets, trim back their commitments, cut their costs, and start making some proper profits.

Whenever people propose things that sound crazy because they say we need radical and new measures to tackle the problems of the time you should ask why the normal laws of arithmetic, and commonsense, have been suspended. Why does it suddenly make sense for the state to take on the debts of the banks? How can the state run them better? Why should taxpayers pay for the mistakes? Let’s take the idea of a Bad bank which is surfacing again. In a way the UK already owns three or four bad banks – it has, after all, taken control of RBS, Northern Rock and the assets of Bradford and Bingley, and has a large stake in HBOS. These are bad banks in the sense that they are all coming forward with large write offs or trading losses, and have all needed injections of government capital. These are so large that they stretch the state’s capacity to fund them. Why should we want to create yet another bad bank to take on the difficult assets of the other banks in the system, when those banks seem capable of sustaining themselves in the private sector? There has to be some limit to how much the state takes on, before its own ability to raise money is damaged and it has to pay a higher rate of interest in order to borrow through issuing bonds.

The truth is the banks have to work their way through their positions, reducing the scale of their risks in the most sensible way possible. This may need management change in the case of the banks that are losing large amounts. It does not need nationalisation to do it. Indeed, nationalisation may delay such a necessary process, as politicians would want the banks to do more than just sort themselves out and slim themselves down. How do you sort things out? The banks should close down their overextended positions in financial instruments as opportunity presents. They should net out positions that can be netted out, to de-gear the overall system. Where they have non-performing loans extended to private companies, they should consider debt for equity swaps or delays to interest payments where they think there is a viable long term business that can one day repay with suitable penalties.

There is no quick fix. Swelling the public deficit too much just creates another problem of too much borrowing, which will become a crisis or a major problem at some point in the future. We need some good bankers who can patiently work through the bad debts, doubtful loans and huge positions which their banks have taken. The state should be the lender of last resort, making sure no major bank goes under. It should not be the funder of first choice, subsidising bad practise, bonuses and overextended banking. If a bank needs short-term state lending it should get it, but on terms which protect the taxpayer and encourage them to stand on their own two feet.

At Evercore Pan Asset we have been accumulating some holdings in corporate bonds, and looking to buy Asian equities on bad days in markets. We think the recovery when it comes will be better in the exporting and saving countries, than in the over-borrowed economies struggling to pay back debts and needing to raise taxes to deal with large public deficits. Our worries about a possible government bond bubble in the west, which we voiced towards the end of last year, has spread to other investors, and there has been some increase in US and UK government bonds yields as markets focus on the huge bond issuance needed in the months ahead.