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"?
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
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.....