UK Asset Resolution, Northern Rock Asset Management, Bradford & Bingley

Most coverage of UKAR's recent results is terribly superficial and seems to miss the point, for example from the BBC:

Northern Rock Asset Management (NRAM), the so-called "bad bank" that manages Northern Rock's mortgage book, repaid £2bn of the government's loan in 2011.

But the bank still owes £19.7bn, said UK Asset Resolution (UKAR), the firm responsible for running down the bad loans of NRAM and Bradford & Bingley... UKAR as a whole - including both NRAM and Bradford & Bingley - saw profits rise to £1.1bn in 2011, up from £444.1m a year earlier.

Well done to the people at UKAR, but neither the profit nor the government loan repayment are particularly relevant in themselves, when you are looking at banks, always start off by looking at the balance sheet (taken from their 2011 results, pdf):What is striking is the speed at which they are winding down the balance sheet!

They have persuaded borrowers holding £7.5 billion's worth of mortgages to either repay or re-mortgage elsewhere (a few might have been repossessed); they have managed to offload (or realise) £5 billion of "wholesale assets" (which is presumably mortgage backed securities issued by other banks); and they have unwound net £1.7 billion of "derivative financial instruments" (whatever they are).

They used all this surplus cash and the profits of the year to repay £13.4 billion of "wholesale funding" and £2.1 billion of government funding. If it were up to me, I'd repay the government funding first, which would only take three or four years at this rate, and then hand over what's left to the "wholesale funders", but hey.

The profits of £1.4 billion or so are not actually that spectacular:Gross interest income of £2.7 billion on average total assets of over £100 billion means that the average interest rate they charge/earn is about 2.7% which is incredibly low; and the net interest margin of £1.7 billion on average assets of over £100 billion is less than two per cent (which is the historical norm), but only because their average borrowing/funding costs are laughably low at 1%.

Then you knock off £0.3 billion admin/running costs (very good value indeed) and other pluses and minuses to arrive at their pre-tax profit of £1.4 billion.

So the people at UKAR can be quietly pleased with what they have achieved - winding down the balance sheet, which is their main purpose - but maybe they could try and push up their interest rates a bit? Either borrowers will pay up (hooray) or they will re-mortgage cheaper elsewhere (hooray - because this means the balance sheet will shrink all the faster).

BTL landords: "We own land! Give us money!"

From The Daily Mail*:

The emergency ‘bank’ set up by Government to oversee the mortgages originally lent by Northern Rock and Bradford & Bingley is treating landlord borrowers unfairly, it is claimed.

A number of large borrowers allege that heavy-handed actions by UK Asset Resolution is leading to widespread tenant evictions, business failures and the sale of thousands of properties at depressed prices...(1)

But landlords claim taxpayers are losing out,(2) along with everyone else, as UKAR puts thousands of properties into receivership, fails to maintain them and ultimately sells them for less than their market value.

The allegations are difficult to prove, but growing numbers of landlords are voicing similar complaints and using popular websites such as Consumer Action Group to air them. What is not disputed is that these borrowers are stuck.

Most have little or no equity in their portfolios of property, and so cannot find another lender. On the other hand, UKAR’s objective is to get their loans off its books.

1) To whom? It strikes me that if tenants could afford to pay the rent, they could more than afford the mortgage were they to buy the home they were renting. This all helps deflate the debt bubble and increases the spread of owner-occupation. Win-win!

2) Most tenants are taxpayers, are they not? However much they lose qua taxpayer (and it will be pennies), they will be compensated ten times over if they can now buy the home they are currently renting.

* Via Taffee at HPC

More financial illiteracy fun with Northern Rock

From The Telegraph:

Richard Branson’s Virgin Money has been accused of “asset stripping” following leaked details about the structure of Northern Rock’s sale. The sale of Northern Rock, which netted the Government £747m in cash is being part funded by existing cash in the bank itself. More than £250m of “excess capital” will be taken out from Northern Rock to help pay for the bank.

Oh dear, oh dear, oh dear, where to start?

When a company is being bought/sold, it is fairly usual to agree a target net asset value for the company in advance, and the purchase price paid on completion is adjusted up or down if the actual net asset value at the date of completion happens to be higher or lower than the target (which it usually is). So if the current owner of the company whips out £1,000 on the day before completion, it is of no advantage to him and the purchaser isn't bothered because the final selling price is then adjusted downwards by £1,000.

So VM paid £747 million for a company (or group of companies) with a net asset value of £912 million*. If NR really had £250 million in spare cash sloshing about, then in theory the government could have taken out that money and agreed a lower selling price of £497. Whether the government takes out the money and accepts a lower selling price or VM takes out the money and pays a higher selling price does not make the blindest bit of difference.

* NR's balance sheet total as at 30 June 2011, minus six months' anticipated losses to date of completion January 2012 minus £150 million in bonds which the government has allotted to itself.

Via MBK.

I can remember when £1 billion was real money

All the usual suspects have rehashed the story about Virgin Money buying Northern Rock plc for £747 million, which they reckon produces a loss for the taxpayer of £400 million. That is based on sales proceeds of £1 billion and an entirely spurious figure of £1.4 billion which "taxpayers had injected... into Northern Rock".

The taxpayer did no such thing, £1.4 billion was an entirely made up figure for the share capital of the reconstructed NR, i.e. the amount by which its gross assets exceeded its liabilities when it was set up. The other half of this transaction is a corresponding shortfall of £1.4 billion in Northern Rock Asset Management (the bit which still belongs to the taxpayer).

Ho hum, so let's do this properly. If you look at the relevant bit on NR's actual website, what it says is this:

* Agreement has been reached with Virgin Money for the acquisition of Northern Rock plc – the sale is expected to complete by the end of the year

* The Government will receive £747 million in cash on closing of the sale, with the potential in the future to receive over one billion pounds in total.

There's no explanation of how this additional £250 million-plus will be calculated or what would trigger the liability, but hey.
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UPDATE, the print version of today's Evening Standard article explained all, there's another £50 million due in cash (why not now?), the government allotted itself £150 million in NR bonds (reducing the net value of the assets sold) and if NR is floated within five years, then Virgin Money has to pay another £80 million. We can forget about the £80 million, but adjust the real purchase price to £797 million.

As it happens, NR had net assets of £1,122 million as at 30 June 2011, from which we deduct the £150 million extra liabilities, giving us a net asset value as at today's date of £972 million, against a purchase price of £797, that's a real book loss of £175 million.

What we do not know is what the goodwill value of NR is, which we would add to the book value to give us the real loss. It is quite possible that NR has a negative goodwill value, as it has made losses of over £200 million in each of the last two years; if we assume that NR will lose another £200 million before it returns to profitability or break even, then we can adjust the £175 million loss to a £25 million profit.

The fact that Gordon Brown might have wildly overpaid for the whole thing in the first place is an entirely separate issue, that is sunk costs. Perhaps we can claw a bit back by placing a charge over the royalty income from his books?

If only they'd thought of this sooner!

A couple of the papers mentioned an NAO report, which praised the UK government for having saved money by buying back outstanding debt in Bradford & Bingley and Northern Rock, which is a variation on the general theme of debt-for-equity-swaps. The NAO report summarises as follows:

4.1 Over the course of 2010 Northern Rock (Asset Management) and Bradford & Bingley [after they had been taken over by the UK government] bought back £2.4 billion of their outstanding subordinated debt for £821 million in cash.

4.2 The debt was trading at substantially below its nominal value (i.e. the amount originally advanced by the investors), principally because:

a. It is not known if and when the principal and accumulated interest will eventually be paid. This makes it difficult for investors to value the debt and makes the bonds particularly unattractive to investors who seek a short-term investment.

b. Although the debt continues to accumulate suspended interest into a sum to be paid once the providers had returned all the taxpayer support, the terms of the debt do not allow interest on the interest (it is non-compound). Consequently the value of the debt and its interest falls with inflation and the money value of time.

c. There is still uncertainty regarding possible future government intervention and the potential for the Government to remove its loans, guarantees and assurances.

d. More generally, market risk remains high for the mortgage sector, and in particular there continue to be concerns about the quality of the mortgages in the mortgage providers’ books.

All good stuff, but it's a pity they didn't just do this years ago when the banks first became insolvent (in the sense that their liabilities, including bonds, exceeded the value of their assets).

Think about it:

1. By and large, the market price of the bonds would be the original principal amount minus all the potential losses of the bank (assuming share capital already wiped out).

2. So if somebody comes along and buys all the bonds and takes over the bank, that person doesn't actually lose a penny if he continues to run the bank, because the losses were all borne by the previous owners.

3. That new owner can cheerfully write down the balance sheet value of the bonds to the amount he paid for them, or convert some of the bonds into equity, it doesn't really matter. If you own all the shares and all the bonds in the bank, the total value of your holdings is much the same however you account for them.

4. As it happens, the total losses suffered by even the worst-run UK banks (B&B and NR), mainly on irrecoverable mortgages, were nowhere near as much as the amount of bonds in issue; therefore the bonds/bondholders could absorb the whole loss and the bonds always had some value (a third of their original issue price, in the above case).

5. Conversely, depositors' money was never really at risk (the UK government has always guaranteed deposits up to a certain level, it was just over £30,000 per person at the time), provided of course the government was prepared to take a firm stance and rank depositors ahead of bond holders in order of priority on a liquidation (and it is the government which writes the insolvency laws...)

6. Therefore... the government (or indeed anybody with sufficient billions to play with and the nerve to see it through) could have sorted out NR and B&B without losing a penny, or needing to actually invest any money directly into those banks, possibly even making a profit if they timed things right.

People used to tell me that I was mad to believe that you could sort out banks using debt-for-equity swaps. I think history is proving me right.

Why depositors are powerless and why bank bail outs make things worse.

Two related issues came up at post-film discussion yesterday where people's thinking appears to be a bit confused, so for the benefit of anybody who's interested:
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1. There is a theory that if a lot of depositors ganged up and all withdrew their money from a bank on a particular day, then if more than ten per cent of deposits were withdrawn, they could bring the bank to its knees (in which case depositors would demand, what? Higher interest rates on their savings?), see e.g. Cantona's Cashpoint Revolution.

Most people ignored Cantona, but what if they hadn't? Well, it would have been a good old fashioned bank run like on Northern Rock, and the government would have just stepped in and lent the bank(s) the spare cash.

Remember that people would have to withdraw their savings in cash (merely taking it from one bank account and putting it in another achieves very little), and a bank note is just an interest free loan that you are making to the government (it is your financial asset and the government's financial liability).

Therefore the government can easily provide loans to banks which are equal to the cash withdrawn. Before the depositors' strike we have this position:

Banks -> owe £ billions to - > people with cash in the bank

And afterwards, we end up with the following:

Banks -> owe £ billions to -> government -> owes £ billions to -> people with 'cash under the mattress'.

If people are too worried about being burgled, they will put their saving in the safest place possible, i.e. the government-run National Savings & Investments, which makes the picture even clearer.
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2. Why don't savers demand higher interest rates? Well, they do, I suppose, but the banks aren't offering them and that is the end of that. It is a cartel which has most successfully managed to widen its profit margins after the downturn, because the banks know (or have good reason to believe) that if they can't get enough money from savers or bond investors, they can borrow it cheaply from the government (and they have done, in spades).

I mean, why would a retailer bother paying a supplier £100 per unit if the government were offering them for £50 each?
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3. As I tried explaining before, the politicians claim that they are bailing out the banks to 'protect savers' money' which is hokum, of course.

The analogy I used was a bit left field, so let's assume that Farepak is a bank and they have managed to lose four-fifths of their savers' money, or £400 per saver.

Now, let's assume that the government had previously enacted a law saying that Xmas club savings accounts were guaranteed by the government/taxpayer, and Farepak went *pop*. Does it make more sense for the government to:

a) Give the savers directly the £400 they lost (or whatever higher or lower amount an individual saver lost) and have done with it (chasing Farepak and its directors for any shortfall), or

b) Give or lend all that money to Farepak on the condition that they fulfil their pledges and promise to play nicely in future?

I'd submit that (a) makes more sense but in most cases, governments around the world have chosen (b). Very few governments allowed banks to collapse and agreed to pay some compensation to savers (method (a), which worked a treat for Iceland) and other countries who are a bit more clued up (and not in cahoots with bankers) have asked their banks to sort themselves out via debt-for-equity swaps (Denmark, and rather bizarrely, Northern Rock in the UK after three years' wrangling), but these examples are few and far between.

Obviously, the government doesn't guarantee your money if it's with a Xmas club and you might not agree with the law guaranteeing your money up to £85,000 if it's in a bank, that's a separate issue.
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4. So there we have it. There is precious little we can do because the government will thwart us at every turn, using our money to do so.

And the underlying reason why 'they' have us by the short and curlies is because they know and we know that the only way to keep house prices at double their true value is by continually pumping in money via the banking system, so while we curse and swear at bankers and their bonuses, this is about as much use as Catholics complaining about priests abusing children.

Until we abandon this thinking that high house prices make us richer, there will always be bankers and politicians ready to exploit this for personal gain, and as long as there are Catholics who believe in their church as an institution, there will be people who abuse that trust, end of.

NuLab BluLab LibLab

From today's CityAM: "[The Conservative Party's manifesto will include] details of plans to sell discounted shares in part-nationalised RBS and Lloyds when they are eventually re-privatised."

From today's Daily Telegraph: "Shares in Northern Rock will be handed to its customers under plans in Labour's manifesto to turn the troubled bank back into a building society."

Richard Branson

Outbreak of commonsense at HM Treasury!

CityUnslicker linked to this article, Northern Rock Defers Payment of Subordinated Debt Coupons (which does what it says on the tin).

I did a bit of digging and uncovered this even better article of two weeks ago, UK government plans a great escape from Northern Rock, the upshot of which is that, as I have been saying since NR first went *pop*, the government can sort out the banks out at nil or negligible cost to the taxpayer by applying the logic of "debt for equity swaps". What these boil down to is that losses are first offset against shareholders' funds, and once these are used up, the next wave of losses is borne by bond-holders.

Happily, there is a pre-ordained, contractually agreed heirarchy as between bondholders, so there's not much to wrangle about. The losses are therefore shared out between 'reckless borrowers' (via higher interest rates, repossessions) and the 'reckless lenders', i.e. those who were willing to accept the highest risks in return for the highest possible rewards (being shareholders and 'junior' bondholders).

Well, duh ... how long did it take them to work that one out?

As I said back in September 2007:

Even if Northern Rock have to write down their loan book by a quarter, there'd still be plenty enough to cover savers' deposits. It just means that bondholders (more sophisticated investors, hedge funds, other banks and so on) take more of the loss on the chin. So HM Treasury [should] put NR into liquidation, lend it £20 bn, allow the savers move their deposits elsewhere, and then pay itself the £20 bn back with interest and let the bondholders squabble over what's left. Shareholders would get nothing, presumably. This would be more-or-less risk-free from the point of view of the government, the taxpayer and the savers.

It looks as though HM Government have finally cottoned on. From yesterday's Times:

The Government is proposing the bank be split to create a new company that takes on the deposits and branches and provides new lending*. Separately, Northern Rock's existing book of mortgages would be put into an asset company to be run off over time... The bondholders are set to be put into the asset company by the Government in a move that has caused consternation among them because they fear that they will be stuck with all the bank's toxic loans.

It's a pity they didn't give me a ring in late 2007, I could have saved the taxpayer tens or hundred of billions of pounds.

Ah well.
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* As it happens, I've been honing the finer details of my original plan over time - the government's final answer is more or less identical to what I posted at Capitalists @ Work last week:

The MW plan:
1. Sell off branches, employees and savings business ASAP (like they did with B&B) preferably as a job lot, but broken up if necessary.
2. Encourage existing NR borrowers to refinance elsewhere by hiking interest rates.
3. What's left over is fairly 'toxic' stuff, but hey, at least they're paying the higher interest rates.
4. Have rabid policy on repossessions, get it over with before house prices fall any further. Properties to be auctioned could be offered in priority to bondholders, SPVs and shareholders so they know they aren't being conned. If these people want to rent back to original owner, then all the better, less hassle all round.
5. Repay taxpayer loan in priority.
6. Whatever money comes in after that gets dribbled out over the years to bondholders and SPVs, who will get most or all of their money back (well, at least half or two-thirds), maybe even shareholders get a few pence.

Readers' letters of the day

From The Metro:

Instead of paying for second homes, parliament should build dorms for MPs. The MP would pay for his or her constituency home and could stay in communal accommodation when in Westminster. They could benefit from car pooling, dedicated access to parliamentary networks (so as to avoid leaving disks on trains) and, at the end of a term, the dorm would pass to the next incumbent of the position rather than the MP pocketing the sale cost.

Phil, London SE1.

... and from The FT:

Sir, Presumably those who received the 125 per cent loans that Northern Rock handed out after the government bail-out are tickled pink. These rare creatures now have low interest loans worth more than their property values and are backed by a triple A rated mortgage bank funded from taxpayers’ cash.

One lender’s toxic debt is clearly another borrower’s fragrant liability.

Paul J Weighell, Purley, Surrey.

"Are securitisation companies above the law?"

Carmel B Butler has sent me a brief summary of evidence she submitted to the Treasury Committee looking at the banking crisis (submission 107, available online here, Word Doc), as follows:

The Land Registration Act 2002 provides that a transfer of a mortgage charge must be registered at H.M. Land Registry. Therefore, when a securitisation company buys mortgages from the banks, the law requires that the securitisation company register as the new owner of the mortgage. Given that 80% of recently issued UK mortgages were securitised* and therefore up to 80% of UK mortgages are owned by securitisation companies, have you ever wondered why no securitisation company is registered as owning a UK mortgage and why the banks incorrectly remain the registered as the owner of the mortgages?

The banks have received billions from the public purse because they say, they are the victims of bad borrowers. The Government have asked the banks to declare the extent of the bad debts on their books and the banks are apparently unable to answer that simple question. It is possible that the real reason that banks do not answer the question is because that would require admitting that the banks do not own the mortgages which are the allegedly bad debts on their books and, they would have to admit that they are falsely registered at H.M. Land Registry as the owner of the mortgages.

If the Government insisted that securitisation companies register their ownership of the mortgages at H.M. Land Registry in compliance with section 27 of the Land Registration Act 2002, the banking crisis would be seen in a whole new light and the Government would not have to ask the banks how much bad debt they have on their books.

The politicians like to mutter darkly about "the shadow banking system" as if there is lots of stuff that is hidden away; whereas it turns out that the reverse is probably true - in the specific case of Northern Rock, it appears that auditors misapplied International Accounting Standard 39 and treated securitisation vehicles as subsidiaries, even though under the terms of the agreement between NR and the SPVs, most or all of the potential losses accure to the SPV and NR is actually just the day-to-day administrator and (incorrectly), the registered legal holder of the mortgage at HM Land Registry.

The terms of all the different SPVs that UK banks set up are all slightly different of course, some may be recourse and some non-recourse, and in turn, the investment arms of banks may have invested in SPVs holding mortgages from other banks and so on, but it does support my overall theory that banks are not just wildly overstating their assets/liabilities, but, now that the taxpayer tap has been turned on, are wildly overstating their losses in the hope of filling their boots.

I asked a chap who works in the business, and he reckoned that Carmel's theory is perfectly plausible, the only question is, what sort of overall proportion of UK mortgages have been securitised?

* The 80% figure is taken from Paragon's written evidence, which ought to be here somewhere. It stands to reason that as house prices rose, mortgages became riskier and riskier and more and more were securitised, so the chances are that of the really bad mortgages, the vast majority are securitised.

Another day, several more reckless throws of the dice (23)

Here's the first batch from today's crop of crap:

1. Northern Rock's staff got £9 million in bonuses for repaying £18 billion of the taxpayers' loan, apparently ahead of schedule. Speaking as a taxpayer, that looks like good value - it's only 0.05% of the money they brought in and repaid. The government has now reversed this eminently sensible policy and now wants them to lend another £14 billion. Question: are Northern Rock staff going to have to repay £7 million of their bonuses? Fair's fair, and all that.

2. "Mortgage lenders should face penalties for repossessing homes too quickly, MPs have urged. The Commons Communities and Local Government Committee criticised the "precipitate" action being taken against the increasing numbers of people getting into arrears. And it said in a report that attempts by the Government to limit repossessions cannot be enforced."

We have the usual assymetry problem here - for every reckless or unlucky borrower who isn't repossessed, there's another family in rented or too-small accommodation who can't afford to buy or trade up at a reasonable price.

3. At the end of that article "The committee said a greater proportion of new homes ought to be stipulated as social housing."

*Sigh*

If homes to buy came down in price, then the better-off-poor would be able to buy their own home; that would get people off waiting lists and out of social housing. Ideally, councils could get private builders to build homes for sale, but institute Land Value Tax on those homes, in other words, instead of Council Tax and Stamp Duty, purchasers would agree to pay, each year, (say) 5% to 10% of the difference between the purchase price and the construction costs (about £75,000 for a three-bed semi or terrace).

The initial amount of the tax would be decided by the first wave of purchasers - if they are happy to pay £85,000 for a house, they pay £1,000 in tax - as long as the total mortgage bill plus tax is less than what it costs to rent, they are happy. When houses on the estate are later sold for higher or lower prices, everybody else on that estate gets a correspondingly higher or lower LVT bill, i.e. the tax in future years would be set by negotiation between buyer and seller.

Further, this highlights the schizophrenic attitudes of people in general and politicans in particular: OT1H, they are desperately trying to reflate the house price bubble (using taxpayers' money) and OTOH, they accept that people are being priced out, so they want to build more social housing (also using taxpayers' money). Or maybe it's not schizophrenic at all - from their point of view, anything that uses taxpayers' money is seen as a good thing.

*/sigh*

Another day, another reckless throw of the dice (22)

It genuinely appears that there is no stopping them, they just keep on doubling their bets (using borrowed money) in the hope that something will turn up...

Northern Rock is to revive its mortgage business with up to £14bn in new loans by 2011, the government has announced. The Newcastle-based bank is expected to take on about £5bn in new mortgages this year and up to £9bn from 2010.

They will be financed with money from new deposits, repayments on existing loans and more government money. The move is part of wider plans to restructure the nationalised lender and follows a government decision to reverse the wind-down of its loans.

Seriously, £14 billion ain't going to be enough; that's just enough to lure a hundred thousand gullible first time buyers into buying a house over the next two years. But remember that the number of sales and purchases is down from a long run average of well over a million per annum to about half a million; the house price bubble is deflating at the rate of £1 or £2 billion per day etc etc.

So in a few months time it will be another £30 billion, then by next year they'll be talking about another £100 billion and so on. Heck knows where this money is going to come from ... oh, I see.

Banks are not too big to fail, never have been, never will be.

CityUnslicker says in the comments to my previous post "Banks are too big to fail. If they went bust the confidence in the UK would go with it. The currency would collapse and the UK could also default on its debts."

Nope. Banks are like utilities - water, electricity, gas - they provide a vital service, but it does not matter particularly who provides that service. If a company that owns loads of power stations went bankrupt because of malinvestment and because it was overloaded with debt, the administrator would promptly sell off the power stations to somebody else, and customers wouldn't even notice a flicker.

It's no different with banks - take for example the Bradford & Bingley. One of the few masterstrokes that this government has pulled was to sell all the B&B's branches and transfer the liability to repay its customer deposits to Santander. If you were an employee of or a depositor with B&B, or the landlord of one of their branches, you wouldn't have noticed the change had you not read it in the newspapers.

This comes pretty close to the New Bank solution that CityUnslicker himself proposed a few months ago.

The mistake that the government made with the B&B was to 'nationalise' the loan book. They should have declared it a 'closed fund' and just let the shareholders and bondholders squabble over the meagre spoils, which is what I suggested after Northern Rock first went *pop* back in September 2007, which seems like ancient history somehow.

Further, our currency has already collapsed and is now bumping along the bottom, and if the government palmed off the losses onto private investors (where they belong) rather than nationalising them, the chances of "the UK defaulting on its debts" would actually be reduced.

Ah well, better luck next time. You can't expect a Labour government to have already learned the lessons of what was blindingly obvious to me a year and a half ago.

Readers' letters of the day

From The FT:

Sir, It is indeed a paradox that the Church feels the need for professional investment advice (Letters, January 21), since this is the one area where even an atheist might well believe that decisions are best left in the hands of God.

Investment at random for a large fund offers full diversification, has very low costs and protects against the sort of expert knowledge and skill which led professionals to invest with Bernard Madoff.

M.R. Weale, London, UK

And, from The Metro:

I believe the bonuses being paid to Northern Rock staff are a good idea. They are necessary to recruit, retain and motivate the right calibre of staff to ensure that NR is profitable and can therefore repay the loans made by taxpayers.

PS I'm not a NR employee.

J Fisher, Hertfordshire, UK.

A Times article puts this in perspective - gross bonuses approx. £9 million, post-tax cost approx £5 million; "The payments were being made because the bank had more than met its target of repaying 25 per cent of the £26.9 billion lent to it last year by the Government, a Rock spokeswoman said. In fact, £15.4 billion had been repaid." Paying out £5 million in return for speeding up repayments to the tune of £9 billion seems like a good deal to me. I suppose it would be nice if there were some sort of cap so that the bonuses do not unduly reward the senior people who created the mess in the first place, but hey.

Another day, another desperate throw of the dice (12)

Hot on the heels of the state-controlled Royal Bank of Scotland's decision to allow mortgage borrowers to rack up six months' of mortgage arrears before commencing foreclosure, thus exacerbating the deficit faced by the borrower on the inevitable repossession and a corresponding bad debt in its own books (enhancing the loss to the taxpayer from the part-nationalisation), the state-owned, taxpayer-funded Northern Rock follows suit.

That's the fifth throw of the dice this week alone, BTW.

Another day, another desperate throw of the dice (7)

Continuing my occasional series, The Badger has noticed that trying to force commercial banks to increase mortgage lending to their crazy 2007 levels in the face of plummeting house prices is trickier than he expected.

Not a problem! The gummint is now going to completely reverse its eminently sensible policy of running down Northern Rock's mortgage book as fast as possible (by simply making sure that NR's mortgage deals were the least attractive on the market). The new plan is to give NR long term taxpayer funded loans and guarantees in order to try and reflate the housing bubble.

H/t Stillthinking at HPC, who adds "... this must count as an extension of government borrowing and so push the pound down further, and ... push up real long-term interest rates."

"Banks to defy Government and raise mortgages rates"

From The Times:

Northern Rock, the Government-owned lender, has announced that it is pulling all its tracker deals for homeowners and landlords and is expected to increase rates when it relaunches the mortgages later this week. It follows a move by Abbey earlier today to increase interest rates on tracker deals by up to 0.5 percentage points.

Umbongo alerted me, in the comments a couple of posts ago, to this fine summary by Paul Krugman, written back in 1999. I can't claim to understand the jargon, but in it he points out that once a depression/recession gets bad enough, cutting interest rates - even to zero - does not stimulate the real economy, what clever economists refer to as 'The liquidity trap'.

This is all well and good in theory*, but there are three far more fundamental and practical points. 

1. To the average borrower, the BoE base rate is completely irrelevant. What matters is the rate that you pay on your mortgage, overdraft, credit card, business loan etc. And real interest rates are basically [inflation + risk free interest rate + risk premium]. Future inflation is anybody's guess - call it 5%. The risk free rate, for UK purposes is the rate that you can earn on UK index-linked government bonds, about 1%. And the risk premium must be at least 1% on top of that, even for a really well run business or a mortgage with only 50%LTV. So nobody is going to lend anybody money for less than 7%. The banks have been pretty stupid over the past few years but they are now learning fast. This is the basic 'cutting BoE rates is like pushing a piece of string' theory.

2. To the average borrower, the interest rate is less important than the total amount the bank will lend him (or her). Whether a profitable business has to pay 8% or 9% on its overdraft is neither here nor, and the same goes for any half-way sensible buy-to-let landlord. What puts businesses out of business is when all of a sudden the bank calls in its loans or cuts the overdraft facility. What is forcing the not-so-sensible buy-to-let landlord to sell up is when the bank decides that a LTV of 90% is too risky and that in future they won't rearrange a loan with an LTV of more than 80%. All of a sudden, said landlord has to stump up 10% of the value of all his or her properties in cash (a 'margin call'). Which ain't going to happen, obviously. Leading to forced sales, further falls in values, further margin calls etc. (and hurray to that, as it happens)

3. Ask yourself why banks are reigning in credit and hoarding cash. It's because they in turn have their bondholders (aka the money markets, aka holders of mortgage backed securities) snapping at their heels asking for their money back. The quickest and fairest way to fix this is debt-for-equity swaps. Such swaps do not cancel a liability (which would be ungentlemanly), they merely convert a short term claim against the bank into a longer term right to participate in future profits of the bank, thus taking the heat off the bank, who in turn can take the heat of the business in need of finance etc.

Here endeth.

* Paul Krugman's theory (sort of) predicted what would happen in Japan over the intervening years; basically Japanese savers would invest abroad in search of higher returns. This is the far more sophisticated 'cutting BoE rates is like pushing a piece of string' theory. And then the Japanese savers went one better and borrowed cheaply in JPY to invest in higher yielding currencies, like AUD. Which worked fine for those prepared to gamble on the 'carry trade', until it suddenly all went pop. But Japan is a country where the government can actually control the interest rate charged to borrowers. We are, luckily, a long way from that here.

If it's good enough for us ...

From The Telegraph:

In August, the Government converted £3bn of its loan to Northern Rock into equity to bolster its core tier 1 capital ratio, which had slipped to the dangerously low level of 2.9pc. The Government may have to inject "£2bn pounds to £3bn more," into Northern Rock, a source close to the Government has told The Daily Telegraph.

Fine. In the grander scheme of things, it shouldn't make much difference in the long run whether you invest in a bank as shareholder or bondholder, and the taxpayer is both in this instance. But as I have pointed out before, debt-for-equity-swaps are the only sensible way to sorting out the banking 'crisis'. If the gummint is cheerfully swapping our loan for equity, why isn't it asking all bondholders to do the same?