Monday, January 21, 2008

Unanswered Questions On Crock Bail-Out

Couldn't he just have done something else with his life?

I've just listened to Darling's Commons statement on the Northern Rock bond bail-out. There are rafts of unanswered questions.

Before we run through them, let's just remind ourselves of one simple but crucial fact.

This is Brown's fault. We taxpayers only find ourselves in this dire situation because the Brown/Balls reorganisation of bank regulation in 1997 was half-baked, based on theory rather than practical experience. They swept away the old Bank of England regulatory regime, tried and tested through 150 years, and replaced it with an arrangement that failed its first real test.

Brown's regulators not only failed to pick up on NR's risky business model as it ballooned out of control, but they then failed to stitch together any of those traditional City rescue packages. Yes, you can criticise the informality and opacity of those classic deals done in smoke filled City dining rooms, but the system had been tried and tested, and had successfully fended off High Street bank runs for one-and-half centuries.

Neither did Brown give us the more formalised system they have elsewhere. He could have copied the US Federal Deposit Insurance Corporation (FDIC) system. That not only provides more generous retail deposit insurance, but also has powers to take failing banks into special administration, allowing depositors to be paid out immediately and the bank to be restructured and sold off over time.

But we have none of that, and it is Brown's fault. Worse, he's compounded our problems by dithering for five months since the crisis first broke (NR hit the funding wall last August- a whole month before the queues on the pavement).

So here we are, with Darling finally admitting that a "purely commercial solution" is impossible. That being the case, his clear duty- apart from offering his resignation- is to protect taxpayers from further pain by nationalising the Crock and putting it into an orderly run-off.

But as we know, taxpayers' interests trail a long way behind political calculation. Hence this fudged worst-of-both-worlds nationalisation, where taxpayers take the downside and shareholders take the upside (see this blog).

So what are the next questions?

1. What will we be paid for the unprecedented open-ended £25-£30bn loan we are extending to NR?

Alliance and Leicester recently negotiated new funding at a rumoured margin of 1.6% over LIBOR (see this blog). At current market rates, that's equivalent to about 7.3% pa.

We should get much more than that for lending to the Crock, because unlike A&L, without our support it is bust.

Darling hasn't given any clue what we'll get, but noises off suggest he's thinking of something closer to LIBOR. Apart from anything else, Crock can't afford to pay a commercial 7%+ since its mortgage book only yields c6%.

In BOM's view a yield of LIBOR would be at least 2% pa lower than a fair price.

Cost? At least £0.5bn pa straight taxpayer subsidy to NR shareholders.

2. What will we be paid for the guarantee on NR's bonds?

Darling told us we'd be getting a fee for guaranteeing the new NR bonds when and if they find private buyers. How much?

The Crock is a bust company and its unsecured debt is junk. Specifically, when last sighted its credit rating for senior debt without the HMG guarantee was BB, a junk bond rating (see this blog).

In recent years, such companies have been able to "credit enhance" their debt by buying insurance from so-called monoline credit insurers. But for obvious reasons, those insurers are themselves now imploding. So unsurprisingly, Darling's discovered insurance is not available on "acceptable terms". No problem- he's going to force taxpayers to supply it instead.

Obviously we don't want to- we'd have to be insane- but somebody seems to have elected these clowns, so we have no choice.

At least we should be told what we're getting paid.

3. What happens if nobody wants to buy the Crock bonds?

On the face of it, with a full HMG guarantee, there should be no problem selling the bonds. If they offer any yield premium over gilts there should be a ready demand (the Major, Mrs T and I will be loading up).

But if the bonds are just 5 year maturity (as hinted) what happens when they mature? What if commercial credit insurance is still far too expensive (as it may be if most of the commerical insurers have been wiped out).

How long must we support this operation?

4. What's our equity share?

The suggestion is taxpayers will get some share of any upside. But how much?

5. How much will we be paid to guarantee NR deposits?

As we blogged here, and confirmed by Darling today, the HMG guarantee on NR deposits will remain in place for the forseeable future. No other commercial bank can offer such assurance, and in these troubled times, it's extremely valuable to Crock shareholders.

So far they've had it for nothing, which may be acceptable in a crisis, but not as a long-term business model. What is Darling going to charge in future?

On a Black Monday when almost every other equity share in the world was falling through the floor, NR's shares went up by 46%. That tells us all we need to know about who's getting the best deal out of Brown and Darling's rescue plan.

Once again, these wibbling simpletons have given away the shop.