Author: johnredwood

I am glad to have won the battle against Vince Cable to avoid nationalisation of Northern Rock. I am grateful to the Jeremy Vine programme and the Week In Westminster for giving airtime to the case against nationalisation. Their commonsense and fairness shows up the lamentable performance of the Today programme, the World at One and Pm who gave ample platforms to the pro nationalisation case but refused me the opportunity to explain why it was a bad idea, and to offer a more positive alternative.

In the arguments with editors I was told that my proposals were unlikely to be taken up, whereas nationalisation was the likely outcome. I explained that the government had to come up with something better than nationalisation because nationalisation would have wrecked the borrowing and spending figures. The BBCs flagship programmes as always remained wedded to an old fashioned state solution and to the Lib Dems, so their listeners were not made aware that there was a better way, and were in ignorance that the governments advisers were working on it.

I am pleased this morning that the government has decided to

1. Avoid nationalisation
2. Get some cash back more quickly by selling bonds to replace the loans
3. Seek a new private sector owner
4. Take an equity stake via warrants to give the taxpayer some profit if it recovers well.

What I want to see in addition is

1. Proper banking disciplines enforced to repay the borrowings. Northern Rock still needs an injection of tough banking controls to make it work.
2. A phased withdrawal of the guarantees ?? we dont just want the cash back, we also want to get the taxpayer off risk
3. A fair competition allowing in new bidders ?? as the basis for bidding is now very different from before Christmas. Otherwise there could be legal challenges.

The government needs to:

1. Get a grip on its lending to Northern Rock and set out how and when it will be getting money back from this bank.
2. Remove wasteful and unpopular public spending, like ID cards, regional government, extra contributions to the EU, too many spin doctors and consultancy contracts.
3. Start applying pressure to raise public sector productivity in those areas where we do need spending. Impose a staff freeze on the civil service.
4. Cancel the increase in CGT from 10% to 18%, and leave the new 18% rate in place of 40%.
5. Issue more index linked bonds to finance the remaining deficit, as inflation will come down after this winter’s fuel and food rises.
6.Create an employee ownership scheme for the Post Office and press ahead with its privatisation involving employees.
7. Open the water industry up to competition, to bring prices down and open up new supplies and new investment.
8. Get on with commissioning private sector investment in energy capacity by granting the necessary licenses and planning permission.
9. Introduce more private capital into railways, reuniting track and train in regional private companies.
10. Call a halt to the overregulation of financial services from Brussels, and put through deregulatory legislation which starts to lift the burdens on business.

This programme would at one and the same time

1.Lower prices by using competition to cut monopoly prices
2.Increase investment in infrastructure where we are short of capacity by harnessing private capital
3.Reduce public sepnding
4.Allow lower interest rates as a result of 1 and 3 above.

<p> The idea that Northern Rock loans will be packaged and sold to the private sector is not a solution to the crisis, especially as there will be a government guarantee on them. Instead, this represents a decision by the government to lengthen the period over which it is prepared to lend to Northern Rock.</p>
<p> It means that all interested bidders wanting to buy a share of the action in Northern should; be invited to rebid, as the terms on which they are bidding are now so much better than they were. It appears that a bidder now has the government as its bank manager, guaranteeing substantial lending, for a long time period. This is a much better proposition than the one they sought bids for before Christmas.</p>
<p> No-one writing up the story seems to grasp the importance of adopting the recommendations that readers of this blog know well, recommendations to the government and Bank of England to get a grip as Northerns most important bank managers.</p>
<p> Whether Northern is to be nationalised, sold to a private bidder or remain independent, the need is the same. It is high time the authorities toughened up the terms of their lending to Northern Rock, and set out a timetable for repayment that is demanding but realistic. It should be up to the management to decide if they can repay from trading profits and cash, or if they need to sell assets to meet the demands for money back by the taxpayers.</p>
<p> I find it almost unbelievable that Mr Darling and the Bank should make maybe £55 billion of loans and guarantees available to Northern Rock with no public statement of how long they can have the money for, how the asset cover has been secured, and when the money has to be repaid. All these things should be public because they have such a big impact on public spending, and so bidders can form a proper view of the value and the liquidity of the business. More worrying is the likelihood that there is no private agreement about how and when the loans will be repaid. What private sector banker would ever lend large sums to a distressed company without first asking and answering the questions How and When do I get my money back?</p>
<p> The governments decision to back the “solution” of selling bonds to the private sector to release cash to the government that it has lent to Northern would work well if there were no government guarantee, but the existence of the guarantee keeps the taxpayer on risk. At the very least if they wish to go this route they should look at time limiting the guarantee, or phasing it out.</p>
<p> This could prove to a dear way of avoiding the ruin of nationalisation. Maybe one day the Treasury will wake up and understand that they have a banking problem. The way out is by applying proper banking disciplines to this business, and making the shareholders and directors of Northern Rock confront the simple truth either they trade their way out of the borrowings, or they sell assets to repay the borrowings. Nationalisation, or lengthening the terms of the loans and guaranteeing them take the pressure off the management. A sensible bank manager with that much money at risk with a single client would want to hold their feet to the fire, not let them off in the way the latest proposal does.</p>

Things are bad enough without talking ourselves into recession.
Some banks and commentators have already called a recession in the USA, when the figures for the last quarter of 2007 show the US economy was still growing well. Here in the UK the retailers have added to the sense of gloom by concentrating on their sales figures on a ??like for like?? basis, leaving out all the sales in new shops.

The current position is both better than the pundits admit, and worse than the government will let on. The bad news is that the banking systems in both the USA and the UK are damaged by discovering that some of the lending they carried out in the heady days of low interest rates and easy money has been in their balance sheets at values that can no longer be sustained. We are living through a difficult time as banks adjust for the losses they have made, and rein in their lending as they are short of cash. In the UK commercial property values are falling fast, undermining the security for some of the loans. Residential property values are under attack from the UK government, who want housing to be more ??affordable??, but are being held up in part by the high Stamp duties and the imposition of Home Information Packs which is deterring people from selling their homes and buying a different one. There are too few homes coming onto the market at the moment to cause a crash in prices. The UK authorities have made the problem worse by their ham fisted approach to Northern Rock and by their failure to keep markets liquid enough during the last four months of 2007.

The good news is that many companies are still trading well. Profit margins are good in many cases, and on both sides of the Atlantic activity is higher overall today than it was when the Credit crunch first hit. Both the US and the UK have experienced a falling currency. As both economies need to divert much more activity into exports, or into import substitution, that will help. Both economies can export so much more to the rich parts of the world ?? China, India, Russia and the Middle East. Both economies now have to seek inward investment from these new giants that have built up huge cash surpluses at the same time as we have built up huge deficits by buying their oil and their manufactures. It is repayment time.

Few forecasters expect a downturn in the UK this year ?? just a sharp slowdown. Some commentators expect the US to get away with a slowdown rather than a recession. The US Fed is very keen to stop a slump, and is taking the right action by making cash available to banks and by cutting interest rates. Now the US President is also promising tax cuts, would boost activity as well. The US authorities recognised earlier than the UK that they had to shift from inflation fighting to recession fighting, and they have been bolder in their actions. They will probably succeed in avoiding recession.

The UKs position is weaker because the UK has increased public spending by too much, wasting too much of the money. At a time when other countries were reining in their public deficits and controlling their spending, the UK government went on a spending binge. This limits the UK governments scope to cut taxes and relieve the pressure on consumers. As consumption is the largest part of activity, this means we are going to experience a slowdown which consumers will feel badly. If the government really wanted to help us out of this change of fortune, it would get a better grip on its spending immediately, cancelling the needless parts like ID cards, computerisation schemes, regional government, and larger EU contributions as well as keeping wages down. Then it could follow the US example and cut taxes to help the hard pressed private sector.

Instead the UK is only going to tackle one of the twin deficits, the balance of payments one, through the mechanism of a cheap pound. Our best hope this year is that the strategy works and the private sector does shift a lot of activity into exports. That could be helped if the government would relent on its planned increases in small business tax and CGT. They need the goodwill of entrepreneurs to right the imbalances in this economy. Its a dangerous time for the government to be sandbagging the very people on whom they rely to recreate their much quoted ??economic stability??. Our economy at the moment is as stable as a row boat in a storm.

There is no need to talk ourselves into recession ?? we can get through with a period of slow growth. To do so, the government needs to curb its own appetite for waste and be realistic about how much it can squeeze out of us in tax.

What price an ethical foreign policy?

Today sees Mr Brown in China trying to act as a super salesman for British business. It is a relatively harmless use of his time, forced upon him by the dire straits of the UK economy under his policies.

Mr Brown has debauched the strong economy he inherited. His first couple of years wisely continued Conservative spending plans and repaid public debt, but elsewhere the long march of this government to a malfunctioning socialist economy had begun. The undermining of the Bank of England proved to be a long fuse to the explosive Northern Rock crisis. The taxation of pension funds began the route march to most people no longer having the benefit of a final salary scheme, whilst burdening too many companies with large deficits to repay.

Worse followed after 2001 when Mr Brown embarked on an irresponsible twin track ?? easy money, and massive spending increases on public services. Because he wrongly saw all public spending as ??investment?? and felt large sums were proof of better service, he failed to ask the obvious question ??What am I buying for all this cash??? The answer turns out to be a whole load of extra civil servants, spin doctors, consultancy contracts, pay awards, quangos and regulators.

Ten years on the UK is one of the world leaders for twin deficits ?? a record balance of payments deficit, and a large government borrowing requirement. Alarmed by the record deficits on the balance of trade figures which he used to pour over to harry the Conservatives when in government, he decided on a trip to China. It is a sign of his desperation that he feels the need to act as pied piper to the British business community to sell more there, and to see the need to ask the Chinese government for more Chinese funds to be invested in the UK. He is right we require the money, to pay for our double deficits.

When the Labour government first came into office its then Foreign Secretary Robin Cook claimed they would run an ethical foreign policy. The phrase was chosen to imply that all previous UK foreign policies had been other than ethical. The Labour knight was to wear the purest white, and would charge into world Councils with morality as the billowing pennant on the lance.

Today that seems a very long time ago. We look back on the invasion of Iraq, the continuing fighting in Afghanistan, the lack of any action over Zimbabwe, the skirting round North Korea, the inconsistent approach to other countries gaining nuclear weapons and the erratic response to human rights abuses and have to ask what ethical or moral stance now lies behind these actions? Arent they all driven by media, by events, by US pressure, by EU argument, by a growing sense in the present Foreign Office that there are many obvious limits to British power?

Worse still, when many want Mr Brown to raise Chinas human rights record as the central issue whilst there is still a window of opportunity before the Olympics, many of us are embarrassed to say this when we look at the deteriorating record of human rights in our own country. Now the UK wants to have the western record for detention without trial or charge, seeks to stifle public opinion by ratting on the promise of a referendum, spends a fortune on clumsy physical ??security?? at so many places and events, treats travellers like suspects or criminals and intensifies the range of thought crimes that preoccupy the elite, we are no longer in a good position to lecture China even if we wanted to.

Mr Browns visit recognises the reality of the new world order. China is emerging as a superpower, with a fast growing economy, a large population, and a wish to project its power. When a country has more than $1 trillion in the bank it is difficult to argue with it, especially when our country has been newly impoverished by Mr Browns policies. He sold our gold holdings for a fraction of its current market value, ransacked our long term savings, failed to stop a run on a British bank and now needs to go cap in hand to China to seek inward investment to the UK. These are sorry times for our country. They have been brought on by incompetent stewardship of our money. It is humiliating to see our Prime Minister ask for sovereign wealth fund money from China to keep us afloat. If he really wanted to improve the UK economy he should have stayed at home, working on how to get more value from his public spending, and how he could curb spending so we do not need to borrow so much.

The debate about Northern Rock on Newsnight yesterday failed to produce a thought through alternative to nationalisation, to protect the taxpayers interest and avoid more damage to markets.

As readers of this blog will know, there is such an alternative. Maybe I have to spell it out again.

The government and the Bank should set Northern Rock targets to

1. repay debt
2. generate cash and profit
3. sell assets

These targets should be tough but achievable. The rate of asset sales should be geared to what the mortgage market can absorb, so the assets can be sold for a reasonable price, leaving the taxpayer with sufficient cover to get our money back.

Putting Northern Rock into administration could lead to a fire sale of assets, and might result in taxpayers not getting all our money back.

Nationalising Northern Rock could lead to huge losses for taxpayers, as taxpayers became responsible for all the rest of Northern Rocks assets and liabilities, including paying the staff, any redundancies, and the pensions shortfall.

Northern Rock has started to follow this managed run off strategy, selling ?2 billion of mortgages recently and using this to repay some of the taxpayer debt.

The meeting today at Northern Rock has been called to try to limit the managements scope to make decisions. This could be used to limit the Companys ability to reduce its debt to taxpayers, so it is not a helpful development from the governments or managements point of view.

The meeting is also a reminder to those who think nationalisation is an easy option, that it could be bitterly fought by existing shareholders. Taxpayers would not take kindly to existing shareholders being offered a good price for their shares, whilst existing shareholders are likely to contest nationalisation for a nominal or low price. I cant understand how anyone sensible can think this would be a good route to follow.

It appears that the government is flirting with nationalisation because it is having trouble persuading the shareholders of Northern Rock to see things its way. It is a very cumbersome and potentially very expensive device to try to get shareholders to do as the government wishes, when the government has a much easier way of doing it.

The government still does seem to have grasped how powerful its position is as Northern Rocks bank manager. It stepped into this role, and is now committed massively to it. As of today it is clearly the only bank manager Northern Rock has that is prepared to extend the huge sums needed for the bank to be able to carry on trading.

As bank manager the government needs to assert itself in the following ways:

1. Set out how much asset cover it wants for any additional lending ?? and make sure it has taken enough asset cover for the loans so far.
2. Set out how much money it expects Northern Rock to repay on specified repayment days.
3. Establish targets for cash generation and profit in the underlying business with management, and make them report variances with explanations of action to be taken to get back on target.
4. Establish the usual banking covenants that Northern Rock has to hit to keep its facility

I read that the shareholders are not happy about selling assets. There should be no argument about this. The government/Bank of England should tell them what repayments they expect. Northern Rock then has four ways of making those repayments:

1. Sale of whole business to an owner that can meet the repayments
2. Refinancing of Northern Rock in the private market to repay the state borrowings
3. Cash generation from the business
4. Sale of assets

The government should just insist on the repayments. It is up to the shareholders and management of Northern Rock to do the hard work and decide how they can meet the need for such repayments. If selling assets is the only option ?? as it appears to be at the moment ?? then they must do that. The government does not need to dictate how Northern Rock refinances itself ?? just has to insist on the taxpayers getting their money back in sensible tranches over a realistic time scale.

As I stated on this blog before, the taxpayer should also be rewarded for making these huge loans that no commercial business would make in the event of Northern Rock recovering well. That can be done by the government taking options to buy shares at the current price at any time over, say, the next five years. This should also be a condition of continuing the lending to the company. Should it then do well the government can buy the taxpayer shares at a favourable price and sell them on to make a profit as a reward for carrying so much risk for so long. I read that this idea is now being taken seriously by the advisers.

There are at least ten good reasons why Northern Rock should not be nationalised:

1. It is bad enough for taxpayers to have ?57 billion at risk in Northern Rock. Nationalising the bank would put more than ?100 billion at risk, a very large sum even for the government and taxpayers.
2. Once nationalised, taxpayers become liable to pay all the wages and salaries. Ministers would have to sanction redundancies if these are needed to cut costs, and taxpayers would have to pay for them.
3. The taxpayer would become liable for the whole pension fund, which has a deficit.
4. The management of Northern Rock appointed by the government would doubtless expect substantial new funding from taxpayers to invest in and develop the business, adding to taxpayer woes.
5. There is nothing the nationalised management could do that cannot be done now to try to cut the liabilities and repay some borrowings.
6. Nationalising would make it more difficult to persuade the management of the bank that there is a crisis which requires exceptional efforts to increase business revenues, cut business costs and sell assets to repay borrowings. It would take the pressure off.
7. Politically it would become a long term reminder of the governments failure to handle the credit crunch well. The bank is unlikely to have been privatised again before the next election.
8. Given the growing pressure on public spending ?? difficulties in finding money for police pay, hospital improvements and the rest ?? it would be an embarrassment to see spending rising on a nationalised bank at the same time as cuts elsewhere.
9. The pay of people at the top of such a bank is likely to be high even by the standards of modern higher pay in the public sector, leading to further embarrassment, especially if they do not perform well.
10. All the spending on Northern Rock would then have to be accounted as public spending, whereas at the moment it is kept off the governments balance sheet to make the public accounts look better.

I was pleased to hear that Northern Rock is selling 2 billion of mortgages with a view to repaying ?2billion of its debt to the taxpayer. We need to see more of such progress as markets permit – the skill is selling at the right pace so you receive a sufficiently good price to ensure taxpayers get all our money back.

I was pleased to learn today that Goldman Sachs are looking at the possibility of selling on the taxpayers loans to Northern Rock. It would be excellent news if taxpayers can get their money back. Then idea apparently is to turn the loans into bonds and seek some other institution or intermediary to grant a guarantee of repayment, then selling them on to the private sector.

There is also at last some movement away from the lunatic idea of nationalising the bank which would mean taxpayers moving from a position where we have ?57 billion at risk to a position where we would be responsible for all ?100 billion plus of Northerns liabilities. (see previous blog entries on why that would be bad news for taxpayers and shareholders alike). We learn this morning they are looking at the government acquiring a minority stake in the company, so taxpayers will get some upside from their shareholding if the rescue works well.

I would suggest there is no need for taxpayers to buy any shares at the moment in Northern Rock. Taxpayers should continue as bankers of last resort. What Ministers could demand to continue in this role is the grant of options to buy shares in the company at a future date. The taxpayers long term interest would be best protected by having the right to buy a substantial minority stake in the Northern Rock at around the current share price at any time over say the next five years. If all goes well and the companys share go up substantially, and taxpayer can then buy its shareholding, the company will get extra share capital, and taxpayer can sell on the shares in the market to make a profit. If the companys shares do not prosper the taxpayer has no share capital at risk and does not have to buy the shares. That would be less risky than buying a stake in the company today and would reward taxpayers if our lending to the company enables it to recover well..