Author: johnredwood

Mr Cable cannot go on the media without saying something nasty about Northern Rock. Today he was accusing a leading shareholder of “blackmail”, when all the shareholder was doing was poiting out that this is a regulated solvent company according to the FSA and the Bank of England, still trading and with a valuable mortgage portfolio. Mr Cable should stop attacking it, and understand that there are ways to protect the mortgages, the deposits and the taxpayer loans without nationalisation. Any sensible person who cares about the living standards of people in the UK should want a successful outcome to the rescue, and would understand that attacking the current shareholders who still decide the future of this bank is counterproductive.

I am glad there are bids on the table that may offer a way forward. There is also the option of running the bank to ensure the taxpayer is repaid, following agreement on the timing of repayments, without a takeover. I still think the government should set out in public how much money it will advance for how long, so every bidder bids on the same basis, and so the taxpayer can see how his or her interest is going to be protected. The taxpayer also needs reassurance that the government/Bank have taken sufficient security over Northern Rock’s assets to protect the position. If they haven’t so far, they should do so now and publish how much collateral they have for the loans.

The absence of public information over how much the taxpayer has committed. Parliament should be told about this large sum. Those assessing the bids should also want to know that all bidders had bid on the same basis concerning the available public support, and should want confirmation that there are no misunderstandinbgs about how much money is on offer for how long. You cannot value Northern Rock shares today, as Mr Richards the shareholder said on the radio, unless you know how much public money is on offer on what terms.

I asked the Leader of the House today the simple question:

When will the government seek Parliamentary approval for the ??25 billion they have spent so far on Northern Rock, and the ??25 billion they have guaranteed and where did the Treasury and the Bank find the ??25 billion?

This should not be a difficult questions to answer. The Leader of the House is meant to know Parliamentary procedure. Every item opf public spending has to be approved by the House under a vote for an estimate. There was no estimate for Northern Rock when Parliament approved this year’s budget. Clearly the government is either going to have to put through a supplementary estimate for the money, or to seek to argue that it does not have to bother, on the spurious grounds that it hopes to get the spending back.

Clearly also, as the govrnment is already borrowing heavily this year, the money for Northern Rock was either borrowed or came from selling other Bank of England assets.I suspect it was mixture of the two. I suspect there is also a Treasury guarantee to the Bank of England.

It is high time Ministers worked out how they are going to report and control this massive spending, to look as if they know what they are doing. Miss Harman told us that the ledning to Northern Rock was made available, amongst other reasons, to ensure shareholders did not lose money. Has she looked at the share price recently? Wouild she like to apologise for getting that wrong?

On Monday we heard from the Chancellor about Northern Rock. He gave us no figures, but it appears they have already lent ??25 billion of our money to the mortgage bank, and have guaranteed maybe a further ??25 billion. This money is either borrowed, or will have to be borrowed if the guarantees trigger.

Later that day the hapless Chief Secretary to the Treasury came to push through a Bill to give away part of the UK’s rebate on EU contributions – one of Tony Blair’s EU poison pills for Gordon on takeover.

As we have come to expect, the very short Explanatory Memorandum supplied with the even shorter Bill cotained at least three errors, along with an errata sheet. Once again a Labour Minister had failed to supervise papers coming to the House properly.

Andy Burnham wanted to disguise the extent of the giveaway, but had to admit that the gross cost of the EU to the UK over the next seven years, after allowing for the remaining rebate, will be a massive ??70 billion. He and Kitty Ussher, the Economic Secretary to the Treasury, seemed to be find it difficult to grasp that it is the gross amount of our contribution (after rebate) that taxpayers have to pay. The fact that some of the money is subsequently spent in the UK does not mean that money is “free”. It either has to be borrowed and repaid with interest by taxpayers, or paid for from higher taxes in the first place.

So on the same day we saw the governemnt announce ??95 billion of extra borrowing – and more possible for Northern Rock – on just two spending items, the EU and a mortgage bank. They will argue that the EU money is already in their spending figures, but it is a sobering thought that they want to commit ??95 billion of money they do not have to these two causes. If we borrow the ??95 billion at 5% for 20 years that means UK taxpayers will pay ??180 billion, assuming we do not have to borrow the interest payments as well! Let’s hope if they get the money back from Northern Rock they use it to repay some debt.

How dare Mr Darling complain that the odd Conservative tax cut would create a “black hole” when he has two such massive black holes in his own figures.

(If you are interested in the EU contribution debate see the link to my speech in the debate )

Yesterday was a dispiriting sight in the Commons. We saw Lib Dems and Labour arguing over the future of a bank when none of them seemed to understand the first thing about how banking operates. Nor did they seem to understand the complicated banking regulations and company law they have put in place over the last decade.

Cable for the Lib Dems set the terms of the debate in an entirely false way, which unfortunately some in the media have copied. He offered two “solutions” as the only possible options – put NR into administration (i.e. bankrupt it) or nationalise it.

Neither of these courses of action make any sense and should be rejected at this stage.

Of course the government could bankrupt the Rock, if it withdrew its funding and the promise of more cash and if no private sector party stepped in with the offer of the money. That would renege on government promises and might break its loan agreement (we still have not seen what form that takes or what period it covers). It would still require the government to bail out the depositors, unless they reneged on that promise as well. It might prove to be dearer than other options, and would probably lead to law suits against the government by shareholder and other interests who could legitimately complain about the inconsistency of government actions.

The government could push a nationalisaiton bill through the Commons with Lib dem support. Presumably that would offer no compensation to the shareholders. Then the taxpayer would be on risk not just for ??24-25billion of loans and the estimated ??16 billion of remaining deposit guarantees, but for the whole ??100 billion of liabilities on the 2006 balance sheet and any additional ones added since the last year end. The government would then have to make the announcements about sacking the staff that were superfluous to the slimmed down business they would be running, would have to pay all the bills whether the company werre profitable or not, and stand behind all the obligaitons of the company. The government would need to repay the debts outstanding to other city institutions as they fell due. Why would that be good for the taxpayer? What does Alastair Darling know about running a mortgage bank that he cannot share with the external management already in place?

The only sensible course of action from here is to ignore siren pleas for liquidation or nationalisation, and to manage the debt and the deposits rationally like a proper bank manager. The government has not “nationalised” the bank by lending it money. What it needs to do, if it hasn’t already is:

1. Secure sufficient asset cover to guraantee repayment of all its lending to NR whatever happens. If it does not have enough asset cover – and in current conditions you need to take much more than100% cover given the possibiltiy that the value of mortgages will fall – it should do so as a condition for future lending.

2. Set out the repayment schedule it expects, preferably in agreement with NR but if necessary it has to impose one.

3. The shareholders and Directors of NR then have a choice – a) trade their way out of it b) find a bidder for the whole who will meet the repayment schedule or c) start selling the assets off piecemeal to meet the repayment schedule. They and the Regulators tell us they are solvent. That means that the assets cover the liabilities, so selling the assets will enable them to repay the liabilities. The government only wants one quarter of the assets of the business to repay it loans so far, so it should be achievable.

4. The deposit guarantee should continue but the governemnt should replace it as soon as possible by the beefed up general deposit insurance scheme they are working on with the City. If the deposit guarantees trigger the need for more funding the Bank of England should allow for that within its schedule of repayments.

The Directors and shareholders should be given a chance to rescue it by methods a) or b). The timetable should ensure that if they do not do so in reasonable time then method c), an orderly run off, kicks in automatically. That way taxpayers can get our money back without legal actions against the government for precipitating a crisis.

Mr Darling failed to tell us what markets and Parliament needed to know yesterday – how much money has been lent on what terms. The absence of this information runs the danger of creating a false market in the shares. It also means the task of evaluating bids for NR is difficult if not impossible . If bidders do not know how much money is available on what terms, how can they ascribe a sensible value to the company? And how can you compare bids, if bidders have made different assumptions about government generosity?

The BBC today offered two visions of the future for Northern Rock. The first is nationalisation, with the Lib Dems recommending compulsory purchase of the Rock, apparently for nothing, wiping out all the shareholders. The second was another Treasury guarantee, this time to small long term shareholders so they do not lose out if things get worse from here.

Both of these ideas are absurb. The taxpayer already has too large a commitment to Northern Rock, and should not be asked to take on a bigger one. It is not the taxpayers job to own and run a mortgage bank. Nor can the taxpayer decide to subsidise one group of shareholders amongst the wider list of shareholders. The compulsory nationalisation of the bank with no compensation to sharteholders would probably trigger law suits from them claiming their shares still had value. The subsidy to some shareholders might trigger law suits from the others claiming the division was arbitrary and unfair.

The Lib Dem acting Leader has pursued a persistent campaign against the outgoing management of Northern Rock in a way which makes offering impartial advice difficult, and has displayed a lack of knowledge of legal obligations and how banking works. That presumably is why the BBC have him on so often on this subject. His advice would put the taxpayer at risk of legal actions by shareholders and leave the taxpayer with larger problems of how to manage the whole mortgage bank.

People ask what could be done? What should the Conservative position be? I think that is obvious, bearing in mind I would not have started from here, as I recommended pre-emptive action long before the bank experienced the run.

What the Chancellor should do with the Bank of England is treat this lending to Northern Rock as if it were a commercial loan. They must agree with Northern Rock the duration and interest payments, with a schedule of repayments. They must take sufficient security to guraantee that in no forseeable circumstance can the taxpayer lose money, and then force the mortgage bank to manage its way out of the debt to the agreed timetable. If they cannot agree a sensible timetable then they have to impose one which they think the bank should be able to meet. Above all they must have enough security to ensure no taxpayer loss. Then they need to agree all that with Brussels, which may be the most difficult part of the obvious remedy. I assume they got Brussels agreement in the first place to temporary assistance – they now need to define how long is temporary.

The Chancellor has to be careful not to create a false market in Northern Rock shares.

The amount and duration of government lending to the mortgage bank is fundamental to valuing the shares. If this funding is to be there for as long as Northern Rock wants, the company will have one value. If the funding is to be phased down it has another value. If it is to disappear rapidly it has yet another value. In circumstances where the funding is withdrawn quickly the value of the bank then rests on what private sector funding is available at what terms. The differences between these values will be large.

In such circumstances it is vital to avoid a disorderly market in the shares that the government makes a statement tomorrow saying:

1. How much money has been lent to Northerhn Rock so far via the Bank of England?
2. How much more might be lent under the guarantees in place?
3. What time limit if any there is on this arrangement?
4. What if any agreement is there over repayment schedules?
5. Is this funding available to any buyer of Northern Rock, or only to the independent company that first asked for assistance?
6. If funding is available to a buyer of Northern Rock, what will be the requirements concerning repayment by them?

The markets need this information so people can value the shares sensibly. Parliament needs it so we can do our job protecting the taxpayers’ interests. I fear a false market in the shares unless we are told what the government’s position is on these and related matters.

The government has to be very careful in how it handles the Northern Rock situation. This morning on the Today programme there was a call for them to nationalise Northern Rock, offering no compensation to shareholders. That is not an attractive proposition for either taxpayers or the remaining shareholders. It could fall foul of the government’s general duty to be fair to the shareholders of a company it is lending money to and of EU competition rules if they then give the bank favoured access to funding. The shareholders would think they had been robbed, as the market currently ascribes a value to their shares. Taxpayers would be on the hook for the long haul, with a new owner with no expertise at running a mortgage bank and all the problems of nationalised industry control.

The problem has arisen because of the actions of the government so far. The current share price of Northern Rock is based on the continuation of loans from the Bank of England and the deposit protection put in place by the government. Those who think the shares have value must believe either the Bank of England will continue to lend the money for as long as necessary, or that there will be a private sector rescue which will ascribe value to the shares (which also probably requires some continuation of government/Bank of England support). In other words, in the immediate future the value of the shares is heavily influenced by what the government and the Bank do over the financing of Northern Rock. If Northern Rock were capable of refinancing its Bank of England loans in the private sector market it would resumably do so.

If the Bank of England is too generous in its loans and guarantees to Northern Rock, then a private buyer may well emerge who can make money out of the situation, benefitting from the taxpayer support. If the Bank is too severe in removing funding from the mortgage bank before there is a suitable alternative available then it retriggers the problems it has been trying to avert.

So what are the government’s options from here?

The first is the completion of a sale to the private sector that the shareholders accept. The government does have to set out what its position is on how much money will be lent to Northern Rock under new ownership for how long. Presumably the government’s interest in a sale is to reduce both the quantity and duration of the loans it makes to Northern Rock. The Chancellor should make an early statement so we the public and Parliament know, as well as presumably making some statement in the Sale Memorandum drawn up on behalf of Northern Rock shareholders. If a buyer can be found who has the balance sheet strength or the access to funding to repay all the current public loans, that would be ideal.

The second is to agree a schedule of repayments and lending reductions with the new Board of an independent Northern Rock, as they have to believe they can trade themselves out of their problems, and can gradually replace public sector loans with normal market borrowings.

The third is to impose a date for the repayment of some or all of the loans, and leave it to the Board of Northern Rock to decide how they are going to meet this, with or without a takeover or new partners.

It is difficult getting accurate information about this on the media. The BBC this morning told us that the Board of Northern Rock had resigned, and this meant a deal must be imminent otherwise Northern Rock was left without a board. Yet the Times says this morning that two new Non executive Directors joined the Chairman on the Board whilst Mr Applegarth, the outgoing CEO, had agreed to stay on for a further two months to help with the sale process. The Times on this occasion sounds more reliable than the BBC. That news is compatible with the view that there is no immediate deal but that serious negotiations are underway with a view to sell the bank. The deal will still need shareholder approval.

From the taxpayers point of view, we need to to be told why so much of our money has now been committed and how the Chancellor expects to get it back and when.

The immediate questions for him are:

1. Where did the ??25 billion advanced so far by the Bank of England come from?
2. What guarantees/ comfort letter has been issued by the Treasury to the Bank of England to enable it to take on so large a commitment in relation to its own size?
3. How long is the money going to be available to the Northern Rock?
4. How does the government envisage it being repaid?
5. When will there be a loan agreement which we the taxpayers can see, with the security, covenants and repayment schedules that one would expect in a large commercial loan?

It is high time Parliament was told more about this huge taxpayer commitment, now bigger than the annual defence budget.

The Chancellor is ever keen to claim a Tory “black hole” in the Opposition figures for any odd billion needed for a tax cut or a spending improvement. Yesterday when I asked him about the ??23 billion “hole” in his own figures he was unable to answer.When I asked Peter Hain at the end of the debate the government still did not know. Ministers had failed to use the hours of the debate to get properly briefed on this important subject – yet they raised Northern Rock themselves in the Chancellor’s opening remarks.

The Chancellor authorised the Bank of England to make ??23 billion (so far) available to Northern Rock. The Bank of England is a company wholly owned by the Treasury on behalf of taxpayers. It is a relatively small bank, with total equity of just ??1.8 billion, and a total balance sheet of around ??40 billion before the Northern Rock crisis.

I asked the simple question, where did the ??23 billion come from? Which account? How will it be accounted for in the government’s reports to Parliament and the nation?

The answer has to be that the public sector has borrowed the money to lend to Northern Rock. I appreciate they believe they will be repaid it as some point – maybe some of it not for several years according to latest leaks – but in the meantime it is money spent. As the public sector overall has been spending more than it raises in taxes, and as it is heavily in debt, the most likely source of the cash is borrowing. Buying a mortgage portfolio should have the same effect on public spending and borrowing as buying property or vehicles or any other public asset.

It appears from the Banking returns of the Bank of England that there has been some reduction of the other assets on the Bank’s balance sheet to make some room for the Northern Rock loan which helps. But it also appears that the Bank has increased its overall borrowings to help finance this loan, which means public borrowing as a whole has increased. We should be told how we are paying for this special finance. We should be told what guarantees the Treasury has offered the Bank of England to enable it to take such a large loan onto its books, distorting prudent management of risk at the Bank of England.We should expect the Chancellor to know how it was done, as he authorised it. We should expect him to tell us, as he is always urging the commercial banks to be more open about their assets and liabilities. As this is our money at risk we have a right to know. I will go on asking these questions until we get an answer.

Today in the Commons it was the Chancellor’s turn to show he has gained his diploma in Tory bashing from the Ed Balls academy.

Apparently the failure to build Crossrail during the last fifteen years is all down to the Conservatives who were in power for five of the fifteen years. Meanwhile we are told that every policy difference between Conservative and Labour is the cause of a “black hole” in the figures.

Can you create a black hole by saving all that money from abolishing ID cards, or slimming down regional government and quangoes, or cutting the regulatory bureaucracy? And how does that mythical black hole compare with the gaping black hole in this government’s figures, filled by borrowing through the government debt market, borrowing through PFI and PPP, and by offering guarantees to others that are not recorded on the government’s own balance sheet? Ever since Gordon divorced Prudence, this government has run up collosal debts, whilst criticising others for being masters of black holes. This Chancellor has added massively to contingent liabilities by offering ??23 billion of loans to Northern Rock and offering to guarantee the deposits of any bank in trouble.

When in a black hole of his own, the Chancellor should stop digging.

The Chancellor’s contribution to understanding the credit crunch has been lamentable. So far he has told us it is an American problem based on bad mortgage lending in a far away country; that Northern Rock is a one off problem in a mortgage bank which has a good mortgage book; that he wants more transparency about off balance sheet financing; that he thinks banks should not be bailed out for the mistakes they have made with poor loans, and believes there should be a re-pricing of risk.

Let’s look at this in relation to his own actions:

1. Whilst lecturing banks on the need to tighten up lending because there would be no bail outs, he has offered a gurantee on all the deposits in any bank subject to financial problems in the market. Such an offer is without precedent.
2. He has through the Bank of England lent ??23 billion to Northern Rock. Recent sale documents for Northern Rock suggest taxpayers will still be lending ??6 billion to them in 2010.
3. Despite his wish for more transparency and less off balance sheet lending and borrowing, he does not put the full details of the government’s PFI/PPP borrowings onto the government balance sheet, and continues to encourage off balance sheet borrowings by government.
4. He has failed to sort out the muddled responsibilities between Treasury, the Bank and the FSA over banking regulation and money market operations.

What is wrong with his analysis?

1. This is not just a US problem. The Credit crunch in the UK will raise the mortgage failure rate here. The world banking system has bought and sold loans between banks from different countries, so it is a global problem.
2. This is not just a mortgage problem. In the UK there will be the need to write down some loans in the private equity, property and business areas as well as some mortgages. People today in the city are finding it difficult to value a range of differing debt instruments, and the property that is often the security for loans.
3. The US banks have started reporting to the market how much they think they have lost in the credit crunch so far. The UK banks do not report for a while, and are probably pondering how to value some of their assets in this volatile and constrained market. There is no sign that Darling’s call for greater transparency has resulted in any changes to reporting or reporting requirements, so why did he call for it?

Mr Darling should take better advice and understand the nature of the coming problems the banking system, the property sector and financial markets face. Property share prices are anticipating a double figure percentage fall in commercial property values in the UK. Housebuilding shares are warning that the housing market is going to be damaged. Some early indications suggest that other forms of debt are going to be marked down by a significant amount.

Mr Darling should start looking forward, and understand his overall responsbility not just for banking regulaiton but for the money and credit markets, as they are heavily influenced by what government and Bank does day to day by way of market operations, and month by month in terms of supplying cash and issuing government bonds. He cannot duck his involvement or responsibility, so he had better start learning how to carry it out. So far his record is poor and full of contradictions. The City’s reputation requires skillful handling by Treaury, Bank and FSA. Over the last 10 years financial and business services in London have been the stellar performers within the UK economy. Mr Darling still needs them to do well.

The danger for him is he allows the crunch to go on for too long, and forces an extreme re-pricing of risk which weakens credit creating institutions too much. If balance sheets are weakened too far by big write downs, then the banking system will be unable to deliver sufficient credit to the market. That will mean fewer jobs, fewer new homes and all that goes with it.