Air Shots

Some while ago I blogged on how many golfers, when faced with an immovable object like a tree blocking their route to the green, will choose to hit through the tree rather than round it in the vain hope that there is more clear space than branch to be hit.

I argued that the reality is that by using a club of a specific loft and length you actually narrow the area of tree you are aiming at and in that 'corridor' of the shot you actually increase not decrease your chances of hitting branches as you increase the amount of space occupied by the branches in the corridor with respect to the total available space in that corridor. When you think about it, you are taking the very randomness of the tree's branch arrangement out of the equation by hitting at it. The logical course of action would be to take the tree completely out of the equation and go around it using two shots rather than risk wasting shots.

I would argue this is precisely what happened on Quantitative Easing (QE) by the Government. In piling a ton of cash at a problem, they viewed the financial crisis as a tree blocking their way to rescue. Their logic was that if you pile so much money at the problem some of it has to get through. But that was the wrong assumption as banks needed an extraordinarily large amount of money to shore up their huge lending gaps - RBS' alone was £161bn and the total QE to date has been £175bn.

What has happened is that the QE has been horded by the banks as free new money which they use to play casino banking or just keep. Very little of it has got into the wider circulation as the recent M4 figures on money supply has shown. In fact, the money measure M4 decreased despite QE.

This was the equivalent of a golfer hitting a ball directly at the tree and hoping they hit a gap to get through. If only someone had stopped and thought what the real cause of the banking crisis was then QE would not have been the best measure to deal with it or at least they could have thought of a better way to introduce it. In fact, by buying bonds in our own debt, they played right into the hands of the very banks that caused the entire problem who had been commanded by the Government and FSA to do precisely what QE allowed them to do - increase their capital to lending ratios without lifting a finger.

In hindsight it was obvious but it has been the modus operandi of the Government in this whole crisis. They have paid millions for duff advice from bankers and think they did the right thing. Now all the real measures of our economy like GDP and money supply show that what they did was either wrong or wrongly executed. You cannot argue with the figures, our management of the crisis was sheer panic measures.

Now we have the great bank sell off bonanza to come. The proposal is that new high street banks will be created in the new market conditions free of encumbrances. Investors are going to have a field day as we split profitable businesses from bad ones and sell them off nice and cheap and just watch how much profit foreign and private investors will make on our business. You can feel exactly what will happen and a few years down the line we will find every single one of our High Street chains of banks will be owned by foreign companies profiting out of our mortgages and lending needs.

You don't believe me? Our utilities have already gone that way in water and power, many High St banks are foreign owned already like Alliance & Leicester, Abbey, HSBC and the Royal Mail will be sold to a foreign company. In each case, the dirty end of the stick will be held by tax payers as we pay the profits of our mortgages to foreign companies.

You could not invent a better strategy to waste tax payers money by constantly leaving them with the bills while the profitable bits of the businesses they bought are sold off. But that is the key to the Government plan - the taxpayer is there to fund the rubbish.

As a quick for instance, the good part of Northern Rock will be sold for £1bn and we will still be owed £27bn when that happens plus the liabilities. Great deal, eh? Just watch the rest of them.

Meanwhile, us would-be golfers have learnt our lesson - it's better to hit round the tree than at it.

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.