Warning that UK is on brink of depression

Published on Sunday 18 January 2009 21:04

BRITAIN is facing an economic depression, one of Scotland's most prominent businessmen has warned, as the government prepares to announce its last-ditch attempt to shore up confidence in the banking industry.

Sir George Mathewson, a former chairman of the Royal Bank of Scotland and chairman of the Scottish Government's economic advisory council, said that economic conditions would worsen.

He also attacked Gordon Brown and Labour for their key policy moves during the crisis: the VAT cut, recapitalisation of the banks and the 20 billion guarantees of loans to small business.

In his bleak assessment, Sir George said: "Right now it's depression we should be really worried about because that causes real, personal suffering for a lot of people."

Asked if this was a real risk, he said: "Oh yeah, of course it is."

He also warned that injecting more capital into banks would not revive the economy.

"I don't think putting more capital into the banks is going to work," he said. "Capital is a concept, it's not a hard and fixed amount and it depends on various accounting assumptions."

His prediction came as the Prime Minister broke off Middle East peace talks in Egypt to confirm that the government is providing new aid to banks.

Mr Brown said: "What we want to do is see businesses get the money that they need to be able to create jobs and secure investment for the future."

The Prime Minister faces a raft of gloomy economic figures this week. On Wednesday, unemployment figures are expected to show a surge, while GDP statistics due on Friday are expected to confirm that Britain is in the grip of a recession.

However, Sir George urged the government to guarantee all deposits rather than injecting even more money into beleaguered institutions.

His gloomy forecast of a depression was backed up by the respected Ernst & Young Item Club of economists. In a report out today, it warns that this year Britain would suffer its biggest annual economic contraction since 1931.

It also said the recession could turn into a depression without further government action.

Today, the government will unveil several schemes to boost confidence in banks, which saw their shares plunge last week as speculation mounted they were in serious financial trouble.

Alistair Darling, the Chancellor, last night said the package was designed to deal with "blockages" in the system that were preventing the flow of mortgage lending.

"The global credit crunch means there is less money around to lend; we need to deal with that problem," he said.

"It has also meant that, as the downturn has affected America, Asia, Europe, ourselves, we tackle the blockages in the system and make sure the banks can pass on lending to people and businesses who need it."

One element of the deal will be that banks will be offered the chance to have their toxic debts underwritten, in exchange for firm contracts with the government to lend more. Taxpayers will be exposed to risk running to at least tens of billions of pounds.

A separate scheme worth 100 billion to underwrite mortgage-backed securities will also be unveiled. A swap of the government's preference shares for ordinary equity shares will also be offered to banks, paving the way for full nationalisation.

In the 37 billion bail-out three months ago, the government took out preference shares, which carried a charge for banks of 12 per cent.

This forced many institutions to try to repay the interest, restricting the money available for lending. This time banks will be able to swap preference shares held by the government for ordinary shares. This would see the government's stake in RBS rising from 58 per cent to 70 per cent.

If the plan fails, the government will almost certainly be forced to nationalise banks. Treasury sources have indicated the conditions will be stricter, with institutions forced to lend in exchange for taking up the insurance scheme.

ANALYSIS

THE economic verdict of Sir George Mathewson:

&#149 On the bailouts of banks, in which the government underwrote 37 billion three months ago and now plans to underwrite unlimited liabilities:

"Every depositor should be guaranteed ... The government has got this contingent liability anyway and I think that if they guaranteed all depositors, that would stabilise the situation.

"I believe that using more capital is not fundamentally the answer, that's why I go along with the guarantee."

&#149 On the guaranteeing of 20 billion in loans to small businesses, announced recently by Business Secretary Lord Mandelson: "It's very difficult to do (underwriting loans] when you get down to the practicalities of it. Who do you lend to, who do you not lend to? Straight off, you are into a bureaucratic nightmare. I do think it is just very difficult."

&149 On the government's decision to cut VAT by 2.5 per cent for a limited time to encourage consumer spending:

"I think the cut has not worked and I have not spoken to a single person who thought it was a good idea, and that is my own view. What I do think could have been done, perhaps should be done, is target VAT.

"We should zero-VAT, for instance, on house extensions. Building new houses is already zero-VAT-ed; why don't we zero-VAT house extensions currently VAT-ed at 17.5 per cent?"