Monday, November 19, 2007
Should Northern Rock be nationalised?
Posted by David Smith at 02:30 PM
Category: Thoughts and responses

Northern Rock's shares have fallen again because,understandably, nobody wants to pay much to take it over. The Bank of England has already lent £20-25 billion and the Treasury guarantee to depositors is perhaps a liability of a further £15 billion, making some £40 billion in all.

Why doesn't the government simply nationalise it for £1, as Vince Cable, acting Liberal Democrat leader and some commentators have suggested? After all, the Bank took a specialist lender, National Mortgage Bank, on to its books for £1 in 1994. And the government effectively renationalised Railtrack.

If this option is being considered by the Treasury, and I have no reason to think it is, it should be firmly rejected. To me, if not others, it verges on the bizarre. National Mortgage Bank was first given assistance by the Bank in 1991, its business was then wound down by the simple method of not cutting mortgage rates when those in the economy were tumbling. The company the Bank took on was a shell. That may one day be the case for Northern Rock but we are a long way away from that.

As for Railtrack, a business essentially carrying out transport operations on behalf of the government, this was a case of a recently privatised business being taken back, or rather being given the status of a company limited by guarantee. Northern Rock has never been publicly owned. Nor would the government want to get into the kind of legal and political flak it endured over Railtrack.

As things stand, not only would the nationalisation of Northern Rock for £1 cheat long-term shareholders but it could also mean an substantial increase in the government's liabilities. Would wholesale lenders want to continue lending to the Rock? If not, that liability could get up to £100 billion, all of it on the government's books. So nationalisation should be left where it belongs, in the history books.

Comments

I agree nationalisation should be a last resort, but given the events of today and the bids that seem to be coming through, the government may be left with little other choice. Certainly I still feel that whatever happens the shareholders will be wiped out.

The 5 year subordinated loan from the Treasury which came to light this morning, which NRK is using to pay the interest on the BoE loan, is genuine state aid. Surely it is illegal under EU state aid restrictions?

Posted by: Minh at November 19, 2007 03:06 PM

I don't understand why the nationalisation of Northern Rock for £1 would cheat long-term shareholders. They bought shares in a company that had a flawed business model and as a result is now essentially worthless. They should have done their homework. Why should they get any money back?

Posted by: Top Cat at November 19, 2007 11:23 PM

Not necessarily getting why nobody would be willing to lend to Northern if it were nationalised? Wouldn't the support of the state increase its credibility?

Otherwise, I agree that privatisation may be a burden for state's budget...

Remy Piwowarski
ECONOMICS INTERNATIONAL Open Forum
http://economicsinternational.blogspot.com/

Posted by: Remy Piwowarski at November 20, 2007 12:16 AM

of course, I meant nationalisation...

Remy Piwowarski
ECONOMICS INTERNATIONAL Open Forum
http://economicsinternational.blogspot.com/

Posted by: Remy Piwowarski at November 20, 2007 12:18 AM

If it becomes clear the public purse will never get its money back then nationalisation may be the only option. But i think it is a last resort. The government doest want those liabilities, rightly so!

Posted by: JohnofScribbleSheet at November 20, 2007 10:13 AM

Surely the problem is that no potential buyer will take NR on at a price that will satisfy the shareholders (or at all, without further state guarantees). The consequence would appear to be that HMG either forces a giveaway, in which case thousands of shareholders will be up in arms (and many jobs lost in the North East); or nationalises the company. A knock-down sale will require HMG to write off some taxpayers money, as well as bunging quite a lot more of it in the direction of whichever company takes it over. If the business is to keep going it will need further lines of credit. IMO this will be a long-running saga which will wreck NuLabour's reputation for financial competence and cost it the next election. If I were Brown and Darling I would grasp the nettle, nationalise NR and allow public interest in the story to die. Your comments David seem to be directed to why this nationalisation would be different from others previous, which is fair enough, rather than why it wouldn't work or would be less advantageous than the alternatives.

Posted by: bears all at November 20, 2007 11:34 AM

Would lenders want to keep funding a nationalised Northern Rock? Perhaps, because there money would be guaranteed by the government. Either way, however, the taxpayers' liability would increase.

On the central point, nationalisation is generally a bad idea, unless there are exceptional grounds for it. Legally, the government has no more right to nationalise Northern Rock for £1 than it does to buy your house for £1. I think it would have to force the company into administration by calling in the loans and then take control of it to ensure an orderly rundown of the business. As long as there are alternatives to that, they are almost bound to be better.

Posted by: David Smith at November 20, 2007 11:54 AM

In response to Top Cat, NRK may have had a slightly flawed business model, but the real problem was created by the credit crunch in the US markets,ans the subsequent panic brought on by the media. No shareholder could have predicted this state of affairs, and so blaming them seems narrow minded

Posted by: Tom Blight at November 20, 2007 12:18 PM

To me it looks like nationalising and then an orderly rundown of the business is the only option. At a fundamental level, can Northern Rock really ever expect to gain any new custom? As a brand it is now totally screwed. Securitisation has meant that the balancing act of assets and liabilities is exceedingly fragile, while the share price is maintained by expectations of future earnings. So, the current value in the company is paper thin, and the future earnings just aren't going to be there. That's why the share price has plummeted. The market already knows this. I find it unlikely that anyone would be prepared to take on the risk of attempting to revive the brand. Why bother?

Posted by: David Bassett at November 20, 2007 12:41 PM

David, if "nationalisation is generally a bad idea, unless there are exceptional grounds for it", I'm wondering how much more exceptional things would have to get before you would consider it.

What sort of price would any rational bidder offer for NR, post credit-crunch, without guarantees from the BoE of an unlimited stream of capital to keep the mortgage book going? How would such a stream be consistent with EU rules?

Posted by: bears all at November 20, 2007 12:48 PM

The fact is that bidders are placing a value on it. As for the EU rules on state aid, thier purpose was to prevent firms in some EU member states gaining advantage at the expense of those in others. I cannot see how that applies in current circumstances. If lender of last resort lending was going to continue beyond February to Northern Rock, which despite the niceties of having to seek EU approval it was, I cannot see why it should continue under new ownership.

We don't yet have enough detail on the bids, but ones that involve a new board and management team and a minority stake in the business seem to me to have a lot going for them.

I agree about the fatal damage to the brand, which may be one of the biggest challenges. How about New Northern Rock? It has worked before.

Posted by: David Smith at November 20, 2007 01:01 PM

David,

Forgive me if I am a bit dim here, but the LIBOR rate reached 6.45% just recently and the BOE seem hell bent on bringing their IR down if they can possibly get away with it without a run on the pound.

Now I did say earlier on this blog (and others did I thought) that IR's should be about 6.25 - 6.5% before XMAS. I don't think the fellow bloggers liked that. But agreed, I was a bit indecisive and thought they may fall as well in view of the debacle in August/September.

But truthfully who is right. Should they fall (I think there will be massive pressure on Mr. King by our Prime Minister, Unelect, to cut)? Or should they rise (taking the LIBOR rate as a slight hint)?

Fancy coming off the fence?

Posted by: Pete Balchin, Solicitor at November 20, 2007 04:40 PM

In response to Tom Blight, if Northern Rock's difficulties were caused by market conditions in the US rather than by its own strategy, why haven't any other major UK lenders gone down? Northern Rock must have been doing SOMETHING different to all the rest. And as for no one seeing it coming, I am sure that all the punters who made a packet from shorting Northern Rock in the months before the crisis (myself included) will disagree. At the end of the day - if you are going to buy shares (or lend money), do your homework.

Posted by: Top Cat at November 20, 2007 06:33 PM

Pete Balchin, Solicitor, is as off-the-point as ever and typically irritating. I give my view on interest rates very often, and at the least before every MPC meeting. But just to give you a sneak preview, I won't be calling for rates to rise in line with Libor, not least because the effect of that would be to push Libor higher. In fact, I can't think of a much more barking idea.

Anyway, back to the point. The trouble is that there are two types of Northern Rock shareholders, the professionals who indeed should have gone in with their eyes wide open and did, and the tens of thousands of small investors, many of them former members of the Northern Rock building society, who could not reasonably have been expected to be aware of Northern Rock's business model and its vulnerabilities. But even the professionals can't simply have their shareholdings reduced to nothing at the stroke of the government's pen.

Posted by: David Smith at November 20, 2007 09:24 PM

True I don't understand Economics as well as your esteemed self, but I should have thought that if LIBOR rates remian so high and the BOE continue to lend money at say a base point below, then this seems to mean the BOE will just continue to print money to do it ?

Perhaps you would like to correct me David. Where will they get the money?

Posted by: Pete Balchin, Solicitor at November 20, 2007 09:49 PM

Oh no. Here's a simple guide to the Bank of England's money market operations: http://www.bankofengland.co.uk/markets/money/index.htm

Posted by: David Smith at November 20, 2007 10:08 PM

David, when you wrote that "The fact is that bidders are placing a value on it", did you have in mind the kind of value apparently placed on Northern Rock by J C Flowers? Less than 10p a share, according to the Graun.

Posted by: bears all at November 21, 2007 09:44 AM

Well, it's more than £1 for the whole company - but I think some of the other bids are higher than that.

Posted by: David Smith at November 21, 2007 10:04 AM

Hmm, sell my house to the government for a pound, and in return they'd lend me 20 billion for a year at 7%. Where can I sign up for that deal?

Posted by: RichB at November 21, 2007 03:02 PM

David,

With Paragon literally gone, I suppose one day you may come to the conclusion that you can't just print money to give to the consumers.

Posted by: Pete Balchin, Solicitor at November 21, 2007 11:03 PM

Weird - as ever.

Posted by: David Smith at November 22, 2007 12:00 PM

Hi David Smith - re your comments - I think it would have to force the company into administration by calling in the loans and then take control of it to ensure an orderly rundown of the business. As long as there are alternatives to that, they are almost bound to be better.

Surely if the BOE simply refuses to roll over its emergency/last resort loan of a £25bn that would have the same effect?

While it might not be wise to nationalise Northern Rock (just consider the initials NR also match those of Network Rail..ouch) surely if the Govenment is lending so much wonga (a technical term learnt in the pub!) it is entitled to a equity share if things go really pair shaped - in much the same way as bond holders would be.

Also if the Govenment had not insisted on a penal rate of interest but had given a fair or even LIBOR rate then maybe we would not be facing this mess? Brussells might not have liked that option but given Governments responsibility to ensure confidence in the financial system I sure they could of managed it - hell the French get away with it !!!

Another David

Posted by: daveboxley at November 22, 2007 02:46 PM

Yes, the government does have a big stake, and a say, in what happens. The question about how much Northern Rock is paying is a little bit murky. The Bank of England insists it is a penalty rate, i.e. above 6.75% (more than a point above Bank rate), but then there is this mystery of the Treasury subordinated loan, referred to earlier, which implies the Treasury, for the moment, is picking up some of Northern Rock's interest bill. All Alistair Darling has done on this is question the numbers associated with this loan, not its existence.

Posted by: David Smith at November 22, 2007 03:04 PM

"The trouble is that there are two types of Northern Rock shareholders, the professionals who indeed should have gone in with their eyes wide open and did, and the tens of thousands of small investors, many of them former members of the Northern Rock building society, who could not reasonably have been expected to be aware of Northern Rock's business model and its vulnerabilities. But even the professionals can't simply have their shareholdings reduced to nothing at the stroke of the government's pen."

Why ever not? If you want your money to be absolutely safe, put it in a safe rather than in shares. David, you seem to be suggesting that investors should reap the rewards of investing in shares of companies like Northern Rock but should be insulated by the government from big losses if things go wrong. Reward without risk. Privatise the profits, socialise the losses.

My father lost his money everytime he dabbled in shares. Can he have his money back too?

Posted by: Top Cat at November 22, 2007 09:41 PM

Don't think you've understood the point. It may indeed be that Northern Rock shareholders lose everything and, as you say, governments cannot indemnify shareholders against their losses. By the same token, however, governments cannot simply expropriate shareholdings that have a market value, however small.

Posted by: David Smith at November 23, 2007 08:56 PM

The plan proposed will mean that Virgin Money, the group’s personal finance operation, will merge with Northern Rock. Cash will be pumped into Virgin Money, valuing it at around £250 million, and in return the Virgin consortium will take a stake of between 50 per cent and 60 per cent.

That is expected to be followed by a deeply discounted rights issue – likely to be controversial with existing shareholders – because it will value the new shares at somewhere between 20p and 40p each. Northern Rock ended last week trading at 86p, valuing it at £362 million.

Formal approval by the Treasury was granted yesterday evening, after a weekend of talks, during which the number of bidders was gradually whittled down. Virgin’s bid includes an immediate repayment of £11 billion of the £25 billion that the bank owes to the Bank of England.

The Virgin consortium also includes Wilbur Ross, the American distressed debt investor, AIG, the insurance giant, Toscafund, a hedge fund, and First Eastern Investment Group, a Hong Kong-based finance house It is backed by RBS and Citigroup. Sir Brian Pitman, the former Lloyds TSB chief executive, is expected to become the Rock’s chairman.

Virgin Money is a UK-based financial services company owned by the Virgin Group and founded by Sir Richard Branson in March 1995. It was originally known as Virgin Direct, and pioneered index tracking by launching the a value Personal Equity Plan into the market. Virgin Money currently offers the Virgin Credit Card (provided by MBNA), a prepaid debit card, loans, mortgages, cancer cover, insurance, savings accounts and pensions.

Business Wire, July 6, 2005
NEW YORK -- Fitch Ratings affirms the classes A, B, and C ratings assigned to all outstanding series issued by the BA Master Credit Card Trust, Fleet Credit Card Master Trust II, MBNA Credit Card Master Note Trust, and the MBNA Master Credit Card Trust II, including MBNA's series 2001-Emerald notes following Bank of America Corporation's (BAC) announced purchase of MBNA Corporation (MBNA). The affirmation affects approximately $67.9 billion of credit card debt.

As of June 30, 2005, the MBNA Credit Card Master Trust II contained roughly $66.6 billion in principal receivables which supported approximately $61.1 billion in outstanding investor certificates and notes. Collateral performance metrics continue to be within Fitch's expectations.

Posted by: bobby at November 26, 2007 06:15 AM

OK, MBNA....is now Bank Of America!!

Where do you think these crooks will find $51 Billion US???

Credit card debt!!!!


Virgin Money is a UK-based financial services company owned by the Virgin Group and founded by Sir Richard Branson in March 1995. It was originally known as Virgin Direct, and pioneered index tracking by launching the a value Personal Equity Plan into the market. Virgin Money currently offers the Virgin Credit Card (provided by MBNA), a prepaid debit card, loans, mortgages, cancer cover, insurance, savings accounts and pensions.

Business Wire, July 6, 2005
NEW YORK -- Fitch Ratings affirms the classes A, B, and C ratings assigned to all outstanding series issued by the BA Master Credit Card Trust, Fleet Credit Card Master Trust II, MBNA Credit Card Master Note Trust, and the MBNA Master Credit Card Trust II, including MBNA's series 2001-Emerald notes following Bank of America Corporation's (BAC) announced purchase of MBNA Corporation (MBNA). The affirmation affects approximately $67.9 billion of credit card debt.

As of June 30, 2005, the MBNA Credit Card Master Trust II contained roughly $66.6 billion in principal receivables which supported approximately $61.1 billion in outstanding investor certificates and notes. Collateral performance metrics continue to be within Fitch's expectations.

Posted by: bob at November 26, 2007 06:20 AM

Calm down, you're adding two and two and making, not just five, but a rather larger number. Whatever the rights and wrongs of the Virgin deal, MBNA is simply a service provider to Virgin Money - it runs its credit card - and has no stake in it. These arrangements are common in the financial services industry. As I say, don't confuse this with ownership.

Posted by: David Smith at November 26, 2007 08:55 AM

Thanks to all
Your posts have helped me with some good arguments for what strategic recommendations i can suggest for Northern Rock in my BA Strategy Exam

Posted by: Kelly at January 7, 2008 12:37 PM