Northern Rock – the fourth way

The choices for handling Northern Rock have been narrowed to three by the spinners for the government and the Lib Dems.

The first is sale of the bank to a third party who could repay some of the government loans immediately, and take care of Northern’s financing needs thereafter. The best chance of doing this was the Lloyds expression of interest before the crisis became acute. The authorities failed to respond positively.

Since then we have not been told of any large organisation emerging as a bidder which has the balance sheet strength to take it on and solve the problem itself. The two preferred? bidders need access to substantial market funding, and one only wishes to buy a minority stake. Even Lloyds needed financial help from government and the markets, as Northern is big even for a bank the size of Lloyds. Anyone needing access to substantial market funding will face the same kind of difficulties that caused the problem in the first place the drying up of credit in markets.

Everyone agrees the sale to a third party who could solve the financing problem would be ideal, although there remains scope for disagreement about how to value the existing shareholder interest in such circumstances, and scope for disagreement about how much money taxpayers should expect to get back immediately, and for how long the remaining money could be lent to the new owners.

The second is nationalisation, the Lib Dem’s recommended solution?. The new Lib Dem leader showed his folly by rushing in to back this irresponsible proposal as one of his first acts, after appointing a pop star as an adviser! He clearly does not want to be taken seriously and does not think things through before issuing the press release.

Taking on over ??100 billion of risk in a single mortgage bank at a time of falling house prices and credit crunch is too big a bet for taxpayers. Many of us think taking on ??25 billion of risk is dangerous, but quadrupling that is absurd. The government itself has stupidly increased our risk by an amount the Chancellor told us on December 19th he could not quantify! It shows they are being far too cavalier with our money.

As the Lib Dems themselves admit, the government would not bring any especial expertise to running a mortgage bank and would need to seek professional management from the City. They say it would be temporary, leading to a sale at a later date. They forget that nationalising would mean the taxpayer had to pay for any one off losses or write downs that may be necessary on inspecting the books, and for any running losses the bank might incur under nationalised management.

If it turns out the bank cannot sustain its current level of employment, the taxpayer will have to pay for the redundancies. If the bank needs to expand its branch network or invest in new computers, the taxpayer will have to make a judgement about that use of public money as opposed to school and hospital spending. Given the scale of Northern Rock total liabilities bigger than the health budget any government would be mad to take on those risks. Just losing 1% of the assets costs more than ??1000 million.

The third is Administration. The government could demand repayment of its loans (subject to any legal promises it has made about their duration, which the government refuses to tell taxpayers and Parliament) which could trigger administration in current circumstances as there is no lender prepared to replace the taxpayer at the moment. That too would be a foolish policy. Shareholders would be aggrieved, as they have been told by the authorities that their bank is solvent and been led to believe taxpayer funding will see it over a difficult period. There is no good market in mortgages and the other principal assets Northern Rock owns, so any fire sale at these levels would guarantee the taxpayer lost money. The Administrator is no more likely to find a big buyer for the whole bank than the current auction team. There cannot be any potentially interested party in the world who is unaware of the sale process. If the government favoured this route it should have refused to lend the bank any money in the first place so no public money was at risk.

There is a fourth option which needs proper discussion. I call it the tough bank manager? approach.

The option starts from where the government has got us from the position where taxpayers have lent money and guaranteed loans but do not own the mortgage bank. It recognises that when you are in a hole you should stop digging. We have to accept that the Treasury/Bank of England combination are the principal bankers to Northern Rock. It is high time they started acting as a bank manager faced with an over borrowed client who cannot repay in a timely way.

They need to:

1. Explain the limits of their funding to Northern.
2. Set out the interest rate and interest payment dates for the loans.
3. Set out a schedule for capital repayments.
4. Take all the asset cover there is left in Northern to secure their huge loans.
5. Insist on daily cash and profit monitoring.
6. Place a cash sweep on the business that returns surplus cash to the taxpayer at regular intervals.
7. Insist on approving all increased spending of any kind on capital and revenue account.

The repayment schedule should not expect repayments currently, whilst the main banks are trying to arrange their own affairs to show strong balance sheets for the year end. It should start phased capital repayments later in 2008. It would be up to Northern’s management to decide whether these repayments could be met from trading profits and cash generated within the business, or from refinancing in commercial markets, or from selling assets. Where assets are sold, the government team needs to insist on a minimum price to protect its asset cover position.

The extraordinary thing is that apparently many of these basics of banking have not been observed by the nation’s top financial team. The Chancellor on December 19th in the news conference once again told us little. I hope they are doing more than they are saying, but there is no evidence that they done a good job on securing the taxpayers position, either by means of securing full specific asset cover or by means of repayment schedules that are tough but achievable. It’s high time they started. We are told they have asset cover for the loans, but specific questions have not been answered about how the protection works. There has been no hint of any repayment schedule.

It appears they hoped the Branson bid, and then the nationalisation idea, would reassure depositors, reducing the pressure for taxpayers to put up more money to replace lost deposits. The best way to secure the deposit base is to take strong and sensible action, so it looks as if the government as bank manager has a professional grip on its over borrowed customer, and will stand behind them until it is sorted out. If a buyer emerges who can raise the necessary money then all well and good the bank manager can agree to the sale if that is what shareholders want to do, having secured the taxpayers’ interests.

All this assumes Northern is a solvent business which we know it has to be as the regulators are letting it trade. Assuming they are right there is no need for taxpayers to lose a penny so why won’t the Prime Minister repeat his promise about that? His hesitation damages confidence. If they nationalise it the taxpayer is likely to end up with a huge bill given the past track record with nationalised businesses, as well as legal actions from unhappy shareholders assuming they offer little or no compensation to them.

I naturally wish those trying to sell Northern every success in finding a good answer, but I do want the government to protect the taxpayers’ money fully in those negotiations.

2 Comments

  1. Mrs Smallprint
    December 20, 2007

    Hi John

    I do hope someone out there is listening, this seems like a sensible approach to me. I’m just waiting to see how long it is before the question is asked whether any of the big bank’s accounts showed “a true and fair view”?

    The valuation of the “loan assets” is the crunch question, how were they valued previously and what checks were made that the valuations were reasonable?

    How did our regulatory system allow this to happen?

    So many questions, so far no proper answers.

  2. affa
    December 20, 2007

    NR, being weak, merely displays the syndrome of a widespread flu (bank lending system failure).

    Imagine prices of antiibiotics surging, all supermarkets hoarding inventories (ie speculating). Patients suffer. Surely government should take over and start dispensing antibiotics directly to patients. Not nationalise (shoot) the patients.

    Imagine fuel prices surging, petrol kiosks hoarding instead of selling. Public transport fails. Surely government should intervene and sell directly, rather than punish everyone for not storing up antibiotics and fuels.

    Banks specialise in lending. When they fail, government lends direct, not letting borrowers fall one by one, so that borrowers specialise on their own business. Lender of last resort.

    5 central banks realise this. They focus on the flu, not the syndrome.

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