Darling's gamble over council cash deposits

The Spectator links to an article in the Times which illustrates just what ignorant bunglers our current government comprises. Over the past few days, since the collapse of Icelands's banking system, and the decision of Iceland's government not to honour debts of banks it has nationalised to depositors in Britain, Britain has taken 'tit for tat' measures against Iceland by freezing Icelandic assets in the UK (quite how 'legal' all of this is I've no idea). At the same time the British government has said it will indemnify all British private depositors with failed Icelandic banks, regulated under the UK FSA. However this indemnity excludes corporate deposits and deposits by local councils around the UK. Earlier in the week I heard a figure of GBP1bn for such deposits being mentioned, but this was 'pooh poohed' by some spokespeople as being an exaggeration, but it turns out, now that all the figures are trickling in, to be roughly correct.

Naturally enough councils around the UK are somewhat alarmed at this turn of events, so it seems they are now 'threatening' to withdraw ALL their deposits from private institutions and instead place them in Government securities (aka 'Gilts'). These deposits represent, apparently, TENS OF BILLIONS OF POUNDS and if they carried out their 'threats' would probably cause a 'run' on all banks affected. What's our government going to do, do you think?

A few caveats, however. I think councils which had deposits with these Icelandic banks needs to asks themselves a few questions and to answer those questions honestly. Much has been made in the past few days that they were actively encouraged by the government to invest their funds for the best possible return and they say they were recommended to place some of their funds into these Icelandic banks by their professional investment advisers and in any case they were authorised under UK financial regulations to take deposits here and had good 'credit ratings' from the major ratings agencies. So far, so good; their story would seem to be 'watertight'.

Now comes the other side of this seemingly rosy picture. Apparently the rates on offer by these Icelandic banks were rather higher than many others in the market and at least one council, Brighton and Hove (according to the BBC 6 o'clock news this evening who interviewed someone from that council), thought this sufficiently of concern to withdraw its deposits before the crash. This really high-lights a timeless truth; councils (and indeed private depositors) need to be more honest with themselves and accept that if they place deposits with an institution which is somehow able to pay a significant margin of return above that offered by other deposit-takers then there is usually a reason for this and a part of that reason may be increased risk for depositors. The reason, the only reason, that our disgustingly self-interested government has rushed to indemnify private depositors who have lost out in this collapse is because they represent a great number of votes, councils don't - even if they are managing funds on behalf of those other voters the council-tax payers. I really wish to know how our government is going to wriggle out of this one!

Finally, I have just been watching another interview with the Icelandic prime minister - he has changed his tune somewhat since yesterday. Yesterday he seemed to suggest that the British depositors of Icelandic banks were not his problem, but that of the UK government. Of course I am well aware that Iceland is facing an unprecedented national crisis as it is effectively 'bankrupt', but the realisation that the UK authorities have blocked Icelandic assets in the UK said to be worth around GBP8bn has probably made him re-assess his earlier belligerent reaction and adopt a more cooperative posture because he knows that, whatever the rights and wrongs of what the British have done, he will have to deal with the consequences at least in the short term.

These issues are just a microcosm of some of the 'beggar thy neighbour' actions that governments around the world might begin to take if the world financial system continues to spiral out of control. I tend to doubt that this particular US President any longer has either the domestic or international prestige to calm the markets, any more than our own Prime Minister does (*). We enter this weekend in what is really a very alarming position - I am apprehensive about what the coming week may bring.

(*) And this report indicates the very limited extent of Brown's influence outside his own family - not zero undoubtedly, but pretty close to it.