Category: Blog

In Northern Rock’s 2006 Accounts they reported how well they were doing. They commented “ The low risk nature of Northern Rock’s balance sheet is reflected in the mix of assets…These assets are well funded through a well diversified range of assets.” They looked forward to further low risk growth, and told their shareholders that the new regulations under Basle II would mean they could reduce the amount of money they needed in their business to support the then level of activity. What a difference a year makes.

Last year they put aside £126 million for possible losses on their lending, most of it for the unsecured loans they had offered people on top of their mortgages. This represented just 0.15% of the amounts they had lent. This year I am sure the new management will want to look at this and step it up considerably. They may also wish to record losses on many other features of the Northern Rock business, as prudence would dictate lower values for some of the assets on the balance sheet, and putting money aside for redundancies and future re-financing costs. There is likely to be a lot of red ink spilled as Auditors and new management try to agree what is fair. The taxpayer will take the hit.

The media and political classes have suddenly alighted on the issue of Granite, the offshore financing company that has issued substantial amounts of paper to its investors, and which holds a lot of Northern Rock’s mortgages. In order to understand what is going on , we need to look at how a mortgage bank can raise money to finance its business.

Northern Rock prided itself on using four principal methods to raise money to lend to people, claiming this showed it was prudent and not too dependent on any one method.

The first is to collect money from savers, through so called retail deposits. If you or I put our few hundred pounds into a bank or building society we are letting them use our money to lend to people on mortgage. Some MPs now seem to think this is the right way to finance a mortgage business, and think it is the prudent way. 22% of Northern’s business was paid for by these deposits at end 2006. Paradoxically, it was this method of finance which led Northern Rock to borrow so much money from the taxpayer, because once the small savers lost confidence in the Bank they wanted their money back, leaving Northern short of funds. It is the ultimate example of borrowing short to lend long – many of the small savers place their money with banks like Northern in deposits where they can get their money out in a day, or with a month’s notice. Mortgage banks lend this money on for much longer time periods, usually safe in the knowledge that their depositors will not all want their money back on the same day, and confident that others will come along to deposit.

The second is to borrow from the money markets – so-called wholesale funds. 24% of Northern’s money came from this source at end 2006. Much of this borrowing is also short term, but banks can usually rely on being able to borrow it over and over again, so again it is usually safe to lend it out for much longer periods. This source of funding dried up in the Credit Crunch of September 2006.

The third is securitisation. 43% of Northern’s money came from this source by end 2006. The bank packaged up groups of mortgages, and sold them to a Granite offshore company. The buyers hold a piece of paper in a Granite company, and receive interest payments based on the mortgages within their company. This financing can be arranged for longer time periods, like the mortgages themselves.

The fourth comes from issuing bonds, where the bondholder lends money to the company for a fixed period. These too can be for longer periods than 1 and 2 above. Northern raised £6.2 billion in bonds, offering mortgages as security for those as well so the bondholders would get their money back if anything happened to Northern Rock itself.

Northern’s critics now tell us this was a risky business model, because it entailed borrowing short and lending long. All banking involves an element of that – that is how banks make their money because they can charge more for the longer term loans they make than they have to pay for the short term money they borrow. They can also, of course, charge more for the loans they make to reflect the greater risks of those loans. Northern’s collapse resulted from the sudden drying up of the money markets, followed by the swift withdrawal of too many retail deposits. Two of its four funding methods went wrong.

The sudden fascination with Granite is probably overdone. Northern took the prudent line on reporting Granite. It kept all the loans and all the borrowings on its own balance sheet. It did so because it manages the mortgages in Granite, and because it has to replace any mortgages that fail to meet the standards required, and because it has to top up the Granite companies with new mortgages if the mortgages are repaid too quickly. Northern also has securitisation arrangements through Dolerite Funding and Whinstone, on a more modest scale than Granite. These are also clearly shown in the last Accounts on the balance sheet.

The argument over Granite revolves around the government saying they are not nationalising the Granite companies and the Opposition pointing out that Granite is part of Northern Rock’s balance sheet with obligations from Northern Rock to Granite that will continue. In addition Northern has an £8.4 billion investment in Granite.

The bigger argument will become how much value can taxpayers put on all of this? The 2007 Accounts are likely to look very different from the 2006. I expect to see some hefty write downs in Northern Rock’s asset base. Valuing their share in Granite is just one part of a much more complex and difficult picture. The valuers also have to take into account the interests of all those who have made money available through securitisation to the Northern Rock business.

Yesterday saw another successful government attempt to stifle debate and prevent serious consideration of an important billon bank nationalisation. I was left with just six minutes to try to discuss all the wide ranging issues involved during the Second Reading debate on the principles, whilst the perfunctory two and a quarter hour committee stage left completely inadequate time for all the amendments we needed to consider.

It was a pity. It was a pity for the North East, and for all who wish to see Northern Rock given a chance of a decent future. It was a tragedy for taxpayers, who will now be required to buy a mortgage bank by a government that seems to have no concern for what it is buying, and no idea of how much it will cost taxpayers over the next couple of years.

I would have liked to have spent more time discussing the importance of Northern Rock to the North East, and how the North Eastern economy could be encouraged to branch out more into the usually profitable and successful world of financial and business services. It is good news that Northern Rock took root there. It is bad news that it should be Northern Rock that got into so much financial trouble, and bad news that there are few other large financial institutions anchored in the North East.

We had no chance to look at the way the Bank and government last summer failed to keep markets liquid enough. The Fed in the USA and the ECB in Euroland did a much better job supplying cash to their markets, so no European or US bank got into the problems Northern Rock faced.

We had no chance to discuss the impact of Gordon Brown’s decision to take banking supervision and government debt management away from the Bank of England. In the Conservative Economic Policy Review we warned that once times got more difficult in money markets the UK was uniquely vulnerable to a banking crisis because these reforms left the Bank of England unable to respond quickly in the way it could have done prior to the Brown changes.

Last August we stated in Freeing Britain to compete:

“We are concerned about the division of responsibility between the FSA and the Bank over banking and market regulation. Fortunately, conditions in the last decade have been benign internationally, with no serious threats to banking liquidity. We think it would be safer if the Bank of England had responsibility for solvency regulation of UK based banks, as well as having an overall duty to keep the system solvent. Otherwise there could be dangerous delays if a banking crisis did hit, with information having to be exchanged between the two regulators; and there might be gaps in each regulator’s view of the banking sector at a crucial time, where early regulatory action might have spared a worse problem”

If the danger was obvious from Opposition, why couldn’t the government see it? Why was the Chancellor lecturing the banking sector on how they had misbehaved, and telling them there would be no bail outs, on the eve of this crisis which triggered the biggest bail out ever mounted in the UK? Indeed, there were rumours about which bank was likely to get into difficulties first in the credit crunch; before the run on the Rock began. We did not repeat the rumours because we did not wish to make life more difficult for that institution.

At this late stage, I still urge the government to consider the serious alternative to nationalisation – the Bank of England acting as Northern’s bank manager, until Northern Rock can repay the state loans and refinance itself elsewhere. It removes all the hassle of a government having to take a public view on repossessions, new mortgage offers, staff numbers and pensions. It gives Northern Rock a better chance of a decent future, as it puts some real financial discipline into senior management that is usually lacking in a nationalised industry in the UK. It protects the taxpayer better, and gives more chance of saving and creating new jobs in the North East.

Nationalisation has proved a long and lingering run down for all too many businesses to fall under its spell. Last night there were no reassurances from Ministers about the future of Northern Rock jobs, and no statement of whether they will be running the Bank down or trying to build it up. I suspect they do not know, because so much rests on what the European Competition Commissioner will let a public sector Northern Rock do. It is a pity the government did not settle that first so they could tell Parliament and public, before committing us to such an expensive and a hazardous project as nationalisation.

I am a businessman by background. I have occasionally bought or sold companies. Never have I been asked to buy a company with so little information available on its assets, liabilities, past and possible future performance as today, when the government wants me to approve the purchase of Northern Rock for taxpayers. Never have I been asked to put my name to such a huge commitment before – placing the taxpayer at risk for more than £110 billion.

They will not tell me how much they wish to pay for the shares. That will be decided after they have announced the purchase and legislated for it! This is not the usual negotiating procedure between buyer and seller.

Because they are compelling sale by the shareholders, they leave taxpayers open to lawsuits. I doubt they will tell us how much of a risk that is, nor will we be given their legal advice to make our own decision about how likely a successful legal challenge for compensation might be.

We will not be told what is the true state of the mortgages that are the banks’ main assets, and we will not be given a schedule of either assets or liabilities. There will be no accountant’s reports, no assessment of the term structure of the loans and assets, and no commentary on the likely movement in the bad debts.

We will not see management accounts for the last year, and we will not have budgets for the next couple of years. We will not even be told what the general outlines of the business plan might be, because they are awaiting clearance from Brussels for how much new trading they can undertake. They will have to be careful about what the bank can offer in the marketplace, as its privileged access to public money leaves it open to allegations of anti competitive trading if it gets the offer wrong.

We will not be given a report on the size of the deficit in the pension scheme and how that has been calculated, nor will we be warned that the pension deficit might be about to get larger in the light of recent regulatory and actuarial comments on how people are all living much longer than has been allowed for in many a pension fund calculation.

There will be no environmental report on the properties with an assessment of risk under Environmental regulation, which any purchaser would need these days. There will be no property report about the leases and freeholds, and the lease and maintenance obligations.

We will not see the main contracts of the very expensive senior staff to be able to review the bonus arrangements and to see how much it will cost taxpayers if we need to terminate some of their employments. We will not receive a Human Resources report on pay, morale and efficiency of the workforce we will inherit.

There will be no survey of customer attitudes or study of the value of the brand post the disturbing changes to it in recent weeks. There will be no report on the relationship with the Trust, on the ability of a public enterprise to sponsor one particular football team or on the extent to which a nationalised company can continue the social and community work Northern Rock performed in its profitable private sector days.

In sum, Parliament will have none of the usual information directors would require as matter of course from acquiring management and their advisers before consenting to an acquisition. Perhaps for that reason Parliament is once again being railroaded and sidelined by the government. It is a farce to allow only one busy Parliamentary day to consider all stages of the Commons procedure for this bill. It means we have had no normal time to read the Bill and table amendments, and if we had there will be insufficient time to debate them. This is rushed debate on a botched nationalisation by a government which has not done its homework. The taxpayer is being put into a deal without knowing the price or the long term risk and cost. Ministers tell us all that taxpayers are risking is guarantee. Not so Ministers – the taxpayer is now liable for every broken window in a branch, every severance and pension payment, every mortgage and loan. If the assets cannot cover the cost of these things taxpayers will have to pay more tax to sort it out.

The Northern Rock crisis has undermined this government’s economic reputation, and deservedly so. They have made mistake after mistake in responding the Credit Crunch and the run on the bank. I have put the main blog entries on Northern Rock from this site together so people can remind themselves of the way the crisis unfolded from last summer. The main errors (highlighted at the time on this site) were:

July 2007 It was clear that credit was too tight and interest rates were too high for comfort. “If the central banks don’t back off soon it could be quite a collapse”. The UK authorities failed to supply enough liquidity to markets or to lower rates.

August 2007 The Credit squeeze became clearer in the markets, and some more City commentators came to appreciate the dangers. The UK authorities still did nothing.

September 1-13 The Fed and the ECB were taking action to relieve the squeeze, but the UK authorities still did nothing.

September 13th The Chancellor makes a stupid speech blaming the banks for poor lending and stating firmly there will be no bail outs of banks in trouble. This was an open invitation to anyone banking with a weaker institution to remove their money whilst they still could.

September 14th onwards Government and Bank of England become lender of last resort to Northern Rock and allow this to become public knowledge, encouraging a run on the bank.

Government fails to arrange a take-over for Northern Rock before the run develops, claiming the legal framework it has put in place does not allow it to.

Government allows the run on Northern Rock to develop, and only when it is very serious does it announce the biggest guarantee and bail out ever attempted in the UK.

Government lends around £25 billion to Northern Rock without being able to assure us it has taken sufficient high quality collateral to ensure taxpayers can get all their money back.
Government fails to set out terms for the loan, including the all important question of when it expects repayment. Government fails to tell us that it has carried out usual banking due diligence and leaves doubt about what power it has exerted to ensure proper monitoring of the loan, strong covenants, and a professional approach to repayment.

Government becomes involved in shareholder discussions and decisions about finding a new management team/new shareholders for the bank and raising new equity for it. These discussions fail to produce an answer acceptable to all concerned, but drag on from September 2007 until February 2008.

Government nationalises the bank, more than doubling the taxpayers’ risk at a stroke and leaving itself open to endless legal disputes and rows about compensation and the way it will run the bank under its ownership.

What should the government have done differently? As this blog shows it should have

1. Made more liquidity available to markets and cut interest rates last summer, to prevent banks like Northern Rock being denied all access to market finance so it did not develop into the crisis we saw.
2. Not lecture the banks on their imperfections when the system was so distressed, as the Chancellor must have known when he spoke
3. Avoid any lender of last resort lending being made public, or cover the lending to one bank by requiring all banks to borrow something so the markets were not spooked about one individual bank – this could have been part of a general liquidity increase and sold sensibly to markets
4. When lending to Northern Rock understand the need to be a strong and firm lender. This meant limiting the sums, and limiting the time of the loan. It meant telling the Board of the bank that they only had so long to find alternative private sector money, and if they could not they had to start selling mortgages and running off their business book to meet the repayments required.
5. Staying out of discussion about new shareholders and new management to increase the chances of something happening, but keeping up the pressure on them to reach a quick solution by demanding early repayment tranches.

At every stage the government made the wrong call. They have now ended up with the worst possible of worlds, and will doubtless run this bank as badly as they have been running Network Rail and the Post Office. In the first case they doubled the costs of running the track quite quickly after nationalising it, and in the second case they have embarked on a large programme of closures having undermined its counters business by their own decisions.

<strong>Click <a href=”http://www.johnredwoodsdiary.com/category/northern-rock/”>here </a>to see the archive of John Redwood’s previous postings on Northern Rock.</strong>

Mr Darling is already in a big hole, thanks to his misjudgements over monetary policy last August and September, the run on Northern Rock, the botched proposals on capital gains tax and the U turn on Non Doms. Now, the man in the hole has decided to more than double its size!

There are ten reasons why nationalising Northern Rock is a bad idea.

1. It more than doubles the amount of money the taxpayer has at risk,from a little over £50 billion to more than £100 billion
2. It means any bad loan Northern Rock owns, the taxpayer will own.
3. It means the taxpayer is now liable for any redundancy payments if Northern Rock has to slim its staff numbers.
4. The taxpayer may have to defend against writs from angry shareholders if the compensation terms are not sufficient.
5. The taxpayer becomes responsible for the pensions deficit for staff
6. The taxpayer has to pay compensation to shareholders at a time when public borrowing is already excessive
7. The Chancellor will have to explain mortgage foreclosures, staff redundancies and other bad news to Parliament each time it happens
8. The amount of total government borrowing will increase as a result of the big increase in the amount of money at risk, and the cash needs of the business.
9. The taxpayer will have to pay any losses, meet any write downs of assets and pay for all capital expenditure of the business.
10. The government and taxpayer may be accused of undercutting other viable financial businesses competing against this bank dependent on public money if they are not careful with their guarantees, subsidies and pricing.

What due diligence will the Chancellor do if any before committing the taxpayer to all these liabilities? What law suits if any is he anticipating from shareholders? What will be the cost of compensation to shareholders? What will his policy be on remuneration for his new state employees and how will that fit in with other public sector remuneration?

Tomorrow we need a statement from the Chancellor. There will be all too many questions, but I fear this botched nationalisation will not come with many convincing answers.

This morning we welcome a new country to Europe. The creation of Kosovo as another state in the unstable Balkans is a reminder of how strong are the passions of people over their identity. The differences between people in Europe have been sources of tension and conflict for centuries. The shifting pattern of settlement, the divisions over religion and creed, the impact of great migrations and the long shadow cast by history lie behind so many of the persistent disputes.

Although Europe now has 45 countries, there are those who would like to see more. Passion is on the side of more smaller units. It is only the politicians and bureaucrats who are the Empire builders, wanting to create neat and larger units, drawing artificial lines across territories that are themselves crossed by the deeper marks of history and culture.

Belgium is witnessing a classic struggle between the Flemish speakers and the French speakers, as the Flemish seek to establish their own independence from the larger country. The Basques have never been happy with rule from Madrid. Scottish Nationalists would dearly love to drop their link to London, whilst English nationalism is now growing. South and North Italy are not entirely happy companions in a single country.There are still disagreements about the ideal shape of the country map in central Europe. In each case there has to be a democratic way to settle these issues that meets with the approval of a large majority to create stability. As a supporter of the Union of the UK I know the government needs to do more to engage people in seeing why it has worked in the past and making them feel it is fair today.In some of these European cases the large majority will want to keep the bigger country where it has established deep enough roots and loyalties of its own. In other cases people will want a redesign of the borders.Past attempts to unite the Scandinavian lands fell apart. Austria is once again an independent country. The two components of Czechoslovakia prefer their divorce to marriage.The three small Baltic states love their ability to go it alone.

I remember discovering just how deep these feelings can run, and how small the units are that command allegiance, when I inherited the task of remodelling Welsh local government. The 1970s reorganisation created large and unpopular units in many parts of England and Wales. The proposed 1990s scheme I inherited had been based on a bureaucratic view of how large a unit you needed to have a “viable” Council. The bureaucratic idea of viability bore no relationship to how people felt about themselves and their area. I decided instead to recreate the old counties of Wales, and to free the larger boroughs, giving to each their own unitary Council. Wherever I did this it was popular. I remember the representatives of Merthyr, overjoyed that I would give them their own Council after all, saying to me that they would have made me a Freeman of the Borough if only I hadn’t been a “Tory”! That was praise indeed.

The official machine disliked all these concessions to history and to feelings. They complained at every new extra Council I wanted to create. We ended up with the battle of Powys, which naturally split into the three old Counties of Brecknock, Radnor and Montgomery. Radnor was tiny, and I buckled over how feasible it would be for it to have its own all purpose local authority. I tried to free Montgomery from Powys, but Radnor and Brecon hated that solution even more. I set up a scheme for devolved decision taking in each County by the Councillors elected for that County in Area committees, so they could have some of the advantages of independence alongside the economies of the larger unit. It was not what they really wanted. They wanted independence. I regret not insisting that we split the three Counties, as I had done for the others, for identity does matter.

I wish Kosovo well, and hope that its independence will bring it more happiness. All those in government should remember just how local loyalties are, and how strong a sense of place and history people have. As a negotiating Minister in the EU I could still feel the fault lines from Reformation Europe. As a Minister involved in local government reorganisation in the 1990s it was obvious that the new and larger constructions of the 1970s had not settled down and had not won popular consent. There are still parts of Europe that feel they are governed from the wrong place by the wrong people. If we want a happier Europe we need more countries, not less, and more freedom for their governments,not more central control from Brussels.

Yesterday I went to meet the new Chief Executive of Wokingham Unitary Borough Council. Chief Executives come and go in local government, drawing good salaries whilst they stay, before moving on to larger Councils or quangos that spend more money and employ more staff. The last couple of Chief Executives at Wokingham have had three big issues on their desks, that have now been passed on to their successor.

The details of the issues will not concern most readers of this site, though they are similar no doubt to issues facing other Councils in the suburbs and shires. The interesting thing is to ask, Where does power lie now in this overgoverned but undermanaged country we live in? How much power does a Chief Executive, working to the brief of the Council leadership, have to get things done?

The three things that the Councillors agree about that sit on the CEO’s desk are that Wokingham is experiencing too much new housing development on green fields, that it needs a redeveloped Town Centre (including some new residential units), and that it needs a new station and transport interchange. These items have sat on the same desk – with different people looking at that from behind that desk – for the last ten years.

My electors are right in thinking that a project like a new station requires efforts from national and local government, from Network Rail and from the Council. In 2001 I included in my election proposals support for a new station and transport interchange. I was careful not to claim I could deliver one. An Opposition MP has no executive power and no budget for such things. I took plans to the Council, the government and Railtrack/Network Rail. I explained how the land – owned by the public sector – could be used for a suitable development which would give enough planning gain to pay for a new station. I reasoned that the Labour government favoured rail travel. It had a policy to modernise the railway. Even assuming it wouldn’t want to spend any additional public money in an area like Wokingham, our golden acres could come to the rescue and raise the money for a suitable scheme. Ministers confirmed they liked the idea of modernising stations out of property profits at Network Rail. Schemes were drawn up. The Council was enthusiastic. The Chief Executive was given it as a task to see it through. Nothing happened. In the 2005 election I dropped all reference to supporting such a scheme, as I concluded that Network Rail simply isn’t up to doing something like that.

My electors are also right in thinking that the national government is heavily involved in all the building on floodplain and over the remaining greenfields which they so dislike. Councillors and their executives are locked in difficult arguments about whether to confront the government and lose, or whether to co-operate with the government and gain more cash from developers when they get planning permission. As an Opposition MP I join with my colleagues to demand more local planning control, and to vote against the centralising measures this government pushes through. The Council has to conform to government requirements in the local plan, and finds that if it turns down too many proposals the government simply trumps it on appeal. If the Council co-operates it can do a better deal for the local community over any given planning application, at the cost of some electors thinking they have been let down by their Councillors who should have opposed it to the last ditch.

The third item on the CEO’s desk is the need for a redevelopment of the Town Centre. In this case the Council has granted planning permission, but the developer is still not in a position to carry out the works. For once it is not government that is the problem, but getting all the private interests together and pointing in the same direction. It is an interesting challenge for the CEO, and one which has defeated her predecessors.

It all adds to people’s sense of frustration with government. The Council they elect cannot have its way on planning matters, and cannot get the nationalised railway company to follow the stated policy of the government that owns it on our behalf. Even when MP, Council leadership and the Council executive team are united on what to do, the stifling inadequacies of central government and Network Rail, or the deliberate wish to follow a different policy in the case of planning conspire to prevent progress or to thwart the will of the community.

The Chancellor makes a habit of clumsy speeches. In the great tradition of telling the banks they had been badly run and would not be bailed out just a few days before he guaranteed the deposits of any bank in trouble, yesterday he popped up again and says the City is paying people too much for poor performance. He would like to see their pay cut.

For once I will agree with him. I think if someone presided over a large organisation which lost all the personal details of half its customers, the boss’s pay should be cut. If someone presided over the first bank run in more than a hundred years, their pay should be cut. If someone rushed out press threats to tax Non Doms more, only to have to withdraw some of the proposals because they were too damaging, his pay should be reduced. If someone decided to increase capital gains tax by 80% for entrepreneurs, and then had to climb down on part of that proposal, we should look at how much they were being paid.

Can anyone think of someone on high pay who might fall into any of these categories? And what should happen to the pay of someone in the unlikely event that they managed to do all four? Should he be paying us to carry on in the job?