Tax Research UK

There’s much talk in the City of junk bonds, many of them issued by offshore SPVs, SIVs and CDOs. There’s little talk of “junk equity”. But that’s what Northern Rock has now got.

Let me explain. The balance sheet of Northern Rock shows that just 4% of its money has been provided by its shareholders. 70% has been provided by bonds of one sort or another before it crashed and 22% by depositors, again, before it crashed. Creditors supplied the rest.

So who is of least concern in this whole issue? Especially now that the government is supplying 22% of the finance needed by the company? You’ve got it, the shareholders. And yet, yesterday the whole focus was on who will own that equity in the future.

Let me ask a serious question. If Northern Rock is going to be entirely dependent upon state aid for some time to come (and it now makes no odds what the EU says about this, if the finance isn’t there the UK government won’t be repaid in which case the aid will continue) why are we spending time worrying about whether Richard Branson wants to fold in his existing financial services business worth £200 million, or some other such ridiculous offer designed to get the chance to manage assets worth hundreds of times the price to be paid, and all backed by the UK government?

Rightly the opposition parties are calling upon the Chancellor to say how he will protect the investment (because that is what it is) the State now has in this bank. That investment does, because of the conditions attached to it give, the Treasury effective control of the bank. In that case, why bother with this distraction of pretending that its someone else’s problem and right to turn this bank around and so get the government out of the hole it is in? Why not just say that the equity in the bank is now junk, that the government has effective control and will use it by taking a majority stake by converting that part of its loan that gives it a right to penal rate of interest into equity and will then trade the bank way out of the current position over time?

Purely economically this is the only rational route to follow. When you’re in for this much money it makes no sense to pretend you can get out because of a takeover bid at knock down prices for the smallest part of the financing of the company. It’s time instead to make big statements: that the government does believe it has a duty to have the asset managed in its own interests and only by owning it can it be sure that this is the case.

And more than that, this is maybe a time for the government to consider using the rump of Northern Rock as the springboard for change in the banking market. If it were to own a bank it could pioneer best practice: it could look at how to make banking more available to those who need banking services but cannot get them. It could look at how to use the bank to beat the curse of the doorstep lender who so plagues much of the north of England, where Northern Rock is based. And it could use it to trial openness and transparency in this sector.

Now is the time to be brave Alistair. This is not the time to take the punches. Please get on and nationalise this bank: it’s the only way forward until it has been put back on its feet, re-established in the market and has proven worth. Let’s put this in context. All I’m asking you to do is behave like the private equity players you and Gordon so admire. Is that so hard?

Richard Murphy Bonds, Economics

I note that the FT has reported that:

The plan for a $75bn superfund to buy assets from cash-strapped structured investment vehicles appears to be gaining support among sceptical institutions, amid concern that SIVs might start dumping bank debt.

The planned superfund, which is being put together by Citigroup, Bank of America and JPMorgan Chase with the backing of the US Treasury, would buy assets from SIVs that are facing funding problems.

It’s a nice idea, but let’s contextualise this (without getting back into the debate on the difference between SPVs and SIVs which adds little here). Northern Rock has currently borrowed about £20 billion form the Bank of England - near enough $40 billion, therefore. How can $75 billion prop up the rest of the market in that case if any serious run were to occur?

It is obvious that the SIV / SPV scenario has created a crisis which we might get through with little harm, if we are very lucky. But it’s equally obvious that the markets cannot be allowed to create such a situation again.

In the 1930s massive regulatory change took place in the USA as a response to the 1929 crash. Whether or not we have a crash now the same response is appropriate.

So why aren’t politicians saying this, now, here as well as there?

There’s another question too. Why are these companies willing to bear this risk? Don’t they simply create the moral hazard that others will now be encouraged to take risk at their expense? Since this is almost inevitable, why don’t they seek regulatory control instead? Isn’t it the case that all the evidence suggests that this is the answer?

Richard Murphy Bonds, Economics, Tax Havens, Trusts