Still sore.

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Where the U.K.'s Bank Bailout Went Wrong

Leonid Bershidsky is a Bloomberg View columnist. He was the founding editor of the Russian business daily Vedomosti and founded the opinion website Slon.ru.
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The price at which the U.K. government has sold a stake in the nationalized Royal Bank of Scotland suggests it will lose money on the bank bailout it constructed at the height of the financial crisis, something the U.S. has managed to avoid. At the time, though, Britain's toughness on rogue bankers was praised and the leniency of the U.S. -- which didn't fully nationalize any big banks -- was condemned. 

So who was right? Here's the math.

The U.K. government, which owned 78.3 percent of RBS following its 2008 bailout, has just sold 5.4 percent of the bank for $3.3 billion. That values RBS at $66.1 billion and the remaining government stake at $44.5 billion. Yet British taxpayers poured $71 billion into RBS, making a net loss.

The U.K. did better nationalizing a 41 percent stake in Lloyds Banking Group, which had been allowed to buy distressed Halifax Bank of Scotland, and two other banks -- Northern Rock, and Bradford & Bingley. The U.K. plowed $32 billion into the bank at today's exchange rate and has so far recouped $21 billion through gradual selloffs that brought the nationalized stake down to 15 percent. That stake is now worth about $13.8 billion, so on paper, the British taxpayer is better off.

Of course, these figures only refer to the nominal cost of the stakes that British taxpayers bought in the two banks, and not the financing costs of the investments. The National Audit Office explained last year that the cost of funding the Lloyds bailout had not been recouped. And overall, the British taxpayer faces a net pure loss on the collective sale of the two banks: It is at this point unlikely that all of the government's initial cash outlay of $190 billion at today's exchange rate will be recovered.

The U.S. government, by contrast, actually made a small profit (again, ignoring funding and opportunity cost) on its Troubled Asset Relief Program, or TARP. It invested $426.4 billion and recovered $441.7 billion by the time the bailout program shut down late last year. Only a handful of small banks haven't yet paid back about $700 million in government assistance.

At the time the two bailouts were hastily put together, the British one was praised for its decisiveness. Economist Paul Krugman wrote in The New York Times that the Labour government of Gordon Brown had "shown itself willing to think clearly about the financial crisis, and act quickly on its conclusions." He criticized U.S. Treasury Secretary Henry Paulson for his slowness to embrace bank nationalization.

The U.S. did eventually inject capital into 707 banks, but in exchange for noncontrolling stakes and without replacing the banks' managers. The biggest recipients of such aid -- the likes of Goldman Sachs, JP Morgan Chase and Morgan Stanley -- felt humiliated and hastened to exit the so-called Capital Purchase Program, part of TARP, paying back the taxpayer funds and dividends. By the end of 2009, only small community banks, held to stricter standards, remained in the CPP (stakes in these banks were later auctioned off, mainly to private funds).

The U.K. approach was more stringent. At RBS, the government has changed chief executives twice since the bailout as it tried to beat the lender into shape. In the three months to the end of June, the bank showed a profit of $457 million, yet this turnaround took more than six years to materialize. The U.S. had no taste for such experiments and has better results to show for its seemingly more hands-off approach.

Of course, the hole RBS dug for itself by buying the Dutch lender ABN Amro just before the crash -- at the time the biggest bank takeover on record -- was especially large. And the U.S. approach may not have been available to the U.K. Still, in a paper published late last year, Pepper Culpepper of the European University Institute and Raphael Reinke of the University of Zurich argued that the U.S. bailout worked better for the taxpayer because the U.S. had more power over its big, solvent banks and it used that power effectively:

Financially strapped banks could not challenge the government in either country. They had to accept whatever policy the government offered, because only with government aid could they have survived. But healthy banks were not dependent on state aid. Healthy banks in Britain were in a better position to resist the state, and they drove a better deal for themselves than did US banks. As a result, the British government absorbed more risk than the U.S. government and lost its taxpayer more money. In effect, the U.K. provided a costless subsidy to its healthy banks, which benefited from the stabilization provided by the bailouts without having to contribute to their cost. In contrast, the U.S. profited from its bank bailout, because it was able to bully healthy large banks such as JP Morgan and Wells Fargo into a collective recapitalization plan.

Paulson, according to Culpepper and Reinke, forced the stronger banks to accept capital injections, as well as the weak ones. Thus, he financed the bailout through cross-subsidies among the banks, extracting some of the upside from the biggest banks when they rebounded.

In the U.K., by contrast, Brown failed to involve solvent HSBC and Barclays in his recapitalization plan, because he thought they had the power to defy the regulators: The U.K. giants were less dependent on domestic business than their U.S. counterparts.

With the benefit of hindsight, the U.S. bailout turned out to be cleverer and less painful for the taxpayer than the U.K. one, even though it seemed at the time to be less harsh on the hated bankers and, as a result, had less popular appeal.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author on this story:
Leonid Bershidsky at lbershidsky@bloomberg.net

To contact the editor on this story:
Marc Champion at mchampion7@bloomberg.net