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Northern Rock around the Clock

by ChrisCook Fri Jan 18th, 2008 at 07:22:00 PM EST

Government bails out Shareholders?

Robert Peston, the BBC business editor has always had the Inside Track on Northern Rock, so that we see after a week of dithering Gordon has finally decided to bail out the shareholders.

Or rather, that's what it looks like at first blush.

Prime Minister Gordon Brown has backed a plan from bankers Goldman Sachs to convert the Bank of England's loans to Northern Rock into bonds for sale.

These bonds would stay on the public sector balance sheet until conditions improve in financial markets.

They would then be sold to investors in small parcels every few months.

The sales would take place as and when financial institutions regain their appetite for such investments.

And they would be guaranteed by the government, rather than by a private sector insurer.

They would use a special purpose vehicle as a "wrapper" for this "securitisation"

Under the Goldman Sachs plan, the Rock's assets would be put into a special purpose vehicle.

This special purpose vehicle would then sell bonds over the coming months and years, as markets recover.

The key questions are:

(a) what rate will these bonds be paying?

(Since this constitutes a major part of Northern Rock's funding costs, and directly affects their profit); and

(b) what will the Government get for their guarantee?

(Again, a cost affecting shareholders)

As Peston says

On those terms, it will be difficult for Northern Rock not to agree a deal with either the Virgin consortium or Olivant - the private sector groups vying for control of Northern Rock.

But what about the "tax-payer"?

Taxpayer exposure

In theory, this would gradually reduce the taxpayers' exposure to the Rock.

A substantial taxpayer exposure, of tens of billions of pounds - in the form of direct loans and guarantees to other lenders and depositors - could remain in place for years. However the Rock would be expected to pay a fee to the government in return for this substantial support

Well: maybe.

We have discussed in detail on ET exactly what effect on the poor bloody taxpayer a default would have. Personally I believe that what the taxpayer has never had, the taxpayer would never miss.

ie the effect would be the same as burning a few skip loads of time-expired bank-notes.

However, some on ET believe the effect would be inflationary.

I don't see how defaults (which essentially destroy money) can be inflationary.


The government may well be attacked by opposition parties for subsidising what could turn out to be vast profits for any future private sector controller of the Rock, such as Sir Richard Branson's Virgin Group.

Dead right. This is potentially the original "licence to print money".

Whatever the effect on inflation, this is a potential goldmine for Branson's Virgin or Olivant. And if it isn't, they simply won't do it.

There must be another way.

The point ignored in all this (in fact, almost deliberately concealed) is that Bank of England credit costs nothing to create, and the "seignorage" on the money minted by the Bank of England to loan to Northern Wreck has been rolling in at the rate of £25m a week plus. These seignorage profits actually will in due course accrue to the tax-payer, as they do now in respect of banknotes in circulation.

The real value provided by Banks aka Credit Institutions (beyond clearing system administration) is that of a guarantee, and they back this guarantee with a pool of Capital as required by the Bank of International Settlements.

The Bank of England, on the other hand, backs their guarantee with nothing at all other than trust and faith.

A Northern Rock Partnership?
No prizes for guessing what I think should be done instead. In my view, a fee should be paid by Northern Rock to the Government for the use of the guarantee into a "Default Pool", and this accumulating fee should form Equity ranking alongside that of the existing shareholders.

This could be accomplished by putting the assets into the hands of a Trustee/Custodian - where most assets are already (quite unknown to the beneficiary of the Trust - the Northern Down's Syndrome Association!), via the opaque "Granite" SIV.

An LLP could be used as a framework / Special Purpose Vehicle for what would be a revenue sharing "Capital Partnership" between Investors and Managers instantly recognisable to Islamic investors.

In this way:

(a) the risks and rewards could be shared equitably, which I would bet my bottom dollar they will not be in the bailout as proposed by Goldman;

(b) there could be a single asset class consisting of proportional "units" or "nth's" in Northern Rock's net revenues after a provision is made into the Pool.

It will be interesting to see what the Northern Rock share price does on Monday.....


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Thank you for the diary.

I do not pretend to fully understand high finance, but am I right in understanding that the Goldman Sachs plan combines more of the sort of exotic financial instruments unrelated to any real assets, which has caused problems. If so, it presumably only works because the Bank of England guarantees instruments which would have little or no value in a free market.

It seems to me it would have been cheaper for the taxpayer to let the bank be put into receivership or be liquidated as insolvent. It would then be right for the taxpayer to guarantee to reimburse any deposits lost as a result, as although this is beyond the limited deposit guarantee scheme I think most people would accept that the depositors had done nothing wrong.

As it is the banking sector can now see that the state will go to any lengths to preserve any banking institution; however recklessly it has been managed. This removes any incentive for banks to adopt more sensible business models.

by Gary J on Fri Jan 18th, 2008 at 08:31:38 PM EST
am I right in understanding that the Goldman Sachs plan combines more of the sort of exotic financial instruments unrelated to any real assets, which has caused problems.

I don't think so.

I think that by banking standards this is quite straightforward, although the mechanics of getting the Northern Rock "assets" (ie genuine mortgage loans a large chunk of which have been placed "off-balance sheet" into the "Granite" SIV) into a new vehicle are likely to provide much gainful employment for high-powered lawyers.

I am sure that others on ET have a better understanding of the nuts and bolts of securitisation than I do.

But everyone appears to be missing the point which is that there is no "tax-payers money" involved here. This is money being conjured out of thin air by the Bank of England which has never been anywhere near a tax-payer.

If you don't believe me, have a look at what Tim Congdon had to say in the FT....

I have not seen this Financial Pornography anywhere else since then: no decent newspaper will print it.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Fri Jan 18th, 2008 at 08:50:57 PM EST
[ Parent ]
One of the major disadvantages I see is that the management team that created the problem in the first place remian in place to spread further mayhem.

Additionally I understand that billions of taxpayer's money will be tied up for a considerable time, not just months, but years.

which leads to a question : NR was a casualty of the sub-prime debacle. The question is that it's unlikely to be the only one working on the basis that as the US economy tanks sub-prime loan ratings will continue to deteriorate over time. So there is a lot of stuff to happpen even yet. Are the govt willing to repeat this level of market support to avoid the apparent ideological no-no of nationalisation again and again ? At what point might they begin to realise that chucking good money after bad is a deeply stupid thing to do ?

keep to the Fen Causeway

by Helen (lareinagal at yahoo dot co dot uk) on Sat Jan 19th, 2008 at 02:20:56 PM EST
Additionally I understand that billions of taxpayer's money will be tied up for a considerable time, not just months, but years.

As above, IMHO you share with 99.9999% of the poulation the general misapprehension that taxpayer's money has gone anywhere near Northern Rock.

It hasn't. We are talking about Bank of England "fiat" money here, created out of nothing - as with bank notes, but without even the cost of printing - and then loaned to Northern Rock.

Are the govt willing to repeat this level of market support to avoid the apparent ideological no-no of nationalisation again and again ? At what point might they begin to realise that chucking good money after bad is a deeply stupid thing to do

The BoE's role is to provide the necessary liquidity, and that costs literally nothing to create.

What does (or should) cost money is a guarantee.

I don't see why the government (ie the Treasury) should not provide guarantees to any Bank's lending (they do guarantee deposits) and charge a fee or provision for the use of it, which will then go into "Default Pools" to be managed by Banks as service providers.

Banks would then share in the default experience - to keep them honest - by putting their own Equity on the line to back the guarantee.

You are right that this is lots of stuff to happen yet, due to the fact that there is a lot of toxic wholesale waste out there and because the retail depositor is a dying breed......

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Sat Jan 19th, 2008 at 02:37:23 PM EST
[ Parent ]


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