Blogging from the Highlands of Scotland
'From fanaticism to barbarism is only one step' - Diderot

Saturday, 19 January 2008

Government attempts 'smoke and mirrors' solution for Northern Rock

Northern Rock is a mess - everyone knows this and no private buyer has yet been found that is mad enough to take this huge problem off the Government's hands - it has committed about GBP26bn (USD51bn approx) in loans. Let us be quite clear that loans represent money out the door. It is gone. If a borrower is sound, one will probably get it back, but let us not forget that the borrower in this case is Northern Rock; servicing the loans at a relatively punitive rate of interest, which Northern Rock is currently managing to do, is not equivalent to saying it is capable of paying them back - it is obviously not in a position to do this anytime soon, if ever. In addition to the loans, the government has issued guarantees so that the total government commitment (i.e. the taxpayer's ) is about GBP55bn (USD107bn).

Now we are told that the Government (i.e. Prime Minister Gordon Brown) is looking favourably on a proposal by Goldman Sachs effectively to securitise the loans by issuing government bonds and, legally, avoid 'nationalising' Northern Rock, so permitting the rump of the business to be sold to a private buyer. However, the bonds issued would be on the public balance sheet and be an additonal government (i.e. taxpayer) liability - no liability for repayment of these bonds will be assumed by any private buyer of Northern Rock. In effect, if not legally, the government is considering writing-off the loans it has provided to Northern Rock. It is theoretically possible that these loans might be repaid in part or even fully, but if so this will take many, many years; it will be a problem for whichever government takes over from the present shower of incompetents - and the ones after that, too. Not to mention the British taxpayer!

Undoubtedly the guarantees given by the government already to secure Northern Rock's continuing ability to operate will have to remain in place for the time being, too. We have no indication at present about which liabilities, if any, of Northern Rock that a private purchaser of the bank would assume in place of the government - my impression is that they would assume very little of any liabilities other than those which their own 'due diligence' teams state are covered by the existing mortgages (which we are told are generally well performing) altough in the case of a 'fire sale (which, let's be frank, this will be) I think one can be fairly certain that the private buyer's credit controllers will be pretty strict about what part of Northern Rock's existing loan/mortgage book they are willing to accept as collateral for liabilities they are asked to assume. In any case, if the government is to retain the collateral of Northern Rock's loan/mortgage book to allow the fiction to continue that the loans to it might one day be recovered, then the loan/mortgage book obviously won't be available to any private buyer to set against any liabilities it might otherwise assume.

Given the conditions which existed in September 2007 I do not quarrel with the comments of Chancellor Alistair Darling last week that urgent and drastic action had to be taken then to prevent the possibility (the likelihood?) that the troubles which had hit Northern Rock would spread to other financial institutions and to the wider economy. However that begs a very large question. It is very arguable that Northern Rock was only able to get into the position it did (borrowing short in the money markets, lending long in the mortgage market) because of the dilution in responsinility for the conrol of the financial sector which his boss, Prime Minister Gordon Brown, engineered as Chancellor soon after Labour came to power in 1997. The 'spin' now is that issuance of bonds will somehow clear the way for a private sale of Northern Rock and obviate its nationalisation, the 'spin' then was that the Bank of England was being granted automony by the government to regulate the economy by being given power to set interest rates (or at least that governing the rate used for loans given under 'lender of last resort' terms) without government interference, but less stressed (i.e. not stressed at all) was the removal of most of the Bank of England's role as regulator of the financial sector. In retrospect this was a calamitous decision and the responsibility for it rests soley with Gordon Brown.

The latest 'spin' is a desperate measure on the part of the government, and Prime Minister Gordon Brown, to avoid having to nationalise Northern Rock by concocting a mechanism which will persuade a private buyer to take over management of the bank. However, let no one be under any illusion that all the troublesome parts of Northern Rock's balance sheet will not remain as a public liability for years to come.

As the BBC's financial editor Robert Peston observes quite correctly:

In this game of chicken, by signalling how reluctant he is to push the nationalisation button, it was the Prime Minister who blinked this weekend – and the hedge funds may well be feeling pretty chipper.

The hedge funds, to recapitulate, are shareholders to the extent of about 18 per cent in Northern Rock who last week were, in the 'spin' at the time, defeated in their efforts to have resolutions passed at the EGM held then to restrict the powers of the Board of Directors to dispose of assets, to issue new shares or to acquire new assets. The defeat for the hedge funds, and all shareholders, last week needs to be seen in the light of the latest evidence of the government's reluctance to go for the nationalisation 'nuclear option'.

As a minor shareholder in Northern Rock myself I long ago gave up any hope of getting much (or anything) back from my investment and whilst I cannot pretend I am happy aobut this I accept it as a part of the risk I take in holding shares - as the caveat emptor phrase always states: "the value of your shares can go down as well as up".

Although Gordon Brown and his cohorts are presenting their latest 'spin' as some kind of solution to the Northern Rock crisis it is in reality nothing of the kind. It is merely an acceptance forced upon them of the harsh realities of the market. They hold an asset on the nation's behalf (the value of the loans granted to prevent the bank's collapse) which no private buyer wishes to acquire except under the most stringent conditons. The government has, however much it may puff and blow, been forced to accept that its, and our, commitment will have to continue for the forseeable future. That is the real meaning of the latest proposals.

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