Iceland on Thames

Just heard that from Will Hutton on Radio 4’s World at One.

When our media were having a go at Iceland in October I said that the UK could well find itself in a similar situation and that, before demanding that Iceland cover UK depositors’ losses, we should consider what impact such a precedent might have on this country. A month or so later, articles in the Times and the International Herald Tribune made the same point. There but for the grace of God…..

And now we discover that 80% of our major banks’ loans were to overseas borrowers. Like Iceland, the UK had become a base for retailers of debt. Our banks simply used depositors’ money to maintain liquidity requirements while they borrowed money in cheap markets and lent it out at higher rates elsewhere.

It’s not often I agree with John Redwood but he is right when he says, “The problem is our banks are bigger than we are,”  although he forgets to mention that his government created the conditions which encouraged Britain’s banks to develop in this way.

To prevent our banks failing and taking the country’s economy down with them, our government is having to underwrite all these loans. Round 2 of the Great British Bank Bailout looks like an open ended commitment as Chancellor Alistair Darling admits that he has no idea how much money will be needed to prevent the banks from collapse.  

So will Britain end up technically bankrupt like Iceland? I guess it’s not often that Peter Oborne and Will Hutton agree either but both think we are facing bankruptcy and a currency crisis. Will Hutton reckons that only membership of the Euro will give financial markets enough confidence in the UK to allow the government to rise the money it needs to cover the bailout.

That said, while the EU economic forecast released today warns of high UK government debt, it also shows that Britain isn’t in a much worse state than the other large European economies. UK debt is currently estimated at 50.1% of GDP and it is forecast to rise to 62.6% in 2009 and 71% in 2010. For Germany, the figures are 65.6%. 69.6% and 72.3%. For France, 67.1%, 69.6% and 72.3%. (See page 47 of the full report.)

Yet the price of insuring UK government debt against default is much higher than that for France and Germany. It may be that, because their economies are so much less reliant on financial services, they are more likely to be able to pay some of this off sooner and are therefore a better risk.

As with Iceland, the UK’s banking sector once powered the country’s economy. Now that same power is dragging the rest of us down in its wake. How far down it will take us only time will tell but when we do finally surface from the deep recession, perhaps we should apply our famous British ingenuity and inventiveness to something other than banking.