Politicians on the Northern Rocks- let them take a third way liferaft

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?


  1. Michael Taylor
    November 20, 2007

    The level of serial cascading institutional incompetence revealed by the Northern Rock panic is astounding and very disturbing. Indeed, from a party political point of view, it's probably a watershed event.

    The way forward now depends on a) the NR assertion, presumably certified by regulators, that it has only a liquidity problem, not a balance sheet problem and b) the extent and terms of current government support. Obviously, if we don't really know b) then we can't be sure about a). Over to you, Mr Darling. . .

    Then there are surely various ways forward. The most obvious is to turn the government support into convertibles – perhaps into higher-yielding preference shares. This is the way the Japanese govt helped rescue their financial system in the late 1990s, and ultimately this not only allowed the banks to (just about) trade their way out, but it also eventually seems to have made the government some profit. But question? Can this be done under existing EU regulations? If not, what is the penalty for breaking them?

    Finally, rather than rush to universal deposit insurance schemes, I would urge you to consider whether commercial banks as institutions still play any useful part in the financial world. Seems to me that their original role of agglomerating savings and then allocating them may have been useful in the 17th century. However, we now live in a world in which information is widely – universally – distributed with virtually no distribution costs, so that rationale no longer holds good. Savings would be better (ie, for a higher return and/or lower risk) allocated by savers themselves by picking amongst a universe of daily-quoted money market mutual funds of differing risk/reward profiles. Whilst we continue to tolerate banks, and their absurd and dangerous inability to assess risk responsibly, we will continue to have to bail them out. Deposit insurance only encourages them! Take the opportunity offered by the Northern Rock debacle to encourage the growth of an alternative set of financial institutions based on the technology of the 21st century, not the 17th.

    Reply: I prefer the government acting as bank manager and requiring repayment of the

  2. Michael Taylor
    November 20, 2007

    (Not for publication).
    Yes, the "banking skills" get transferred, but only as credit assessors who get paid on results as advisors to the money market funds. Meanwhile, if their "skills" turn out to be abject, what happens is that the quoted value of the money-market unit gets marked down to reflect the losses. But, of course, that's not a matter of life and death (and certainly not a matter for universal deposit insurance!) because, after all, if the markets have been doing their job, the holder will already be getting a better dividend from having voluntarily and knowingly have opted for a ride at the riskier end of the risk/reward curve.

    The idea was much more extensively worked-through by Randy Kroszner whilst he was seconded to GT in Hong Kong under John Greenwood. You might like to look up his paper "Banking in HK: Regulation, Stability and the Role of Money Market Mutual Funds." Mr Kroszner, I discover, is now a Fed governor in Washington, so who knows, it may happen. . . . rgds

  3. Neil Craig
    November 20, 2007

    I agree with your assessment & think that the current zigzagingof policy is damaging. Nonetheless I view putting in a liquidator with some equanimity. It is possible for a liquidator to keep a company running for a considerable time while searching out a buyer &/or selling off bits. Bankruptcy under these terms is a well established procedure which effectively deals the shareholders to the end of the queue (nationalisation puts them & their inevitable lawyers at the front). It also makes negotiations to buy purely between the liquidator & prospective purchasers, which greatly lessens their ability for arm twisting over government guarantees of future hidden subsidies. Since the company is now effectively without leadership this may be the best option.

    We are told that the prospective purchasers all say that the current share value "overvalues the company" though whether that means it has a negative value, which would require hidden subsidies has not been disclosed. In any case the existing share value clearly depends on an assumption of government help & there is no ethical reason whatsoever why they should get it. The legal maxim is that the value of something is what the market is, at the time, prepared to pay for it & that looks like about nothing just now.

    Reply: This company is trading and solvent according to its Directors and regulators. Companies can only be put into liquidation if they are unable to pay their bills and creditors take action.

  4. mikestallard
    November 20, 2007

    I do not understand money at all.
    However, here are some other observations:
    1. Mr Brown's boasting about having made the Bank of England independent is now revealed as a very dodgy transaction. In fact, now that we can read the small print, we can see what a tricky little fellow the ex Chancellor turns out to be. As a result of this fiddle, the Bank of England was prevented from handling the whole thing behind closed doors as it has done so effectively in the past. But no – this time, the new bureaucracy kicked in and caused this terrible disaster. Further proof that the Central Government ought to keep out of matters it simply does not understand.
    2. Of course, if you do not allow discussion, rumours spread. The sums talked about on (leftie) BBC last night were in the region of

  5. Cliff
    November 21, 2007


    I am neither an academic or an economist, however I read on another website, a suggestion that the Post Office should be allowed to buy NR for a nominal amount. This would give both companies access to a vast branch network and allow the PO to diversify.
    Is there any credibility in this idea?
    I notice that a new board has been appointed to NR, have the Government been able to put one or more of their people on that board using the amount of public money as the excuse to justify it?

    Reply: As the taxpayer owns the Post Office that would mean nationalising Northern Rock, which I would not favour. No, the government has not proposed a Director, though they could if they wished in the cirumstances.

  6. Cliff
    November 21, 2007

    Perhaps rather than nationalise NR, perhaps we should de-nationalise the PO and allow it's managers to manage. The PO is closing branches, but it still has many in small villages, the kind of places a building society would be unlikely to see sufficient customers to justify opening a branch, but combine the two services and it may be viable. NR has many branches on high streets. Combine NR and the PO and this may kill two birds with one stone. Both business' are likely to benefit from the takeover/merger. In towns where there are both a PO and a NR branch, one could close and be sold off, this would generate additional working capital for the new company. Both services would then occupy the one building, with each service complementing the other.

    Is the idea at all feasable?

    Reply: I do favour introducing private capital into the Post office with a mixture of new shareholders and employee shares. It is proving difficult enough to get the government to do that, without the complication of also having to arrange a takeover and offer for sale of Northern Rock as part of the package.

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