Darling’s ‘Bad Bank’ Won’t Guarantee U.K. Rebound, Analysts Say

By Gonzalo Vina and Mark Deen

Feb. 4 (Bloomberg) -- Chancellor of the Exchequer Alistair Darling should be careful about adopting proposals to create a “bad bank” because it would trigger a surge in U.K. government borrowing without ensuring lending resumes, economists said.

“The bad bank idea is still suboptimal,” Andrew Clare, professor of finance at Cass Business School in London. “There is no guarantee that it will work, and it will cost several hundred billions of pounds that will go onto the government’s balance sheet.”

Two weeks after pledging credit guarantees to U.K. lenders, Darling is weighing calls for full-scale nationalization of some banks against climbing costs of rescuing the financial system. Creating a state-owned company to take assets off the hands of troubled lenders is one option being studied, he said yesterday.

Before he acted, Darling would first have to identify and price the value of the loans the banks need to purge. JPMorgan Chase & Co. estimates the value of “toxic” assets owned by major U.K. banks at 260 billion pounds ($376 billion), or 22 percent of economic output. Moody’s Investors Service says up to 18 billion pounds in specialist loans must be absorbed.

“The big problem you come up against is how to value those distressed assets,” said Philip Shaw, chief U.K. economist at Investec Securities. “The political barriers to any such scheme might be quite large, especially as unemployment rises and the economy deteriorates.”

The risks for taxpayers are also spiraling. In addition acquiring majority stakes in Royal Bank of Scotland Group Plc and Lloyds Banking Group Plc, Prime Minister Gordon Brown’s administration has nationalized Bradford & Bingley Plc and Northern Rock Plc, two of the nation’s biggest mortgage lenders.

In all, Britain already has shifted about 1 trillion pounds of contingent liabilities from banks onto the government books, a sum that nears the 1.2 trillion-pound value of goods and services produced in the economy each year, according to the Institute for Fiscal Studies.

Brown and Darling are prodding banks into offering more loans to help businesses and households as the economy tips into its first recession since 1991. A bad bank alone won’t make that happen, said Mamoun Tazi, a financial services analyst at MF Global Securities Ltd.

“Just the bad bank itself will not be enough for banks to start lending,” Tazi said. “You do this as part of other measures. You provide the framework for things to recover slowly and for lending to come back.”

For now, the Treasury is watching the impact of its existing loan insurance plan that was announced on Jan. 19. It’s negotiating with banks about the terms of those loans and what securities it will cover.

“There is the whole question how you deal with toxic assets,” Darling told the House of Lords Economic Affairs Committee yesterday. “We have set up an insurance scheme and we have certainly not closed the door on a bad bank scheme. You do need a range of options.”

The U.K. is not alone in wrestling with how to fix the financial system. In Germany, Chancellor Angela Merkel and her coalition partners are split over the nationalization of Hypo Real Estate Holding AG. President Barack Obama’s administration in the U.S. “appears to be tying itself in knots” to avoid nationalization, economist Paul Krugman said this week.

Senator Charles Schumer said yesterday the U.S. Treasury should provide guarantees for toxic assets, rather than set up a bad bank to purchase them.

Even so, Brown faces growing pressure to make his next move as the U.K.’s recession deepens and his own popularity ratings slide. Brown said the government “soon” will announce its plans to tighten regulation of the banking industry, which is supervised by the Financial Services Authority.

“This confusion over such a sensitive area of policy gives the impression that the government doesn’t know what it is doing and risks further undermining confidence,” said George Osborne, a Conservative lawmaker who speaks on finance.

To contact the reporters on this story: Gonazalo Vina in London at gvina@bloomberg.net; Mark Deen in London at markdeen@bloomberg.net