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UK Embraces Moral Hazard


Royal Bank of Scotland investment is clear conflict of interest.

When I read that the UK government was going to invest in equity to prop up its banks, I thought "Finally, someone gets it!"

But that was only for a moment last week: After reading the details of the UK's "investment" into Royal Bank of Scotland (RBS), I must officially retract all of the nice things I said about Gordon Brown.

Buying £5 billion worth in preference shares while "underwriting" the public offering of £10 billion in ordinary shares is, to me, the moral equivalent of flying first-class while trying to sell seats in coach - and for the highest price! (But at least it helps explain PM Brown's comments this morning that the UK government's purchase of equity will be "temporary and profitable.")

With governments around the world now likely to follow in the UK's footsteps, private investors would be wise to recognize that we now have public entities in the underwriting business. And, as anyone on Wall Street will tell you, underwriters only make money if prices rise.

That no one seems to see the UK government's conflict of interest is truly remarkable.

While we may have seen a bottom last week, the bottom will come when governments buy bank common stock - not trying to turn a quick profit, but expecting to lose money.
No positions in stocks mentioned.
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