It is ten years ago today that Northern Rock failed. I will be speaking at a Tax Justice Network organised event at the Royal Society of Arts this evening to mark the occasion.
I have particular association with what happened at the time. I reproduce below what was the first of many blogs that I wrote on the subject. This one was just three days later, making me one of the first people, if not the first person, to ask the questions which eventually were seen as core to this issue on matters such as securitisation, a shadow bank, the use of orphan entities, the abuse of offshore and structuring via special purpose vehicles. Back then most people had never heard of many of these things. Little did they know the price they were to pay for their existence.
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Northern Rock is in trouble because it has financed its mortgage book by borrowing commercial money rather than taking deposits from customers. To do that it has issued ‘commercial paper'. And now no one wants it.
I've looked at that ‘paper'. I'm not surprised no one wants it. Most of this ‘paper' is issued through a long series of special purpose vehicles which re named in its accounts. To get some idea look at this list:
That's near enough £40 billion of notes in issue.
Then look at how just one of these is structured through Granite Master Issuer PLC. The deal structure diagram looks like this:
It gets more complicated though. The securitisation structure looks like this:
All of which is a completely prefabricated farce. How can I say that? Take these facts:
1) Note who the share trustee who owns Granite is — it's a Law Debenture Company. This group exists to provide services to special purpose vehicles. No surprise it has offices in London, New York, Delaware, Hong Kong, the Channel Islands and the Cayman Islands.
2) Granite is actually owned by a Law Debenture subsidiary, not by Northern Rock. I've checked.
3) However it does so as trustee — the beneficial ownership is supposedly explained here (it's in the first diagram above as well):
The entire issued share capital of Holdings is held on trust by a professional trust company under the terms of a discretionary trust for the benefit of one or more charities. The professional trust company is not affiliated with the seller.
Any profits received by Holdings, after payment of the costs and expenses of Holdings, will be paid for the benefit of the Down's Syndrome North East Association (UK) and for other charitable purposes selected at the discretion of the professional trust company. The payments on your notes will not be affected by this arrangement.
4) I have a word for this. It is a sham. I can say that because the Northern Rock accounts say:
Basis of consolidation
The financial information of the Group incorporates the assets, liabilities, and results of Northern Rock plc and its subsidiary undertakings (including Special Purpose Entities). Entities are regarded as subsidiaries where the Group has the power to govern financial and operating policies so as to obtain benefits from their activities. Inter-company transactions and balances are eliminated upon consolidation.
In other words that trust is not real. Northern Rock controls Holdings, but pretends not to via complex legal structures for certain purposes to try to avoid some of the risk of ownership arising from doing so, no doubt. Why else do this?
I call this three things:
a) An abuse of the charity involved, who (I stress) need not even have given their assent to be used in this way;
b) A contempt for those who take the real risk on financial markets, which is at the end of the day as this fiasco is showing, you and me and the government;
c) The construction of an arrival device to ensure that as few people as possible, almost certainly the Northern Rock directors included, know just how this deal works. I guarantee you it's a tiny number that do.
And it's this wholly artificial construction, seeking to shift liability and to avoid responsibility and abusing common sense decency with regard to the abuse of charity to achieve commercial aims that is pulling Northern Rock down.
Of course it's not alone. This type of deal is constructed every day off shore. It's the bread and butter of international finance.
It's why we can't trust markets. It's why regulation is needed. It's why ownership has to be revealed. It's why declaring where you're working is so important. It's why accountants have once more to put substance over form.
Now I know that for a change these Northern Rock entities were on balance sheet but most aren't. And can you see as a result why no one will lend inter-bank now? They've all been so busy creating these sorts of artifice that no one dare do so — because they all know the warts in their own system, so presume there must be as many in everyone else's.
It makes me believe, more than ever that the City is rotten to the core. Prove otherwise is my challenge.
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And there was our Chancellor yesterday assuring the City he will protect its ‘ global position ‘ . For what ? Money laundering anyone….
[…] have this morning already noted that today marks the tenth anniversary of the collapse of Northern Rock. I have also noted that i […]
In other words it looks to me that Northern Rock was the British equivalent of ENRON.
Would that be an exaggeration?
No
Reminded me of the Enron fiasco too.
I saw it played out on stage. It would have been a comedy if it wasn’t real.
Wikipedia reports it was slated by the NY Times on Broadway ensuring it didn’t run for long. Hatchet job? Probably.
I believe that would be an exaggeration for one simple reason. A number of top directors of Enron were prosecuted, given long jail sentences and had their assets seized. Just remind me what happened to the directors of Northern Rock?
Ah! But Enron had establishment investors take a big hit. It made fools of Wall Street and dangerous enemies in the process.
Northern Rock rooked investors further down the food chain.
Big difference.
Both had large and small investors
What is your view on the campaign by Northern Rock’s small shareholders to get their money back? I’m flip flopping about this, on the one hand I take the view that when ‘investing’ by buying shares a risk is being taken shares may rise or fall, you might do well and you might not. On the other hand its hard to see how an ordinary person could make an educated decision about buying into something like this when the companies arrangements are so complicated and seemingly designed to obscure. Two things are weighing me in favour or not compensating these people, firstly I don’t see buying and selling shares as investing, secondly buying shares seems to be a bit of a gamble, would we concider compensating people whose horses/scratchcards/in-play bets didn’t pay out?
Stan Kroenke is the majority shareholder of Arsenal, I have seen him referred to as an investor (in Arsenal) but actually he has not put a single cent of his own money into the club, he has simply bought shares and is collecting rent. Do we, as a nation, need to have a think about buying and selling shares and how we lock money into this system that might work better elsewhere? Again I might be being spectacularly ignorant here.
They took the risk as if capitalists
They lost
They should take the risk
That’s what capitalists claim to do
I take that point, Richard, but how many ‘investors’ were people who were being gulled because they thought they were still investing with a building society; not having taken on board the deregulation which meant that Northern Rock although still trading under the same banner was a completely different class of company.
That there have been no major convictions for fraud or even negligence in the aftermath of the 2008 debacle speaks volumes for the total uselessness of the regulatory structures which were put in place by the governments who oversaw privatisations. Not just of finance but of utilities aswell.
As you suggest the board almost certainly didn’t understand any of this arcane accounting jiggery pokery. Doesn’t that make them negligent? Is it not their duty to act in the interests of investors?
I accept all the points about the failure to convict
I think removing of peerages should have gone along with knighthoods too
But I really do not think the state has the job of compensating shareholders who could not be bothered to find out what they were doing
Richard’s answer is partly true. But if shareholders lose money because of probable criminal acts of the directors they can sue the directors to seek to minimise their loss. It would have helped if the directors had been prosecuted and convicted but it’s not essential. Some of the former directors like chairman Matt Ridley are pillars of the establishment and appear to be loaded. So you’d have thought the shareholders would be having a punt. No way should the taxpayer be responsible.
Do we know who put these structures together – the lawyers, accountantants or other advisors? And who were their auditors?
With ENRON, their auditors were ultimately held to account. I’m not aware of any of NRBS’s advisors being exposed, let alone held to account. Arguably they are at least as guilty as the senior management.
I had Northern Rock as a client in the 70/80s and got to know them well. They were very well run with a great culture and values, and their Foundation was outstanding. For me it was exceptionally tragic and indeed wicked that a few managers at the top set them on a course to disaster, driven by greed and ambition. It is is especially galling that the appalling Matt Ridley, who is utterly unapologetic, is still regarded as an expert commentator by the likes of the Spectator, Telegraph and even the BBC
Re Ridley, I admit he sickens every time I see him
He could at least have had the decency to just disappear
I do not know who created the structures
“I do not know who created the structures”. Interesting point that nowhere on the net can I find who created these structures and the Parliamentary enquiry didn’t report on it. My guess would be your old employer KPMG Richard. My reasoning is as follows. NRs first fd on flotation was Ex KPMG. In the late 1990s KPMG had a very strong team in the north selling VAT schemes to building societies and ex building societies run by KPMG alumni. This press statement http://news.bbc.co.uk/panorama/hi/front_page/newsid_7865000/7865638.stm from NR states the Granite structure paid U.K. CT as the companies were U.K. resident but CI registered which was done for reasons of Vat efficiency on issuing bonds. Couldn’t have been PWC as they were auditors, Deloittes and EY weren’t in the game. Which only leaves Andersens. Oh did they have something to do with Enron? Toss of the coin then.
There’s a hint that maybe PWCs role was wider than just audit which would not be surprising
https://www.theguardian.com/business/2007/dec/04/northernrock?CMP=Share_iOSApp_Other
At the very least their letters of comfort suggest detailed knowledge of Granite and its role at NRBS. A bigger question would be whether they should have been questioning NRBS’s adoption of wholesale funding and securitisation as core strategy rather than for top up or at the margin.
PS I was also in KPMG in the 90’s, albeit through acquisition, as a management consultant (business operations). Their Leeds office was very active though I’m not sure how much of this kind of advisory work they did. The audit side was generally pretty conservative and tended to be wary of the consultants.