Curly’s Corner Shop, the blog!

Banking crisis will return to bite Brown!

I foresee that it will not be the spin and deceit, or the control centre mentality over government, or the hiving off of Britain’s gold reserves, or the destruction of pension funds, or the rebuilding of New Labour, that will mark the competence of Gordon Brown and his Premiership and stewardship of the British economy. Rather it will be the financial ramifications of the shoring up of Northern Rock, the Gosforth based bank and lending institution.

The crisis was waiting to happen, the drastic fall in the share price was screaming out that investors knew that the business model was fatally flawed as long ago as the beginning of this year, yet government ministers up to the Chancellor and the Prime Minister ignored the market’s warnings whilst Brown concentrated his mind on whether or not to stall his plans for a general election. Political expediency and the shoring up of thousands of votes in the North East and elsewhere took precedence over financial probity and a “quick fix” was cobbled together to protect the interests of depositors, the man previously known as “the iron chancellor” cowed his colleague Darling into writing an open cheque to keep Northern Rock afloat.

That cheque appears now to have consumed an estimated £24 billion, a significant 20% of the Chancellor’s budget, and all of it belonging to us, the tax payer! £24 billion would fund more than the entire cost of education in this country and will prove to be an absolute millstone to whoever is intent upon buying the Northern Rock. £24 billion pound poured into the black hole of borrowing currently consuming and destroying a business and it’s directors. The fact that Adam Applegarth and various non-executive directors have resigned their positions is indicative of a swift change coming at the top in readiness for a takeover, however changing the driver is no guarantee of changing the direction of this vehicle. Traffic will be one way only, breaking up the bank, hiving off it’s constituent parts in some gargantuan struggle to repay the Treasury.

The Northern Rock memo “Project Wing” which the Northern Rock and Schillings prevented publication of by way of injunctions is still available to see on the internet here, and it was quoted from in the House of Lords by Liberal Lord Oakeshott of Seagrove Bay on Wednesday, as was reported in the Financial Times Alphaville blog at length. Lord Oakeshott said:

“It is pretty hairy stuff. Northern Rock has what are called “together” unsecured loan accounts of £3.3 billion and standalone unsecured loan accounts of another £4.5 billion outstanding. It then claims that it writes only prime mortgage business on its balance sheet. The giveaway in the memorandum is the bank’s stating that the growth has been possible through attractive products and pricing. The problem is that it has been far too attractive. Northern Rock has been pumping out mortgages at unsustainably low interest rates, and as the credit-worthy borrowers who have taken out Northern Rock mortgages during this dash for growth come to the end of their fixed-term mortgages, they will all start to remortgage elsewhere, leaving Northern Rock with an ever increasing proportion of lower-quality loans in a falling housing market.

Its arrears have been low during the past few years because, in a raging-bull market, if borrowers start to struggle, they just sell their house and walk away with the profit. But when house prices are falling, as they clearly are today all over Britain, loans of 100 per cent or more of a house’s value, such as the loan of 127 per cent that I was offered when I rang up three or four weeks ago—taxpayer’s money—quickly turn toxic. They have repossession risk written all over them. The British taxpayer is effectively underwriting a substantial slice of a falling housing market.”

Jeff Randall writing in The Telegraph yesterday was far more damning

The Rock was built on flimsy foundations, but its intrinsic instability was exacerbated greatly by the Prime Minister who, when at No 11, swept away longstanding arrangements for dealing with financial turmoil and established a new “tri-partite” system, involving the Bank of England, the Financial Services Authority and the Treasury.

Put to the test by the run on the Rock, the system proved wholly dysfunctional. In the view of Professor Willem Buiter, a former member of the Bank of England’s Monetary Policy Committee: “Responsibility for this design flaw must be laid at the door of the man who created the arrangement – the former Chancellor and current Prime Minister, Gordon Brown.”

Brown of course is saying little, in the House of Commons he claimed that commercial sensitivity prevented him from disclosing any information, particularly any that might implicate him in the decision to risk such massive amounts of tax payers money. Yet he ought to be displaying the openness and candour which he proclaimed his government would give, he ought to be making clear just how the tax payer will be protected by his fateful decision to throw our cash down Northern Rock’s black hole.

Randall concludes:

When the light of public scrutiny is finally shone on the Rock’s main asset, ie, its lending book, I will be amazed if there are not a few nasty surprises. Rapid expansion of the kind the company undertook is invariably accompanied by a collapse in quality control. Or, as Prof Buiter notes: “Creditworthiness vetting must have slipped.”

Sale documents, prepared by the Rock’s directors, assume that the Bank’s £20 billion-plus line of credit will be extended for the foreseeable future and that interest charges on the loan will be reduced. It is envisaged that by 2010 the Rock will still owe the Old Lady £6 billion (doubtless on knockdown terms).

This is an outrageous – and unacceptable – demand for private profit at public expense. The intention, it seems, is that someone should make off with the gold mine while the rest of us are given the shaft.

Guido Fawkes discloses that one of the resigning non-executive directors Sir Derek Wanless sold over £2.6m of shares at peak prices while still urging thousands of employees and investors to buy shares when the company was facing trouble. He adds:

Sir Derek, sits, like so many other of New Labour’s great and the good, on various government quangos; the Statistics Commission and the National Endowment for Science, Technology and the Arts.

More importantly he chairs Northern Rock’s Risk and Audit committees. If anyone should have known what was coming, it was Gordon’s favourite banker. He had to sign off on all strategic risk management issues.

There will be no rich pickings for any institutional buyers, there will be no satisfactory outcome for the thousands of Northern Rock employees, there will be no hard guarantees for the tax payer, and only limited safeguards for Northern Rock depositors. The bank is a busted flush, it’s brand is broken, and beyond the standard guarantees provided by the government for the first £3,000 of depositors’ investment the Prime Minister and Chancellor should have stood aside and allowed the markets to intervene in their normal fashion. At worst, and against my better instincts, they could have nationalised the bank before slowly and painfully breaking it up.

The decision to open up the Bank of England’s coffers in the way that they did was a miscalculated gamble of the highest order, and one which will come back to bite the Prime Minister in the most damaging manner. Northern Rock will one day prove to be the obstacle that broke New Labour’s ship!