The Treasury hedge fund

HM Treasury today becomes perhaps the biggest hedge fund in the UK: it is investing £25.5bn in Royal Bank of Scotland shares and £5.7bn in Lloyds shares, financed almost exclusively by borrowing.

It's probably quite good business.

If we're past the nadir for the economy and for bank shares - and that's a fair bet - it's not a bad punt to borrow at an average interest rate of around 3% (by selling new gilt-edged stock with maturities of five years or ten years) to invest in assets with substantial potential upside.

I'm not sure that I'd recommend that the government speculate its way out of its debt problem by taking further stock-market punts, but there is a delicious irony that economic and financial woes caused by banks gearing up their balance sheets in the boom years are being solved by HM Treasury now gearing up the public-sector balance sheet.

Of course, the chancellor would never concede that he's become a hedge-fund manager.

His motive for deploying taxpayers' funds in this way is to shore up these two banks.

Even though the outlook for both of them is way better than it was six months ago, they're still chronically short of capital.

The weakness of RBS is the most terrible indictment of its previous management and board.

Only with the most complex and delicate of financial engineering has it escaped the fate of being 100% nationalised.

Because on top of the £25.5bn of new capital - provided by you, me and 30 million other British taxpayers - the state is also (as I pointed out yesterday) selling it catastrophe insurance through the revised Government Asset Protection Scheme (Gaps) and promising to inject a further £8bn of capital were there to be a further calamity of biblical proportions for the banks.

Here's how to see all this: Royal Bank is being forced to raise sufficient capital to protect itself against the losses that are most likely to materialise over the coming few years; and it has a contingency plan just in case the worst were to happen.

As for Lloyds, it too became perilously fragile - although compared to poor old RBS, it looks a model of prudence.

Lloyds' requirement for £21bn of additional capital is one of the great humiliations in the history of banking.

But the bank has retained, perhaps, just a scintilla of dignity, since it is raising most of this capital from the private sector, rather than from taxpayers.

Here's what may strike a few of you as odd: Lloyds is paying a staggering, unprecedented, reputation-destroying £2.5bn fee to the Treasury for being propped up by the state over the past few months; and (like the management of RBS) the executive management of Lloyds' board has only agreed to defer their bonuses for their performance during the past appalling year until 2012.

To be clear, it was the current top team at Lloyds that (unlike their opposite numbers at Royal Bank) were the architects of the bank's woes. Which is why some might say that cancelling bonuses would perhaps be more appropriate than postponing them.