Wednesday, 29 July 2009

Rock Unsolid

Here's a conundrum. The Government stepped in to save Northern Rock in February 2008 by nationalising it. When they did so, they assumed the bank was no longer a going concern and so severely wrote down its value.

By doing so, they offered to pay far lower compensation to shareholders than they should have done. Those shareholders have now run the matter through court and their appeal against the Government's actions and for higher compensation has been defeated.

The Government's argument is that the bank had been loaned £45bn prior to the nationalisation, without which the bank would have failed and therefore the shareholders would have seen their investment reduced to nothing. The Government, therefore argues that they were doing the shareholders a favour.

It is a difficult situation. The Government did indeed rescue Northern Rock but at the time there were other avenues that could have been explored. When nationalised, the entire liabilities of the bank were assumed by the taxpayer, some £100bn and we are by no means clear of danger although the Rock has been paying back considerable amounts of its loan. Danger was unjustifiably increased when the interim CEO, Ron Sandler, somehow allowed the Rock to continue to hand out 125% mortgages, the very product that nearly killed the bank, for a good 6 months after nationalisation. Then Sandler and is team almost unilaterally renegotiated the terms of its loan facilities from the taxpayer in order to offer around £14bn of new mortgages.

There were two alternatives at the time. One was that Northern Rock was sold as a 'going concern' albeit with its liabilities effectively underwritten by the taxpayer for a period to someone like Virgin One who argued that the Rock brand was defunct and that Virgin would revive it by offering their own branded products. The Government argued that the Virgin plan did not inject enough capital into the Rock and therefore it was not viable. The second option was to let it go bust in the same manner as the Fed did with Lehmans and let others pick over the parts of the business which were viable.

In many respects what happened gave the worst of both worlds. The taxpayer ended up covering the entire liability anyway, we gave the loans, we were exposed to the stupid extra 125% loans, we paid the bonuses to the Rock staff just for repaying some of the debt, we pay the vast bills for Sandler and his army of consultants, we allowed the Rock to renegotiate the deal to save itself and the juicy assets of really nice mortgages were tied up in a vehicle called 'Granite' which we do not own. Meanwhile, the shareholders got shafted whereas, arguably, with Virgin's management and skills they could have shared in some future profit as part of the Virgin brand and you can bet your life Sandler, the daft mortgages and bonuses for loan repayments would not have featured in the equation.

There is another aspect to this case, though. As the Credit Crunch unfolded and major bank after major bank revealed their stupidity, the Government actions veered markedly from its action on the Rock. Almost as if they realised they were stupid to have nationalised the Rock, they tried a variety of other methods to save the other banks such as HBOS, Lloyds, and RBS.

Two major cases are very prominent. First, events triggered the Government to virtually force Lloyds to buy HBOS against all anti-competition rules and all good advice. Immediately, both banks came cap in hand to the Treasury and we had to save the entire new group to the extent that we now own nearly 50% of the new Lloyds Group. What the Government did was to fund an anti-competitive takeover that now gives the new Group an unhealthy 28% of the UK mortgage market. The shareholders of both HBOS and Lloyds, in the wake of one of the most ill advised takeovers you could imagine as Lloyds discovered the extent of the HBOS situation as it was not allowed to do full due diligence and pay the right price thanks to Government intervention at the highest level, they also stepped in to save the skins of Lloyds shareholders so that they may benefit in the future from any rise in the market. The Rock shareholders were afforded no such luxury.

Secondly, as Bradford & Bingley sank, the Government allowed Santander, a Spanish bank, to increase its share in the UK market after already buying Abbey and Alliance & Leicester by letting it buy only the bits it wanted - the juicy ones of course. On top of this, the Government later proposed the Asset Protection Scheme which allowed banks to ring-fence their toxic debt and have the taxpayer 'insure it' by paying a premium.

If any or all of the above options had been allowed for Northern Rock, it is arguable that while the shareholders would have lost out in the short term they would have reaped some benefit as the markets recovered as the shareholders of all other banks will. The argument here is that the nationalisation of the Rock was a knee-jerk reaction that cost us all a great deal of money, it was mismanaged and there were alternatives, particularly after the Government sat down and thought about it.

Personally, I was in favour of the Rock going under and then bought for a song by some other bank who would have done a better job than Sandler, who for all his excessive fees has only done the obvious. I do not have a great deal of sympathy for the shareholders in the Rock, even now as it was a bank that had traded on a substantially flawed model that was cruising for a disaster. However, in the light of the actions to save other banks, the shareholders have a very good point. All other banks offered loans, guarantees and capital were effectively saved by the Government and respected the interests of shareholders. The Rock was a fiasco that benefited no one - least of all the British taxpayer.

I dare say, the 'rescue' of the Rock will feature in future Economics lectures, although hopefully long after they have rewritten their text books and fired the lecturers. They got it all so horribly wrong, after all.

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