Between Northern Rock and the hard place of the money markets.

The authorities stumbled forwards yesterday as they sought to tackle the twin and related crises of Northern Rock and broken money markets.

The 25 basis point (0.25%) off the MPC interest rate was a belated and hesitant step in the right direction. It just goes to show if we all shout loudly enough at our so-called independent MPC they throw their economic essays out of the window, eat the words of their recent speeches, and change their minds. We need to do it more often.

Cutting interest rates on its own is not going to correct all the damage to bank balance sheets that the MPC and the regulators have done,but it does help begin the repair job needed. It means fewer people defaulting, which in turn means a better value in the market for packages of loans, which in turn gives stressed banks another option to raise cash.

The government should now tell the international community it cannot press on with the Basel II regulations, which compound the folly of encouraging banks to take on off balance sheet instruments which lie behind the current international banking difficulties.

The arrival of the Olivant bid for Northern Rock has perked up some of the shareholders, who think it offers better value for them than the Virgin bid. It means there is now some healthy competition to take over the distressed bank.

The tragedy is the failure of the government to use this situation to get a better deal for the taxpayers. According to today’s media accounts of the rival bids, the improvement in Olivant over Virgin has come in the terms to shareholders, not in the terms to the taxpayer.

The government is making us all pay for its own incompetence. Either it should have set out tough requirements for repayments in advance that all bidders had to hit – tougher than those offered so far, or it had to demand that bidders bid on how much money they could repay how quickly and tell the shareholders that otherwise the government would demand early repayment.

The government has failed in its duties to both taxpayers and Parliament.
It has failed to act as a responsbile bank manager, lending cautiously, taking plenty of security and insisting on repayment timetables.
It has failed to tell Parliament – and the market – what it expects from an owner of Northern Rock.
It has failed to tell Parliament how much it has lent on what basis, or to seek Parliamentary approval for this massive sum.

Putting some fo these mistakes right would still help the government dig itself out of the hole, as well as creating a more orderly market in Northern Rock’s shares and expediting the auction process.

Presumably Virgin now loses its preferred bidder status, unless that had some legal force we have not been told about.

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2 Comments

  1. Posted December 7, 2007 at 11:10 am | Permalink

    I can just see the government's position getter weaker and weaker as times goes on, to the point where they just palm off Northern Rock in a cut price deal that ultimately costs the taxpayer huge sums of money.

    I think the bidders know the government has a poor bargaining position and will exploit it – which they are perfectly entitled to do.
    http://lettersfromatory.wordpress.com

  2. Tony Makara
    Posted December 7, 2007 at 3:13 pm | Permalink

    John, do you think the 25 point cut was a token gesture to appease prominent critics like yourself or a sign that the MPC will continue to make piecemeal cuts for the immediate future? Also How do you think that stands in relation to the ECB decision to leave rates unchanged and the deferential between Sterling and the Euro?

    Reply: I think the MPC gave into pressure, and will cut again unless the currency falls too far too fast, bank lending picks up and threatens more inflation.

  • About John Redwood


    John Redwood won a free place at Kent College, Canterbury, He graduated from Magdalen College Oxford, has a DPhil and is a fellow of All Souls College. A businessman by background, he has been a director of NM Rothschild merchant bank and chairman of a quoted industrial PLC.

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