Wednesday 25 February 2009

When Governments And Commerce Collide

There is a good reason why Governments interfering in commerce is not a good idea and that's because they generally change the rules or allow it to happen. As we have seen in the past with the Railtrack fiasco, even if companies get into trouble, nationalisation should be a place of last resort.

What we are seeing in this financial crisis is a series of knee jerk reactions which typically end up favouring certain businesses and markets over others and the same can be said for individuals. While people with mortgages have had their woes eased, those saving for the long term have been hammered seeing not only their investments trashed heavily in the stock market dive but to add to their heartache their savings are not getting anything either.

Northern Rock

The same can be said of bondholders at Northern Rock. While it could be said the bank would have gone bust without Government intervention, people who funded it previously stand to lose out considerably as new proposals are forwarded by the Government-paid clever Consultants swarming all over the Rock.

Northern Rock has now revealed it is to create a 'Bad Bank' of its own to park its 'Toxic Debts' as a spin off so that it can start relending in the mortgage markets where there are lucrative rewards to be made in a new risk-clear legal entity. How very convenient.

Of course, in the real world of commerce such a thing could not happen and certainly not without some recourse in law. However, creditors who hold the bonds fear they will get dumped into the 'Bad Bank' and the Northern Rock bond prices have slumped on the news. It will not have escaped their notice that around £12bn in bonds were held and the new mortgage funding Northern Rock will release will be £14bn.

Bonus Bonanza

In the bizarre world of the bank bail outs and Credit Crunch fiascoes, despite announcing a £1.4bn loss, Northern Rock will be paying its staff and 100 executives a nice chunk of bonuses, principally as they hit their deadlines of paying off £18bn of the £27bn we loaned them. Of course, we as taxpayers get no bonus for helping them out as the buck stops at us but while we hand out money, companies can do what they like with it. I don't suppose we have a great deal of sympathy for the holders of the £12bn of bonds but it must gag in their throat to see what is going on here.

Having clapped themselves on the back for paying us back on time, there is a catch to be heard. Naturally, now that Northern Rock has fulfilled part of its obligation, it can change the rules. It has now decided to start relending in the mortgage market to make fat profits again and therefore it will pay us the rest of the money back at a much slower rate, which means they can pay themselves whacking bonuses on the profits to be made.

We must be mad, but that's what we agreed to.

Government Interference

This all started when the Government took over Bradford & Bingley. They unilaterally rewrote contracts which would delay capital repayments and reduce interest - see, it's easy when you are not subject to the law. This affected what is known as the sub-debt market where these bonds are traded and spreads became far wider as creditors started to panic.

It's fine to do it right now but of course this has long term repercussions. The sub-debt market is a vital area for all companies to raise money by issuing bonds upon which interest is paid at an agreed fixed rate. If the Government is going to start playing God in these markets then potential creditors will just walk away. While that may be a viable risk in the short term to get banks out of the mess they are in, going back to it in the future will be difficult. This has a potential spin off in the equity market where nationalisation plays havoc anyway. In reality, the City is very dependent on what the Government does today to ensure it is a long-term viable centre for capital raising. At this moment, the prognosis does not look too good.

Losses & Losers

Gary Hoffman, CEO at Northern Rock, whose puppet strings are pulled by the Consultant Ron Sandler, confirmed the taxpayer would not be paying anything further than the £3bn of capital we promised in August claiming this was enough capital to manage good and bad assets.

However, capital is being used pretty quickly there. Northern Rock suffered £1.4bn in losses in 2008, writing off £900m of bad debts and they are expected to make significant losses in 2009. The FSA has already had to waive its rules again with Northern Rock on its capital levels, you might have thought now was the most important time to be very hard. The fear is that the £3bn new capital is already blown and that creditors will be the ones holding the new losses.

Never Mind That - Lend!

Northern Rock, under the original plan, was due to return to profit and be free of our generosity by 2012 - which seems long enough, quite frankly. However, Hoffman has now confirmed that the strategy has been 'suspended' to allow it to lend the £14bn over two years at up to 90% loan to value. How nice of them to consult us before informing us they are re-inventing the rules. In fact, it is no longer apparent when Northern Rock will once again be a private company as the executives seem to see a great opportunity to have 'the best of both worlds', i.e. to make whopping profits on loans and capital they have unrestricted access to on their own terms which they can change as and when they like. It's too good to be true - but it is. How a private company would love to have such wonderful terms to raise funds, yet banks are having this luxury.

In fact, having paid back £18bn of its £27bn loan from us, it plans to slow its repayments in order to borrow a further £10bn to support the new lending while its bonus payments are a mere snip at just £9m although senior staff may get deferred bonuses in the form of loan notes - slightly dangerous as Norther Rock now has a policy of changing loan terms whenever it wishes.

We are a generous lot, we taxpayers, you know. We have also granted Bradford & Bingley the right to pay £1.7m in bonuses and a further £1.3m in deferred bonuses to senior managers who busted the company.

Wake up - the coffee smells great!

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