Has Covid-19 crisis cost the economy more than the 2008 credit crunch?

Craig Johnson charts the striking parallels and key differences between how governments have dealt with the financial and economic ramifications of the global banking crisis and the coronavirus pandemic.

Rebalancing the country’s finances after spending heavily during the pandemic to support the economy is likely to take many years, if the experience of the 2008 financial crisis is anything to go by. Picture: Shutterstock

Wind the clock back to October 2008 and then-chancellor, Labour’s Alistair Darling, unveiled a rescue package to bail out Britain’s banking system in the face of a global financial crisis. Watching over his shoulder was his predecessor, Gordon Brown, just months into his tenure as prime minister.

This article formed part of The Scotsman’s Talking Money magazine. You can view the 2020 emag here >>

Fast-forward to March 2020 and there was an element of history repeating itself. Conservative Chancellor Rishi Sunak – flanked by relatively new Prime Minister Boris Johnson – stood at their Downing Street podiums and announced a series of measures designed to save the British economy in the face of the coronavirus pandemic.

The party colours and the haircuts may have changed, but the similarities were stark – two prime ministers who had yearned for the top job, but on winning the prize were quickly plunged into crisis; two wet-behind-the-ears chancellors who were nevertheless limbering up to open the nation’s chequebook, and two economic crises almost without parallel that threatened to engulf the UK.

At first glance, the initial reactions of the two chancellors to splash the cash share similarities. Yet the responses of Darling and Sunak went on to diverge, in part due to the sheer scale of the task at hand presented by Covid-19, and in part due to the immediate need to tackle the ongoing pandemic.

In 2008, Darling earmarked an eye-watering £1.162 trillion – that’s some £1,162,000 million – to tackle the banking crisis. That support took two distinct forms – cash that taxpayers had to fork out, and guarantees to restore confidence and stop a run on the banks.

The National Audit Office (NAO), the watchdog that monitors UK government spending, has reported that the cash element came to a total of £133 billion. That included buying shares in Royal Bank of Scotland (RBS) and Lloyds Banking Group – which was created through the government-backed shotgun wedding of Halifax Bank of Scotland and Lloyds TSB – lending money to the Financial Services Compensation Scheme and insolvent lenders Dunfermline Building Society,

London Scottish Bank, and to Icelandic banks so that they could repay deposits.

The remaining guarantees peaked at £1.029tn and included underwriting the Bank of England’s special liquidity scheme, introducing the credit guarantee scheme, and creating the asset protection scheme.

However, as the House of Commons report into the bank rescues noted: “Guarantees are promises to repay or compensate investors if they lose their money so that, if all goes well, guarantees don’t cost the UK government.”

Indeed, in 2015, then-Conservative Chancellor, George Osborne, claimed that the UK would make a profit of more than £14bn on bailing out the banks. His prediction hasn’t come to pass… yet.

The 2016 Brexit referendum dented the share price of the banks in which the UK Government still held shares (the government sold its final share of Lloyds in 2017; it still owns about 60 per cent of RBS). The interest payments on the money the Treasury borrowed to fund the bailout also make calculations trickier.

Latest figures from the NAO reveal that the outstanding guarantees have dropped from £1.029tn at their peak to £13.5bn as of 31 March, 2019. The asset protection, credit guarantee and special liquidity schemes ended in 2012.

The remaining guarantees relate to Bradford & Bingley and Northern Rock loan facilities which have not been used.

Most of the cash paid out by the Treasury has also been recouped, with the total owed dropping from £133bn to £20.5bn. Money has flowed back into the coffers thanks to the sale of all its shares in Lloyds, some in RBS, and the “good bank” part of Northern Rock to Virgin

Money in 2011. Repayment of some loans from the “bad bank” part of Northern Rock – rebranded as “UK Asset Resolution” – and money recovered by the administrators of the failed banks also helped.

While the public purse is still sitting on a “loss” of £34bn from the banking crisis, some – if not all – of that cash could be recovered eventually, depending how much money

the Treasury can make by selling the remaining RBS shares it holds and whether any of the remaining guarantees are needed. Only time will tell.

But, as the NAO stated in 2009: “If the support measures had not been put in place, the scale of the economic and social costs if one or more major UK banks had collapsed is

difficult to envision. The support provided to the banks was therefore justified, but the final cost to the taxpayer of the support will not be known for a number of years.”

At first glance, the NAO’s estimate for how much the UK Government has pledged in total to tackle coronavirus – £210bn, “rounded to the nearest £10bn”, at the last count on

7 August – seems a pittance compared with the £1.162tn price tag for the banking crisis.

Yet that is perhaps the wrong comparison. The NAO’s £210bn figure is packed full of real cash costs, and so the £133bn from the cash element of the banking crisis may prove to be the fairer comparison.

Even before Halloween’s announcements, the £210bn Covid price tag so far includes: £39.3bn for the Coronavirus Job Retention Scheme

(furlough – likely to rise significantly after the Chancellor announced its extension to March 2021; £13.4bn for the Self-employed Income Support Scheme; £12.4bn in grants for retailers, hospitality businesses and others hit by the lockdown; £9.4bn for the job retention bonus, which gives employers £1,000 for bringing staff back from furlough; £4bn for personal protective equipment, £5.9bn in universal credit and other social security payments; and £500m for August’s Eat Out to Help Out scheme. Grants, obviously, don’t get repaid.

Guarantees offered to the banks to lend money through the Bounce Back Loan Scheme, Coronavirus Business Interruption Loan Scheme and Coronavirus Large Business Interruption Loan Scheme are already costing the taxpayer – some £5bn of write-offs in the NAO’s data. Then there is loss of income through measures such as the business rates holiday (£11.8bn), the temporary VAT cut for the hospitality industry (£4.1bn), and the temporary English stamp duty cut (£3.8bn).

By the end of the current financial year, the cost to the Treasury could hit anywhere between £263bn and £391bn, according to the Office for Budget Responsibility, the independent watchdog set up to monitor the public purse.

In the same way as the UK’s post-war debt took decades to repay, so too will future generations be faced with the ongoing cost of coronavirus. The knock-on effect of higher taxes and lower spending on public services to meet interest payments on the national debt could be features of life for much of the rest of the century.

Where does all the money come from?

An old-fashioned word describes how the UK government borrows money: “gilts”. A gilt is a government bond – in essence, the buyer lends a set amount of money to the Treasury for a fixed amount of time and receives interest payments called a “coupon”.

Commercial banks, pension providers, sovereign wealth funds and even other states buy gilts. But individual investors can buy them too. Gilts are sold by the UK Government’s Debt Management Office (DMO) and can then be sold on through a secondary market. That’s where the Bank of England comes into play.

Through its quantitative easing (QE) or asset purchase programme, the Bank of England can buy gilts on this secondary market. Back in November 2009, the Bank spent £200bn on QE; by March this year, that figure stood at £645bn, hit £745bn in June, and was extended to £895bn last week.

Buying gilts from commercial banks means those institutions then have more cash to lend to businesses or consumers, helping to keep the economy going in times of crisis. The Bank of England creates digital money to buy the gilts – the practice is common among central banks, including the US Federal Reserve and the European Central Bank.

The Treasury uses taxes or other sources of income to pay the coupon or interest on the gilts. As the Chancellor borrows more and more money by issuing gilts, that interest bill goes up and up.

While interest rates are low, that’s manageable. If rates start to rise, so will the cost of borrowing money. When the gilt reaches “maturity”, it’s time for the UK government to repay the money it has borrowed.

When the economy is booming and there are lots of tax revenues rolling into the Treasury, the Chancellor may choose to repay such borrowing from the nation’s reserves. What is more likely is that the DMO will issue another gilt instead, just like an individual taking out a new loan to pay off an old loan, or a new credit card to transfer debt from an old one.

This article is taken from the November 2020 special report Talking Money which first appeared in The Scotsman newspaper. To receive your free delivered copy please email [email protected]. UK addresses only. Subject to availability.