Having nationalised Northern Rock, why doesn't the government just run it down? That is to say: why not ban the bank from making new loans, close its branches, and order a skeleton staff to concentrate solely on recovering the £110bn of outstanding loans?
Yes, good start.
This idea represented the most potent line of attack against the chancellor yesterday since the thought behind it carries some economic and political weight. Why, for example, should Northern Rock's more successful rivals suffer competition from a state-backed organisation with access to cheap funding?
And, if the quality of Northern Rock's loan book is as high as we are told, where would the danger for the taxpayer lie? The public money would come back slowly, but the vast bulk would be returned within five years. That's how long it would take for most fixed-price deals to expire. When they do, borrowers could be offered uncompetitive rates to persuade them to take their business elsewhere.
Certainly the basic premise has been grasped here, of not distorting the market even further in these awkward circumstances and of not risking even more taxpayers money.
Those arguments are tempting, but let's be clear - in the real world, banking doesn't work that way. To place Northern Rock into run-off - in effect, to nationalise the bank in order to kill it - would open up new dangers.Here we go...
For a start, the day-to-day difficulty of managing operations would be magnified. Most of the head office staff would be made redundant immediately since most are employed to process new mortgage applications, not to collect monthly payments.They can be paid bonuses to stay on, or alternatively, what is the harm in this. Top managers will soon get new jobs.
Most of the branches would also have to be axed. The savings base might become unstable again. The shock might be so great that Northern Rock would be unable to perform even its new humdrum role effectively.Branches to close; good, less money spent on taxpayers behalf. Savings to become unstable, what has that got to do with anything, we are trying to run the business down after all? The final sentence is just meaningless and shows how far any coherent argument has declined already...
There would also a political risk. Not every borrower with a Northern Rock mortgage would be welcome elsewhere. The taxpayer might be left with a rump of poor-quality loans via a process bankers called "adverse selection" - in other words, the good business walks away, and the bad business stays.This is indeed a problem - why the nationalisation was a bad idea in the first place as compared to a liquidation. Keeping the bank open to make more dodgy loans is not really the answer though is it?
That sounds like terrific news for rival lenders, but not for the taxpayer or for borrowers.The borrowers in the above definition have been mis-sold too, Nils wants more of this does he?
In the end, a fudge - expressed by the chancellor's "business as usual" phrase - is probably the most practical solution, even if it feels unsatisfactory. Of course, Alistair Darling doesn't mean his words exactly: operating within EU rules on state aid is not normal business for most organisations. But we know what he was getting at: Northern Rock's new mission is to return to being a provincial medium-sized bank as quietly as possible.Eh? This had not been explicitly stated anywhere (certainly not in the legislation), no one knows what Ron Sandler is going to do. The idea that the Rock can become a provisional bank with £100 billion of taxpayers money backing it is simply fantastical.
If that is the course set by Northern Rock's new chairman, Ron Sandler, many of the grumbles heard yesterday will fade. The European Union is highly unlikely to rock the boat. It does so only when France and Germany protest, and those two countries may be looking to bail out some of their own banks before long. It is not as if Northern Rock, as a purely UK lender, threatens foreign banks.The EU has already bailed out the European banks and I don't see where the confidence comes from that there is no desire to poke the awkward man of Europe. I would expect nothing less of the French.
Rival high-street banks in the UK would also be well advised not to complain too loudly. They haven't been put out of business by other state-supported enterprises such as National Savings and the Post Office. If Northern Rock settles for a quieter life as a smaller operation, that is not such a bad outcome for the big boys: an upstart will have been put back in its place.So everyone should accept market distortion as fair enough? Is it not enough that the banks already had to compete with a competitor who was breaking the rules and was not monitored closely enough by the FSA? No the socialists say time to settle down and just accept fate; right at the beginning of the house market downturn too. Easy to give advice when it is not yourself affected?
The open question is whether Sandler will play along. Yesterday he boasted that Rock would "compete vigorously" within EU rules. We shall see, but the comment seemed designed primarily to sustain morale internally.Sandler will say what he is told to by his puppet masters, of course.
The reality, as Sandler will soon have to acknowledge, is that substantial redundancies are inevitable and that Northern Rock will have to fund its mortgage activity more conservatively. That will mean shrinking the business - but not shrinking it out of existence to satisfy an economic theory that wouldn't help taxpayers in practice.The concept of going concern, one of the first principles of accounting, seems to be passed by here. Shrinking the Rock is happening by market forces anyway - with the real market sure to bankrput the bank, anything the government does is simply life-support for a John Doe.
It is easier to answer the other question left open yesterday - what should Northern Rock's shareholders get? The answer is nothing. The shares were worthless without government support so investors deserve no compensation. It's as simple as that.Or you could argue, that the shares became worth nothing BECAUSE of the bungled Government intervention; as I am sure the litigants will be doing. I don't see the European shareholders having been left out to dry in the same way.
The hedge funds can argue that the assets are worth 400p or so, but that's a book value.
If the asset sales cover more than all the outstanding liabilities then they should be paid. But we won't find out now, because there will be no asset sales until the court cases are dismissed.
Value on the ground depended on Northern Rock being in business and being viable. Without support from the Bank of England - support that went well beyond the role of "lender of last resort" - Northern Rock's fate would have been administration. In that event, shareholders would have stood firmly at the end of the queue.
Yes, but as above, that does not mean you get nothing Nils; such a lack of understanding here it is frightening.
It's tough on small shareholders, but the Johnny-come-lately hedge funds pushed their luck too far. Threatening to vote down the Virgin deal was a dumb tactic.
They took a risk and now will have to fight the hard way, I certainly don't write-off entirely their chances yet. The Virgin deal was clearly the best idea of late, but Brown hates the idea of profits or success for anyone but himself. Now we are landed with all the risk and with little hope of reward.