Following on from the debate in Parliament last night, in which John McDonnell MP rightly raised concerns expressed on this blog about Granite and Northern Rock I have this morning written a note on this whole issue and the implications it has for the Northern Rock nationalisation. It reads as follows:
Northern Rock raised the finance it needed to issue its mortgages by issuing debt through a series of companies all sharing the name 'Granite'. More than £40 billion is involved. The mortgages in question are the highest quality debts that Northern Rock might have issued.
The Granite companies are legally not part of Northern Rock. They are owned by a charitable trust established by Northern Rock for the supposed (but not actual) benefit of a charity for the benefit of disabled children in the North East of England. This wholly artificial structure means that they can be considered completely legal distinct from Northern Rock and can be considered 'off balance sheet'.
The trust is in part administered through Jersey. Some tax savings may arise as a result.
Many advisers to Norther Rock have undoubtedly benefited from this arrangement.
In practice Northern Rock considered it controlled the Granite companies even though legally they were quite distinct. As such it has included them in its audited accounts. This was misleading. It claimed as its own assets which it did not own. In doing so it represented that some of its best mortgages were available for it to use to grant security when they did in fact already belong to a legally separate company, with the security on them already being wholly pledged to other people.
However, although that security had been granted to other people Northern Rock had not eliminated the risk on the Granite debt from its own affairs. This was because the money Granite borrowed was relatively short term (a few years at a time, with the whole debt being due for repayment over a relatively short number of years) whilst the mortgages Norther Rock offered using Granite money were granted over the long term (25 years or more). If when Granite becomes due to repay the sums it has borrowed to its financiers then if it is unable to do so Northern Rock has to step in to make good the deficit. This is exactly the scenario that plunged Northern Rock into its crisis last year.
This poses an enormous problem for the nationalisation programme. Northern Rock does not own Granite. It is however wholly responsible for it. It's officially 'on' its balance sheet in its accounts. But it is legally 'off' its balance sheet when it comes to getting hold of its assets as the basis for the security of the sums owed the Treasury: these assets are instead already beholden to others.
When the sums in question represent more than 40% of the assets of Northern Rock this is not an issue that can be left to be dealt with later: this issue is at the core of the nationalisation agenda for Northern Rock.
The government has called for greater transparency in finance. It has criticised the use of 'off balance sheet' structures and artificial financing mechanisms. Granite is all these things. It has to take a principled stand now. If the directors of Northern Rock could create this abusive structure then they must also now take the steps required to unravel it: to bring all the Granite entities into the ownership of Northern Rock and under its explicit control. Only then will the benefit of these assets be available to the taxpayer. Only then will the whole of the finances of Northern Rock be under state control for the benefit of the taxpayer. Only then can we be sure that 'off balance sheet' methods will not be used to secure benefit for some parties at further cost to the state from now on.
There are no grounds for ambiguity here. Action is needed.
For more information read:
They've got to get this one right.