It's all about confidence, stupid. Plummeting markets keep the economy the primary concern of voters everywhere, but remedies are a tough sell especially for governments that have been in power too long to blame the current mess on their predecessors.
That was one reason so many Americans regarded Hank Paulson's bailout plan with skepticism. And it's why Britain's Prime Minister Gordon Brown and his Chancellor, Alistair Darling, did not want to dwell Wednesday morning on how Britain's banking sector had got into such a parlous state that the government was compelled to spend up to $88 billion in taxpayers' money to secure it. Their emergency rescue plan was hatched over weeks but finalized in such a hurry that bleary officials labored overnight to finish it before the skittish markets opened. At a morning press conference, both men maintained that the problem started with the U.S. sub-prime crisis; Brown refused to answer questions about how Labour policy over more than 10 years in office might have contributed to the situation. "This is the time to talk about the future," he said.
As he spoke, the future for British banking was looking grim. Behemoths such as HBOS and the Royal Bank of Scotland group had seen their shares fall by 39% and 42% respectively on Tuesday, continuing a trend set at the beginning of the week as the FTSE 100 racked up its biggest fall in 21 years. Last month the government was forced to nationalize the mortgage lender Bradford & Bingley, and earlier this year it took over another debt-ridden bank, Northern Rock, guaranteeing the deposits of retail customers. Britain's protection scheme for private-sector banks guarantees deposits only up to $87,500, causing some jittery savers to look on enviously as some European Union countries announced full protection for all retail accounts.
A number of Britons began moving their money to these apparently safer havens, but that's not what triggered the precipitous slide in bank shares on Oct. 6. Ironically, it was leaking news of the British government's still unfinished rescue plan that caused mayhem in the markets. The government is offering to help banks raise up to $88 billion of new capital, either by buying preference shares in the institutions or encouraging commercial sources to invest. Together with an extension of the Bank of England's special liquidity scheme, which will now make $350 billion available to banks in short-term loans, the package is intended to stabilize the banking system and foster the sector's recovery. It can be implemented without any new legislation or parliamentary votes.
But the scale of the envisaged capital injections indicated how large the government anticipates the holes in banks' balance sheets may actually be. The market is also mulling the impact of the government's stipulation that banks participating in the scheme must restrict executive pay and dividends to other shareholders. The voluntary nature of the scheme is also problematic, says a City fund manager based at an Asian-owned bank. "It would have removed more uncertainty if the government had just applied the plan to the banks across the board," she says. "Now we have to worry about which banks might need to participate, which managements will admit this, and how damaging it will be to admit needing it."
"Remember markets are global," an anxious Treasury official reminded journalists leaving the building after a briefing as word filtered through that the formal announcement of the rescue package had failed to immediately restore optimism in the market. At market close, London's FTSE-100 index had fallen by 5.18%, even though the bailout plan was swiftly followed by coordinated rate cuts in the U.S., Britain and elsewhere. France's CAC 40 closed 6.3% lower on the day, and Germany's DAX lost 5.9%. Certainly, at least some of the downwards momentum was generated the day before by sinking New York shares and rocky rides in other stock markets across the globe. Brown believes elements of the plan he has stewarded for Britain could also be applied in other countries to help to reduce the turbulence buffeting his own economy.
Maybe so; Brown cuts a convincing figure abroad. But he finds it harder back home to win over doubters to a plan that could cost British taxpayers dearly, though he promises they may eventually earn dividends from the investments backed with their own money. Yet the crisis has had a bracing effect. A recent mutiny against his leadership in Labour ranks evaporated after a bold Cabinet reshuffle, and rebels shrank back from a coup attempt at such a tense time. "Who would have dreamed that a financial crisis would have given Labour a lifeline?" former Home Secretary David Blunkett wondered aloud at a drinks reception on London's South Bank, as across the river Treasury officials sweated over the final details of the bank rescue. "Labour is still on the ropes. It just looks different," he concluded. With confidence levels running so low even among Labour grandees, it's not going to be easy to restore confidence in the dealing rooms of the City, or among Britons facing a wrenching change in fortunes.