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- Business editor Robert Peston
- 5 Nov 07, 07:45 AM
frighteningly large new losses were triggered by two events: a further housing market this autumn; and downgrades of sub-prime US mortgage-related assets by rating agencies.
Here鈥檚 the worrying thing about Citi鈥檚 . Much of the losses related to $43bn in 鈥淎BS CDO super senior exposure鈥 backed mainly by 鈥渟ub-prime RMBS collateral鈥.
I鈥檒l translate that for you. It means Citi is suffering humungous losses on the reprocessed and repackaged bits of sub-prime 鈥 or exposure to US homebuyers with a poor credit history 鈥 that were supposed to be top quality, not far off the quality of top corporate bonds or government debt.
Citi has given the lie to the idea that was so prevalent in markets over the past few years that financial engineering 鈥 through the medium of collateralised debt obligations and structured credit 鈥 could turn ordure into gold.
So let鈥檚 hope that the painful experience of Citi and other institutions leads bankers to once again show due respect for one of the golden rules of banking: you may be able to make money from merde, but don鈥檛 pretend you鈥檙e selling anything but merde.
Citi estimates that since September 30 (the end of its previous accounting quarter) the decline in the value of its sub-prime exposure will reduce reported revenues by between $8bn and $11bn.
That would be enough to bankrupt many a good size bank. But then many a good size bank isn鈥檛 big enough to accumulate exposure to sub-prime on the scale of what Citi did, or some $55bn as of September 30.
And don鈥檛 forget that these losses relate to just one portion of Citi鈥檚 business. This is a bank which grew its assets 鈥 primarily its lending 鈥 by an astonishing $769bn or 48 per cent over the past 21 months.
Such asset growth is astonishingly and disturbingly fast at a time when there were bubble conditions in many markets. Not all of that new lending will have been top quality.
Anyway, it鈥檚 funny what people end up doing. I鈥檝e known since the 1980s, when he was just a youngish man on his way up as head of the small London merchant bank, Schroders. Now he鈥檚 a grand old man of world banking, and is stepping into the breach at Citi, the world鈥檚 biggest bank as chief executive 鈥 albeit on a temporary basis, until a permanent replacement can be found for .
The other interesting board change is that the former US Treasury Secretary and one-time Goldman head honcho is to become chairman 鈥 apparently on a permanent basis.
The previous incumbent of those two posts, Prince, says he is doing the honourable thing by going, though honour may have been prompted by hard economic reality. Still, his exit will cause a frisson among senior bankers all over the world, because few of their organisations will escape unscathed from the problems in credit markets.
That said, Citi鈥檚 hit from sub-prime is spectacular. And it will cause widespread concern that other banks will be forced to disclose increased losses from their respective holdings of sub-prime, CDOs and the rest of the gilded rubbish, probably exacerbating a downturn in bank shares that acquired momentum last week.
Recent entries
- Business editor Robert Peston
- 9 Oct 07, 10:01 AM
There has been a disturbing outbreak of common sense at the Treasury. It has that it will provide Northern Rock with the kind of stable funding and protection for depositors that should allow the bank鈥檚 board to avoid selling the business at a knockdown price in a fire sale.
In fact, Northern Rock now has till February 2008 to decide whether it makes sense to sell itself. It鈥檚 odds on that the bank will be sold, but at least the Rock now has the time to judge the seriousness of the multiple expressions of interest it has received from putative buyers.
The Treasury鈥檚 big decision 鈥 made after consulting the Bank of England and the Financial Services Authority 鈥 is to provide full protection for all retail deposits made at Northern Rock after September 19.
This probably makes Northern Rock the very safest place for anyone to put their cash in these uncertain times.
If such succour turns out to be controversial, it will be because Northern Rock鈥檚 competitors 鈥 especially the smaller banks like Alliance & Leicester and Bradford & Bingley 鈥 may feel that the Rock has now obtained an unfair advantage.
Why would anyone not put their cash into Northern Rock right now, unless it starts paying a dreadfully low interest rate? Whatever today鈥檚 pre-budget report discloses today about a deterioration in the public sector finances, Northern Rock鈥檚 guarantor, HMG, is not going bust.
Now Northern Rock is paying an arrangement fee to the Treasury for this insurance, which will remain in place until normal market conditions resume.
And it would also pay to the Bank of England a small percentage of any new deposits it takes 鈥 in order to deter it from offering a crazily attractive interest rate to woo customers.
But whatever that arrangement fee and payment to the Bank of England turn out to be, they are by definition not commercial terms for the insurance 鈥 for the simple reason that Northern Rock simply could not obtain such insurance in the marketplace.
So in the interests of maintaining a level playing field for banks, I wonder if the Treasury would be able to refuse to provide the same insurance on the same terms to other banks, if they demanded it.
The Treasury says it would turn them down 鈥 unless they were in dire straits.
And I guess no bank would want to admit it needed such state insurance, because that would be a dangerous admission of fragility which would alarm customers.
Even so, it is plausible that the protection for Northern Rock constitutes unfair state aid, of the sorted prohibited by the EU.
Also agreed today is a widening in the range of collateral Northern Rock can pledge to the Bank of England in return for the emergency loans it is drawing for the Bank.
This has been done to help Northern Rock take advantage of the 拢10bn or so of commercial funding on offer from Citigroup, the world鈥檚 biggest bank.
At the moment, the Rock cannot borrow from Citi or any other commercial lender who may make funds available, because the Bank has taken a charge over all Northern Rock鈥檚 prime assets.
But now that the Bank has agreed to lend against the security of assets of lower quality, the Rock can pledge the better stuff to Citi.
It all means that 鈥 with copious state support 鈥 Northern Rock can plot a course towards perhaps becoming a normal commercial operation again one day.
This won鈥檛 happen overnight. As of now, it has borrowed almost 拢11bn from the Bank of England in emergency support. And it may be forced to borrow another 拢10bn or so from the Bank in coming months, as its existing liabilities come up for renewal.
That said, Northern Rock鈥檚 shareholders can breathe a small sigh of relief that the Treasury is no longer trying to get the troubled bank off its books at a speed that would squish the value of its equity to zero.
However don鈥檛 be fooled into thinking the rescue is without very serious costs for Northern Rock and its owners. There will be an incremental one-off charge of up to 拢50m in the results for the year to December 31 just in respect of an indemnity to pay all costs incurred by the Treasury, the Bank of England and the Financial Services Authority in respect of their work on Northern Rock, plus the pickings of the Rock鈥檚 own advisers.
And that hit to profits does not include any of the punitive interest charge levied by the Bank of England.
Make no mistake, the Rock鈥檚 shareholders are paying a very steep price for the crisis at their institution.
- Business editor Robert Peston
- 1 Oct 07, 08:00 AM
is famed for being one of the world鈥檚 most conservative financial institutions. So it is both humiliating for it and troubling for us that it is the first of the world鈥檚 top-flight banks to disclose a substantial loss from this summer鈥檚 turmoil in credit markets.
Take it as a warning that the relatively strong performance disclosed last week by some of the leading Wall Street investment banks does not mean all banks will emerge almost unscathed from the debacle triggered by the collapse of the market in US sub-prime residential loans.
The mess is doubly embarrassing for UBS since it took a substantial hit in the dry-run for this summer鈥檚 market mayhem, the crisis afflicting the giant hedge fund, , in 1998.
The statement that UBS put out this morning is a little opaque, but the headlines are:
1) It will make a pre-tax loss for the quarter of just under $700m, its first quarterly loss for nine years;
2) The main culprit is the fixed-income, rates and currencies division of its investment bank, which made 鈥渘egative revenues鈥 of around $3.4bn;
3) The source of the losses are the 鈥渓egacy positions鈥 of its now-closed hedge-fund and proprietary trading business, , together with holdings in its mortgage-backed securities trading business;
4) It has taken significant though unspecified write-downs on positions in 鈥渟uper senior AAA-rated tranches鈥 of collateralised debt obligations.
The losses on CDOs are particularly piquant and are further proof that these manufactured securities do not always do what they say on the label: triple-A rated bonds are not supposed to incur 鈥渟ignificant鈥 losses.
Here鈥檚 UBS鈥檚 predictable explanation. It says that the underlying cause of most of this mess is 鈥渢he deterioration in the US sub-prime residential mortgage-backed securities market鈥 which was 鈥渕ore sudden and more severe than in recent history鈥 鈥 and the ensuing illiquidity that led to 鈥渟ubstantial valuation losses鈥.
To its credit, UBS is doing less of the 鈥渘ot our fault, guv鈥 routine than you might expect of a famously stuffy global bank. The chairman and chief executive of the investment bank, Huw Jenkins, is stepping down, to be replaced 鈥渇or the foreseeable future鈥 by the chief executive of the whole bank, Marcel Rohner. Jenkins will however be retained as 鈥渟enior advisor鈥 to Rohner. And there are various other senior management changes, all designed to improve the bank鈥檚 control of risk.
Also, it has begun that process of shedding staff which I warned about a few weeks ago (see Scything the City). UBS鈥檚 employee numbers will be cut by 1,500 before the end of the year.
And there is an ill-augury for its competitors. It has taken a loss on its relatively small exposure of loans to private-equity buyouts. With somewhere between $300bn and $400bn of these loans sitting on other banks鈥 books, that implies its rivals may be sitting on losses of between $20bn and $40bn just on the private-equity or leveraged buyout debt they have been unable since July to place in the market.
UBS is big enough to more than weather this storm. For the year as a whole, it will make a substantial pre tax profit of somewhere around $8.5bn. But other banks likely to be damaged by the sub-prime fallout are not quite as big and robust.
UPDATE 12.50: Citigroup has now joined UBS in the roll-call of sub-prime shame. It has announced that it expects third quarter post-tax profits to slump by 60 per cent. Why? Well there is $1.3bn of losses on sub-prime mortgage backed securities and $600m of losses on fixed-income trading.
But the big story, which I hinted at above, is $1.4bn of pre-tax writedowns on private equity loans. This is cringe-making for Citi鈥檚 chief executive, Chuck Prince, who in July told the FT 鈥 using notoriously hubristic language 鈥 that his bank was 鈥渟till dancing鈥 in the private equity market, long after it was obvious that the private-equity bubble had been pricked and was deflating at an alarming rate.
- Business editor Robert Peston
- 26 Sep 07, 02:00 PM
That for the three-month loans on offer from the was wholly predictable. As I said in my note yesterday, if someone is charging you 拢6 for five-pound notes, but you can have them at 拢5.50 in the market down the road, what are you going to do?
The Bank was charging 拢6, in effect. And the only takers would have been those barred from the market.
So does the total absence of anyone wanting the Bank鈥檚 readies mean that the banking crisis is over, that it鈥檚 business as usual, that there are no residual liquidity problems for any small banks?
No, no and no.
Confidence is returning to markets. The rates being charged by banks for lending to each other have been on a steady downward path for a few days.
But credit is still pricier than it should be. And there remain serious challenges for smaller banks when endeavouring to finance their lending activities. They are succeeding by their skin of their teeth 鈥 but it isn鈥檛 easy.
The Bank of England isn鈥檛 abandoning the auctions. It will hold them on Wednesdays in each of the coming three weeks.
A reasonable criticism of the Bank is that it is charging too much for this money (see Banks' Scary Auction). The funds are attractive only for banks with the financial equivalent of devastating BO and which find it hard to raise funds from other banks. But, understandably, no bank dare admit it wants the Bank of England鈥檚 cash, because that would be the equivalent of sticking up a hand and shouting, 鈥淟ook at me, I smell鈥.
However it makes sense for the bank to offer the money again in coming weeks, just in case the BO is a symptom of a rather more worrying condition.
- Business editor Robert Peston
- 25 Sep 07, 02:45 PM
How do you cause a run on a bank?
Well, according to the wags in the City, you put a brilliant economist and two former Whitehall permanent secretaries in charge of the .
It's not the funniest joke ever and it's not fair. But it contains a grain of truth.
The Bank seems to have lost the feel it had for markets during the previous few years when successive deputy governors were former investment bankers (also, the previous Governor, Eddie George, had a nose for the important weather in the City, even though he was a Bank lifer).
So will the Bank redeem itself with tomorrow's 拢10bn auction of three-month loans?
Well, it has already injected just a bit more confidence in markets simply by announcing that it would be having the auction. Bankers are reassured that the Bank is at last prepared as a matter of routine to lend longer than overnight and against a much wider range of collateral than hitherto. By way of evidence, the interest rates at which bankers are prepared to lend to each other have come down.
But this very success could also spark disaster.
The Bank is charging a penal, minimum interest rate on the three-month money of base rate plus one percentage point, or 6.75 per cent.
Why? You all know the answer, so repeat after me: "moral hazard". Yes it is once again because of Mervyn King's understandable fixation on spanking the banks for getting us into this money-markets mess in the first place.
But here's the problem with his refusal to charge a market interest rate, as opposed to a punitive one. A bank would have to be truly desperate to want to take advantage of the pricey money - and heaven help said desperate bank if its identity were to leak.
The big banks, , , and so on, are awash with cash and have no problem borrowing from other banks at the interbank market rate of 6.34 per cent. So it would be totally irrational for any of them to borrow from the Bank at 6.75 per cent and none of them will do so.
The only banks for whom it would be rational to take advantage of the Bank's auction would be those smaller banks in danger of running out of money and to which the other bigger banks don't dare lend.
In other words there will be a massive stigma attached to accessing the Bank's new facility. And for that reason, no bank would do so unless it were in pretty dire straits - which magnifies the stigma.
That said, in theory the names of any borrowers won't be disclosed. But I am not sure that's sustainable under Stock Exchange listing rules. Asking the Bank of England for this money is so plainly a massively price-sensitive event (it would knock the relevant bank's share price for six) that the borrowing bank would surely have to tell its shareholders that it had done so. Just remember how the share prices of and were pummelled by unsubstantiated rumours that they were running out of cash.
There's only one bank which can take advantage of the auction with impunity. And that's - simply because its reputation has already been smashed up by having received emergency loans from the Bank of England. In fact, it would probably be irrational for Northern Rock not to participate in the auction.
The risks of doing so for any other bank are daunting, to put it mildly.
Some bankers are therefore trying to gee themselves up with the thought that Mervyn King might yet have a Damascene conversion.
If at this last hour the Bank switched to charging a market rate, all the banks would be delighted to participate in the auction - because there would be neither be a prohibitive financial cost nor a devastating reputational one.
- Business editor Robert Peston
- 23 Sep 07, 10:03 AM
Time to take stock of the astonishing consequences of Northern Rock鈥檚 decision to apply for emergency help from the Bank of England on September 13.
Here is where we are today:
1) The Government is underwriting all deposits in the British banking system; it has said that no depositor need fear the loss of a bean, thereby incurring a potential liability to the public purse on a mind-boggling scale.
2) The Treasury has very specifically insured almost all forms of lending to Northern Rock, so it has done what would normally be the unthinkable, which is to provide a public subsidy for the value of Northern Rock鈥檚 shares.
3) The Bank of England has belatedly provided the kind of three-month lending facility to the banks which it resisted doing just weeks ago 鈥 and which could well have prevented the crisis at Northern Rock, if it had been made available in early September.
4) The Chancellor has signalled that the existing system for insuring deposits at banks is to be swept away and replaced with one that gives greater protection and pays out with greater speed.
5) City confidence in the ability of the Bank of England to cope with this kind of crisis is very badly shaken.
This is the equivalent of the wreck of a city after an earthquake. So where does blame lie for this disaster? Here is the preliminary roll-call of responsibility:
a) If at the heart of Northern Rock鈥檚 problems was a business model that was too dependent on the money markets, then its management are first in line for criticism 鈥 and second in line are its non-executive directors, for failing to rein in the exuberance of management (and if you want an illustration of how blinkered they all were, both Northern Rock executives and non-executives were still buying shares in Northern Rock at the end of July and in early August).
b) Again, if the underlying cause was Northern Rock鈥檚 shaky business model, it is reasonable to ask whether the laudable aim of the City watchdog, the Financial Services Authority, to provide freedom for banks to innovate and flourish went too far in this case.
c) The Bank of England seems to have shown too little imagination in the way it provided funds or liquidity to money markets after they seized up on August 9. Its obsession with not rewarding banks for their bad behaviour seems to have made it blind to the option of flooding the market with cash, but making that cash expensive (both in terms of discounts or the 鈥渉aircut鈥 applied to collateral and a high interest rate). Such funds would have allowed Northern Rock, for example, to continue trading without the stigma of applying for an emergency loan. And Northern Rock would have been suitably spanked, because its profits would have been wiped out by the pricey terms of these funds. For what it鈥檚 worth, the Chancellor Alistair Darling signalled in The Times on Saturday that he would now favour a 鈥渕ore generalised system of bank support鈥 along these lines 鈥 though the words 鈥渂arn door鈥, 鈥渉orse鈥 and 鈥渂olted鈥 come to mind.
d) Banks are bemused by how little direct contact they have had with the Bank of England during the money-markets turmoil of the summer. This may in part be due to an understandable desire by the Bank of England to avoid duplication of effort with the Financial Services Authority. However it is difficult to see how the Bank felt confident to refuse the agonised demands of the banks and the FSA for more liquidity to be pumped into the market 鈥 as the Bank consistently did 鈥 unless it had first-hand knowledge of the scale of the problems at individual banks. This may point either to a failure at the Bank or a failure of the tripartite alliance of Bank, FSA and Treasury (which was created by this Government around ten years ago and was supposed to be the optimal system for coping with banking crises).
e) The decision-making efficacy of the tripartite alliance doesn鈥檛 look brilliant in a second respect. There is something very odd about the Treasury sanctioning the Bank to provide lender-of-last-resort funds to Northern Rock when the Bank and the FSA were more-or-less persuaded that the inevitable consequence would be a run on Northern Rock (largely because of the inadequacies of the deposit-protection system). The four-day delay in announcing that the Government would not allow any depositors to lose money made their fears come true. A banking crisis was transformed into the national humiliation of the first run on a British bank for 141 years. Was this delay the result of Treasury reluctance to expose the public-sector balance sheet to the problems of Northern Rock? Were the Bank and the FSA poor in communicating their intimations of doom to the Treasury?
These are important questions. Hooray that they will be examined by the Treasury Select Committee. But arguably there should be a proper public enquiry of a wholly non-political sort.
However, if there is already a single glaring lesson of the Northern Rock debacle and the wider problems in money markets, it is that the global regulatory system has put too little emphasis on the risks of liquidity crises. As a matter of urgency new rules have to be drawn up to ensure that all banks have proper emergency plans in place to secure access to cash in the event that it becomes difficult to obtain through normal channels. Oh, and it might make sense for the Bank of England to review its own emergency procedures.
- Economics editor Evan Davis
- 20 Sep 07, 04:26 PM
I don't think one can overestimate the importance of what Mervyn King told MPs this morning.
In effect, he told them that Britain currently has no proper defence mechanisms against bank failure. We built up the Maginot Line to protect us, only to find that when the Germans wanted to invade, they could wander in through Belgium.
At its first big test, the current system has quite spectacularly failed to prevent a bank run - indeed, worse than that, our defence mechanism caused one.
Why did our system fail?
We used to have old informal arrangements that did work. The Bank of England could orchestrate an immediate, secret takeover of a failing bank to be announced as a fait accompli before the depositors could let panic get out of hand. Or, the Bank could use its famous lender of last resort facility to help a struggling bank, without depositors knowing there was a problem.
That old system worked rather well.
But now we have laws against that kind of thing. The shareholders need to be told what's going on. The banks need to disclose material facts. So with everything in the open, when the lender of last resort facility is used, it (rationally) engenders panic among the depositors.
We could do everything in the open - and avoid panic - by ensuring that enough depositors have a secure enough guarantee of immediate access to all their money if the bank fails, that they don't need to queue to get their money out.
But our compensation scheme is slow and inadequate as well. Inferior to those elsewhere, the Governor told us this morning.
This is all pretty shocking.
And it's hard to see how this could have been avoided by early action, because at any stage you act openly, without full protection of depositors, you run the risk of creating panic.
Is Mervyn King just making excuses for his early inaction and failures to swamp the money markets with cash? Possibly. But injecting the whole market with the volumes of cash that would have been needed to protect Northern Rock, would have made life rather too easy for some other banks.
So where do we go from here?
Ironically, the one aspect of the system that MPs thought might be to blame - the splitting of authority between the triumvirate of the Treasury, the Bank and the FSA - is not the bit that didn't work, according to Mervyn King.
Others may not agree with him. But that is probably the least immediate area for reform.
The two (related) issues that need addressing are the deposit guarantee arrangements; and the insolvency arrangements for banks. We need to find a better system for guaranteeing retail deposits in respectable institutions; and the insolvency arrangements have to favour the depositors.
At the moment, the boom in securitisation (by which banks like Northern Rock sell their mortgages or borrow money secured against them) implies that the depositors are at the bottom of the queue for assets in the event of insolvency. The capital market investors have a prior claim to the mortgages which are the security for the loans they have made.
That is all fine, but not if it involves the depositors being unprotected, or protected at the expense of the taxpayer.
It's no wonder that Mervyn King believes we urgently need some thinking and some action - preferably in that order.
- Business editor Robert Peston
- 20 Sep 07, 04:20 PM
It is a matter of deep principle for Mervyn King that we all take responsibility for our financial mistakes.
Today he cited the case of a young woman who had borrowed too much.
Her bank told her that it could not write off her debt, because that would encourage other customers to binge on borrowing in an unhealthy way.
A good thing too, Mr King said.
And it鈥檚 why, he added, that he has been resistant to the immense pressure from Britain鈥檚 banks for the to pump an ocean of money into the banking system.
That, said King, would have been to reward them for their imprudent lending, when they should have been punished.
There can鈥檛 be one rule for customers and another for the banks.
Quite right, most of us would think.
Just the sort of thing we would want from a Governor.
So surely he has a view about who was to blame for the grotesque run on 鈥 which was swiftly followed by the Treasury writing a blank cheque for the depositors in all British banks, to ensure none of them need fear they could suffer losses in the current market turmoil.
Well when the put this to him today, it turned out that no one was seriously at fault.
It was all due to the unintended consequences of well-meaning financial regulation.
Which, in a nutshell, is why Mr King鈥檚 stock is a long way from its all-time high in the City.
It鈥檚 all very well to lecture bankers that they need a sound thrashing for their naughtiness. But is Mr King really persuaded no individual at the Bank of England, the Treasury or the has made an important error of judgements since the merde started flying on August 9?
- Economics editor Evan Davis
- 20 Sep 07, 09:49 AM
A group of experienced climbers decide to enjoy a party on the top of a mountain. It seems quite sunny, so they pack a few drinks and as they reach the top, they crack open some bottles and blithely dismiss the warnings of impending storms that come from the mountain rescue people patrolling the area.
The climbers are very drunk when the storms eventually hit, but pretty soon they sober up as they realise they can't get down the mountain. So they call for the rescue helicopter to come and and get them and their picnic boxes.
Instead of sending a helicopter straight away, the mountain rescue team tells them to dump their picnic stuff and to try to make their way down the mountain alone. The rescue chief thinks they can still get down safely, and anyway he thinks it's only right to let them learn their lesson.
But he's wrong. They get into a bit of trouble, one is injured (although no-one dies). Once he sees there is trouble, the chief does relent and sends the helicopter for them.
This is not a very unfair characterisation of the situation between the Bank and the banks.
And who at the end of this tale should get punished? The experienced climbers? Or the boss of mountain rescue team?
At the moment, there is a keen desire for someone to blame, and the spotlight is falling on Mervyn King.
The case against him is pretty clear. He could have taken actions that would have avoided the Northern Rock debacle. He could have pumped cash into the banking system that would have obviated the need for Northern Rock to humiliate itself and come and get some on its own, creating a bank run. But he didn't.
Mr King would have had to pump quite a bit into the system, because to give enough to Northern Rock would have required giving a lot to many banks who didn't need it so badly. And if he had just injected a little cash, it wouldn't have found its way to Northern Rock.
But in the tripartite division of responsibilities, Mervyn King was the only one with the rescue helicopter, and he chose to use it later than many others wanted.
And as if to prove he was wrong, he made the U-turn yesterday, and did what everyone else had wanted all along.
The case in the defence of Mervyn King is pretty strong too, however.
It's quite simple. Rescuing the banks by validating their reckless behaviour has a cost. It encourages them to be reckless in future and it strengthens the relative competitive position of mis-managed banks over well-managed ones.
In addition, the Bank maintains that any solvent bank can get cash, just as long as they are willing to pay for it at a penalty interest rate. If they don't want cash, it's because they are too concerned with preserving their profits to borrow it.
In addition, Mr King has always recognised that there is a trade-off between letting the banks suffer from their actions, and helping the economy. He has always been clear, you can change your mind about where we are on that trade-off without performing a U-turn. He changed his mind this week.
For many, the subtleties of the argument are irrelevant. There has been a problem, someone should resign. It would be undoubtedly convenient in the city and in Westminster if it was Mervyn King.
But whatever the case on both sides, and whether or not Mr King keeps his job (I suspect he will, incidentally, but may not get his term in office renewed) the real questions after this affair are not so much about the handling of it in the past three weeks, but about the handling of it in the past three years.
- Business editor Robert Peston
- 20 Sep 07, 09:24 AM
I was really struck yesterday at the torrent of support for Mervyn King from readers of my blog 鈥 and those messages are still coming in. If King is Jose Mourinho, the fans certainly don鈥檛 want him to quit.
But I now fear that the briefing by the Bank to me last night 鈥 to the effect that the decision to offer three-month loans against the security of mortgage-collateral would not have been enough to help Northern Rock 鈥 was disingenuous.
The first Bank auction may only be 拢10bn but future auctions could be bigger or smaller depending on demand and market conditions. Such a facility could have prevented the Rock hitting the rocks. And Northern Rock itself is absolutely persuaded that if these auctions had been available a few weeks ago, there would never have been the liquidity crisis which prompted it to go cap in hand to the bank for emergency help.
The role of King in the collapse of Lloyds TSB鈥檚 attempt to mount a rescue takeover of Northern Rock also needs examining.
Lloyds TSB offered 拢2 a share, which Rock鈥檚 board was minded to accept. And according to a senior, well-placed banker, Lloyds TSB believed initially that the Bank of England had signalled it would be prepared to provide some kind of guarantee of funding for Rock鈥檚 拢113bn assets. Then the Bank changed its mind and said it could not be seen to be subsidising the deal.
The consequence was that the Rock then had to apply for succour from the Bank as lender of last resort. And the rest is the wrong kind of banking history.
So the criticism of the Bank of England is that it jeopardised confidence in the banking system so as not to face the charge that it was insuring Lloyds TSB鈥檚 shareholders against the full risks of a takeover 鈥 which could have been seen to be tilting the level playing field for takeovers and giving Lloyds the dangerous freedom to take undue risks with the Rock鈥檚 balance sheet.
The credibility of the Bank鈥檚 governor, Mervyn King, is in the balance. I have spoken to members of its "court" (the equivalent of its board of directors) and they are split on whether he will or should quit.
- Business editor Robert Peston
- 19 Sep 07, 05:15 PM
One of the main functions of a central bank like the is to provide liquidity - or funds - to banks to ensure the smooth running of the financial system and the economy.
It鈥檚 a bit like a water company - no one really notices its existence until there is difficulty getting stuff out of the taps.
Well, on August 9, the equivalent of the mains system in the banking market seized up.
Banks became reluctant to lend to each other and would only do so at relatively high interest rates.
Think of it as turning on a tap at home and only finding a trickle.
However, the Bank of England consistently said that its system for providing liquidity didn't need overhauling.
It claimed that to do so would be to bail out banks which had lent or invested in an injudicious way - and it had no intention of doing that.
It has now changed its mind.
The Bank has agreed to accept mortgages from banks as collateral against three month loans.
Baffled?
It's the equivalent of opening up a whole new reservoir in the water system.
But here's the humiliation for the Bank.
If it had done this three weeks ago when banks were clamouring, might never have feared that it was running out of money.
So it would not have had to approach the Bank of England for emergency support.
And there would never have been that on Northern Rock - the first run on a British bank for 140 years.
The possibility that the flight of capital from Northern Rock could have been avoided is seriously embarassing for the Governor of the Bank of England, Mervyn King, one of whose functions is to maintain financial stability.
Right now, stability may not be the correct word to describe his employment prospects.
IMPORTANT UPDATE: 19:59 The Bank of England has now told me that individual banks can only apply for 拢1.5bn each under the 拢10bn facility. It says that Northern Rock would have needed far greater funds - and that if this finance had been provided three weeks ago or so, the liquidity would not have eliminated the Rock's funding difficulties.
It is slightly odd that the Bank should divulge this to me now, because it failed to provide this detail (or any answer at all) when I asked this afternoon whether what it announced today could have provided succour to Northern Rock. So although the Bank of England has changed course in respect of the way it is prepared to tackle the crisis in the money markets, it is sticking to the position that it has no regrets about the way that it provided its initial support to Northern Rock.
- Business news chief Daniel Dodd
- 19 Sep 07, 04:34 PM
The blame game has started. Who's to blame for the run on the Northern Rock - the management for their over-reliance on the money markets to fund their business, the regulators for not reacting quickly enough to guarantee the safety of depositors' cash, or the depositors themselves for panicking and ignoring the reassurances of the authorities?
We have also seen (on this blog, amongst other places) that some people blame the 大象传媒 for its reporting of the crisis.
From the moment the story broke - a terrific scoop by our business editor Robert Peston on Thursday night - we were clear we had to handle the story carefully. We talked internally about the need to be responsible in our coverage - not to provoke panic but to tell people straight what was happening (see Peter Horrocks' blog on Thursday).
We set out to be restrained and factual. We have given plenty of air time to Northern Rock, to the Chancellor and the to reassure depositors and we have repeated those assurances throughout our coverage over several days. But despite this, obviously we had a run on the bank - I think this is down principally to two things:
1. The power of the images of long queues forming and...
2. The fact that for many people this was indeed a 'rational' thing to do, if you were exercising the precautionary principle. Until the Chancellor's announcement on Monday evening unequivocally guaranteeing that no depositor would lose money there was just a chance - a remote chance - that things might unravel in such a way that people would lose money (in part because the current compensation scheme does not pay back the full amount after the first 拢2000). So as one customer in a queue told us, "I'm not panicking, I'm being completely rational".
Should we have carried images of the queues? Of course we should and everybody did. The public needs to know what's going on - but we had a responsibility to do it in a balanced way. So the fears of those interviewed in the queues were set against the reassurances of experts from the financial services industry and the politicians and the regulators. It is not the fault of the 大象传媒 or the media in general that these assurances were not believed until the chancellor removed all doubt.
- Business editor Robert Peston
- 19 Sep 07, 08:03 AM
What happened at Northern Rock, the first run on a British bank in living memory, has caused deep shame and embarrassment in the banking industry.
It is not the sort of thing that is supposed to happen here.
Senior bankers are livid and looking for someone to blame.
First in their sights is Mervyn King, Governor of the Bank of England.
His refusal to flood the banking system with cash over the past few weeks is the cause of the humiliation of their industry, or so they claim.
Just over a fortnight ago, the biggest UK banks 鈥 HSBC, Barclays, HBOS, Lloyds TSB and Royal Bank of Scotland 鈥 met with Hector Sants, chief executive of the Financial Services Authority.
Sants asked if there was anything the FSA could do to ease the conditions in the money markets.
They replied that there was little the FSA could do, but it would be helpful if the Bank of England would widen the collateral it was prepared to accept from banks in return for providing short-term funds.
The FSA communicated this demand to the Bank through the tripartite group of Treasury, Bank and FSA whose job is to steer the UK through financial crises.
Sants and the FSA鈥檚 chairman, Sir Callum McCarthy, were broadly sympathetic to the demands of the banks.
In a way, that is predictable. They are both former investment bankers, with a visceral understanding of markets.
However King 鈥 a world-class economist with an intellectual grasp of markets rather than an emotional one 鈥 said no.
He feared that he would in effect be bailing out some banks and financial institutions which 鈥 for the future safety of the financial system 鈥 ought to feel the pain of their imprudent lending and investments.
Minimising moral hazard is, for King, paramount.
What鈥檚 more King received representations from one or two banks which had taken the brave decision not to follow the pack into some of this dodgier lending and were therefore outraged at the idea that their injudicious rivals would be bailed out.
So the Bank stuck to its own rulebook of how much it would lend into the banking market and how it would do so.
There was no recovery in banks willingness to lend to each other and - with a grim inevitability - Northern Rock started to fear it would run out of cash.
An attempt to sell itself to Lloyds TSB foundered on the Bank of England鈥檚 refusal to effectively subsidise the deal by providing guaranteed credit to finance Northern Rock鈥檚 loan book.
So Northern Rock had no option but to request an emergency loan from the Bank of England 鈥 which it was duly given last Thursday night.
What followed has been a shocking new chapter in the annals of banking history, as images of queues of anxious customers flashed across the world.
The Government too has been humiliated. All its reassurances to Northern Rock depositors were ignored, until - with all the appearance of panic - it ditched its existing limited insurance scheme for depositors by promising that no Northern Rock depositor would lose a penny.
The Chancellor, Alistair Darling, was bounced by the crisis into pledging that in a worst case of Northern Rock running out of funds, it would be nationalised.
So for many banks, King's purist refusal to provide succour to all of them eventually forced the new prime minister, Gordon Brown, to agree that 拢113bn of mortgages made by Northern Rock could go on the public sector balance sheet.
Again, that is just not the sort of thing that is supposed to happen in a well-functioning economy.
Is King at fault?
It is too early to say.
As of this moment, no depositor has actually lost any money.
And it is unclear precisely how much the seizing up of the money markets will slow down the wider economy.
More germanely, few would dispute that the Bank must take enormous care not to reward foolish lending or investing 鈥 because that would only encourage foolhardy institutions to behave even more stupidly next time, to the detriment of all our future wealth.
That said, top British bankers 鈥 who met the FSA again yesterday 鈥 are sickened that their industry, the very heart of the economy, should have been tarnished by those pictures of anxious depositors scrambling to withdraw funds.
Their anger at the Bank of England shows no sign of easing 鈥 and it is shared by one or two members of the Government.
For the sake of his reputation and that of the Bank, King has a lot of explaining to do.
- Economics editor Evan Davis
- 19 Sep 07, 07:01 AM
The trouble started in the US, and the Federal Reserve's decision to cut interest rates had been awaited for weeks as one potential solution to it.
Indeed, there are worries the US might have become overly dependent on the Fed coming to the rescue at times of financial difficulty - if Superman is always there to save the day, then doesn't Lois Lane let herself get into trouble?
But at the moment, such concerns are not bothering Wall Street. They got what they wanted - the authorities to shift their recent preoccupation with inflation, and to ease the pain of those that have been suffering from their lending decisions. As it is, the US is adjusting to a slowdown - from growth rates of about three per cent, to those of about two per cent.
That adjustment is probably inevitable, as Americans move to more sustainable levels of borrowing and saving, and not even Superman can prevent that. But the goal is simply to prevent a slowdown turning into a recession, particularly given falling house prices.
However - in the UK, where similar issues arise, the heroic job of steering the economy through current stresses is being made far easier by falling inflation. If the Bank of England doesn't have to worry about that, it has more room to manoeuvre to deal with other problems, perhaps sometime following the US with lower interest rates.
- Political editor Nick Robinson
- 18 Sep 07, 11:59 AM
"The system has worked". No really, it has. Or so says the chief executive of the . In four words he inadvertently captured the gap between the regulators and the public.
You might think that the sight of people queuing through the night to get their money out of the bank was a sign that the system had not worked. Or, indeed, you might point to the dramatic policy U-turn which produced a guarantee that every penny in every account in every single solvent bank would be underwritten by the government.
The regulator would reply that Northern Rock stayed open, no saver lost money and the integrity of the banking system was preserved. Sure, shareholders may have lost cash (though rather less if they sold today than yesterday). And, perhaps most worryingly the North East of England stands to lose not just jobs but a source of regional identity, pride and charitable funding if Northern Rock is lost as an independent institution. Ah, the regulator might reply, it is not our job to worry about share prices, job prospects or regional economies. Quite so.
However, if this was not policy failure it clearly wasn't a triumphant success. In the past few days Whitehall insiders have described the scenes of the past few days as illogical and irrational and called it a psychological or social problem. They have been baffled by the public's unwillingness to accept the Bank of England's guarantee that all would be well. Policy will clearly have to change.
What though will be the political fall out? My hunch is that it will be more like the fuel strikes of 2000 than Black Wednesday. In other words, a short term knock to confidence in the government's economic confidence. The thing that could change that is if voters associate falling real incomes and falls in the value of their house with the sight of queues outside the bank.
- Business editor Robert Peston
- 18 Sep 07, 08:00 AM
If the run on isn鈥檛 stemmed by the Government鈥檚 decision to guarantee that no depositor will lose money, well then nothing will stem it.
The decision is without precedent. Historically, all British governments, regulators and the have been persuaded that to 鈥渕ake whole鈥 all savers would be to create a serious moral hazard problem.
They have believed it really important that Mr and Mrs Bloggins should live in fear that they could lose some money by having their savings in Northern Rock or any bank, in the rather na茂ve believe that the Blogginses and other depositors would put pressure on said bank to conduct its affairs in a prudent way.
The theory is, of course, utter nonsense in complex modern capital markets 鈥 where even the specialist watchdog, the , has difficulty understanding the precise risks being run by individual banks (as we have seen in recent weeks).
And in practice the puritanical theory that everyone has to lose something has led to the near-collapse of Northern Rock.
Why?
Because when Northern Rock was singled out as a vulnerable bank after it was given emergency support by the Bank of England, the one thing the Blogginses remembered was that the official deposit protection scheme only guaranteed that a portion of their savings would be safe 鈥 and they may also have recalled that it would be months before they received even this limited compensation, in the event that Northern Rock collapsed.
So even though Northern Rock was not bust, it was not rational for the Blogginses 鈥 and all those other savers 鈥 to keep their money in Northern Rock, once even the faintest question was raised about its viability.
What the Northern Rock panic demonstrated is the huge potential for there to be runs on banks, when savers have so many banks to choose from. And, if Northern Rock鈥檚 website had been a little less prone to falling over, it would also have shown how technology has increased the risk of capital flight in these circumstances.
However, there is no point in providing this protection for simply Northern Rock or any other bank that faces a funding shortage in the current market turmoil (the chairman of the FSA, confirmed to me last night - you can watch the interview here - that such protection was being extended to all other British banks).
The Government must swiftly legislate to formalise this new approach to the public insurance of savers鈥 money.
The good news is that senior officials tell me such legislation in on the cards.
However, some important details are yet to be worked out.
The Bank of England would like elements of the US model to be imported, such as a provision for all small depositors to receive their money within days of a bank going bust.
But perhaps the most important question is where the ceiling on insured deposits should be set.
In the current crisis, the Treasury is saying that no depositor will lose his or her money, no matter how big the deposit.
That is not sustainable as a general approach, because it would create a serious moral hazard issue. It would effectively be extending protection to sophisticated professional money-market players 鈥 which would have the effect of reducing the pressure on banks not to take excessive risks, because they could take comfort that the Government would pick up the tab if it all went wrong.
The pressure on banks not to take excessive risks must come from the substantial providers of capital, those who buy their shares, purchase their bonds or finance them in other ways through the wholesale money markets.
Make no mistake, Alistair Darling has bailed some or all of them out in the Northern Rock case. And that is a very unfortunate precedent.
If it became the general rule that all deposits were protected, well the financial system would soon go to hell in handcart. As one bank after another took stupid risks to inflate profits, they would all end up in public ownership.
- Business editor Robert Peston
- 18 Sep 07, 07:45 AM
Last night I interviewed Sir Callum McCarthy, chairman of the City watchdog, the Financial Services Authority, about the run on Northern Rock and the wider crisis in the financial markets. McCarthy said the era of cheap money based on banks 鈥渕ispricing risk鈥 was probably over. That may push up the cost of borrowing for all of us. But in the long term, it should put the economy on a more sustainable footing.
You can watch the interview in full by clicking here.
- Political editor Nick Robinson
- 17 Sep 07, 01:34 PM
Economic stability is the rock on which New Labour's election victories have been built. No wonder then that their opponents - in both the Tories and the Liberal Democrats - could not hold back their excitement at the possibility that that reputation might be destroyed by the sight of people queuing up to take their cash out of the bank.
And yet in the speech David Cameron has just delivered, he pulled back from repeating - let alone escalating - the suggestion he made yesterday that ministers were somehow to blame for the Northern Rock crisis. Just to remind you, the Conservative leader that, "though the current crisis may have had its trigger in the US, over the past decade, the gun has been loaded at home."
Today, though he repeats his criticism of economic growth "built on a mountain of debt", there is not the slightest hint of a direct connection between the government's economic policies and Northern Rock's problems. No wonder. There is a lively debate about whether the regulatory regime set up by Gordon Brown - which, remember, includes the Treasury as well as the Bank of England and the Financial Services Agency - have got their response right (see my colleague Robert Peston's latest blog for an admirably clear summary of the case for and against).
There is another lively debate about whether Britain and Britons are too heavily indebted and, if so, what to do about it.
I struggle to find anyone who believes, however, that Northern Rock's troubles result from government action or inaction. Indeed, Willum Bowter, a former Monetary Policy Committee member and professor of European political economy at the London School of Economics has just told The World at One that that the suggestion is "ludicrous".
Of course, if Northern Rock's problems spread to other institutions, if they are seen to be the beginning of economically turbulent times, few voters will study the economic arguments. Alastair Darling himself recognised this in an interview this morning when he was asked if his reputation was on the line. He replied: "it is, I'm afraid, yes".
- Business editor Robert Peston
- 17 Sep 07, 10:20 AM
I had to chuckle when I heard Will Hutton on Today this morning (you can listen to the interview here). Here was the leftish head of the making the same arguments about the need for the Bank to pump money into the financial system that I have been hearing from the uber-capitalists of the investment banks and the commercial banks for weeks.
The bankers want the cash from the Bank to ease the pain they are feeling from the injudicious way they invested their capital over the past few years. And, funnily enough, Hutton feels their pain too and thinks the Bank should have provided an analgesic weeks ago.
It鈥檚 is wrong of me to be flippant. There is an important debate to be had about the response of the Bank, the Financial Services Authority and the Treasury to the crisis in financial markets.
Simplifying slightly, the bankers and Hutton believe that some weeks ago all banks should have been allowed to borrow from the Bank of England more-or-less in the way that Northern Rock has been allowed to 鈥 and via a generalised special lending facility, rather than as an emergency loan to ward off imminent collapse.
What they argue is that if banks had been allowed to pledge all manner of assets of questionable value as collateral for Bank borrowing 鈥 Hutton mentioned the asset-backed commercial paper that no one wants to hold any longer 鈥 then there would have been enough liquidity or cash in the financial system to reverse the rise in market interest rates and also to encourage banks to lend to each other in the normal way.
Just possibly, Northern Rock would not then have faced a strike by the institutions that normally lend to it and would not have had to go cap-in-hand to the Bank.
That might be right. There is, for example, some evidence that conditions in the eurozone and US money-markets, where the central banks have been a bit freer with their injections of liquidity, have not been quite as tight as here.
Another possible argument against the way that the Bank used its lender-of-last resort powers to bail out Northern Rock is that the very act of saving it in this way also damaged it, possibly beyond repair. There is a huge stigma attached to requesting emergency funds in this way: Northern Rock was identified very publicly as a victim which therefore created the very anxiety among depositors that has led to the mass withdrawal of funds we鈥檝e seen since Friday.
So the Bank may end up giving more financial help to replace the Rock鈥檚 lost deposits than it would have had to do if it had been less uptight up pumping cash into the banking system more widely and generously.
That鈥檚 the case against the Bank of England.
And I can understand why Hutton and the bankers are quite emotional about it: the pictures of those queues outside Northern Rock branches are quite shocking; they鈥檙e not really the sort of thing that ought to happen in one of the world鈥檚 largest and strongest economies.
There is however a powerful argument in the Bank of England鈥檚 favour.
The first is that the Northern Rock was an accident waiting to happen. It was far too dependent on the money markets to finance the growth in its lending. And if the Bank had pumped a ton of money into the system to allow Northern Rock to weather this particular storm unscathed, there is a significant risk that Northern Rock would have faced bigger, uglier and scarier problems in the months and years ahead.
The second is that if the Bank had allowed all the banks to dump asset-backed commercial paper and mortgage assets on it in return for loans priced at the base rate plus a bit, a mountain of dodgy assets might have ended up on its books 鈥 and with no certainty that normal service in the money markets would have resumed.
In the process, the investment banks and commercial banks would have learned a dangerous lesson, which is that so long as their foolish lending and trading is on a big enough scale, the Bank will rush in to prevent them suffering undue losses.
At least in the case of the Northern Rock bailout, the Bank knows there is an upper limit of how much cash it would have to pump in 鈥 which is probably around 拢20bn in the highly unlikely case that every retail depositor were to take out his or her last penny.
To be clear, I am not yet arguing that the Bank and FSA handled this crisis in an optimum way.
Much will depend on what happens to Northern Rock over the coming days 鈥 and also whether there is contagion in the form of a loss of depositors鈥 confidence in other lending banks.
Northern Rock鈥檚 woes are a bit worse than just a little local difficulty. But it is premature to say that the Bank of England鈥檚 conduct has turned a crisis into something a good deal worse.
UPDATE 17:15 According to well placed banking sources, this afternoon鈥檚 massive Alliance & Leicester share price fall does not reflect any run on the bank鈥檚 deposits, either by ordinary customers or by other banks and financial institutions.
Like all banks, A&L is suffering from the illiquidity of the inter-bank market, but is much less dependent on other banks and institutions for funding than Northern Rock.
A&L itself believes simply that it has been targeted by hedge funds looking to profit from identifying the next banking victim, which have been short-selling the stock.
It and other small banks 鈥 like Bradford & Bingley, whose shares are also down sharply, though not as much 鈥 will remain vulnerable to this kind of negative speculation unless and until the Bank of England succeeds in restoring confidence to wholesale money markets.
- Business editor Robert Peston
- 16 Sep 07, 09:29 AM
For all the talk 鈥 including by me (see my earlier comment, Rock or Crock) 鈥 about how Northern Rock must surely soon find itself under new ownership, I have learned that it cannot be taken over by another bank in the absence of a major policy shift by the Bank of England.
Here is why.
Bankers tell me that Northern Rock spent a good deal of the summer exploring whether any big bank was prepared to acquire it lock, stock and online accounts. It had appointed the leading investment bank, Merrill Lynch, to sound out possible buyers.
There was, I am told, interest in a possible deal from substantial international banks.
But 鈥 and here鈥檚 the important point 鈥 the seizing up of interbank markets proved an insuperable obstacle.
No other bank wanted to take on the responsibility for financing Northern Rock鈥檚 total assets of more than 拢100bn at a time when it is very hard and very expensive to obtain funds from the money markets and banks.
So it was the realisation on the part of Northern Rock鈥檚 board last week that selling the bank had become impossible in current market conditions which actually persuaded the board to approach the Bank of England and ask for access to emergency loans.
Plainly, a takeover would have been a less humiliating option. But it just couldn鈥檛 be done.
Here鈥檚 the great banking Catch 22 of our time.
The Bank of England under its governor, Mervyn King, takes a very purist line to exercising its role as lender of last resort.
It is prepared to bail out a bank like Northern Rock to prevent serious damage to the banking system and the wider economy, although only on condition that the Financial Services Authority deems said cash-strapped bank to be solvent.
However in their words and deeds, King and the Bank of England have made it clear throughout the crisis in credit markets that they are not prepared to make good the losses of those they think have behaved imprudently or injudiciously.
Mervyn King wants to spank banks and other financial institutions, in the hope that they鈥檒l learn from their mistakes.
He is obsessed with moral hazard, and understandably so.
So the emergency lending facility can be used by Northern Rock as an independent bank to stop it from falling over while its worried depositors remove their cash.
But it cannot be used to prevent holders of Northern Rock鈥檚 bonds or shares suffering losses that stem from their decision to invest in a bank whose basic business model turned out to flawed.
What follows from that?
Well, the Bank of England would remove the emergency lending facility more-or-less the moment it was taken over by a bigger bank.
If it didn鈥檛 do that, the Bank of England could be accused of subsidising the sale of Northern Rock and propping up the value of Northern Rock鈥檚 shares and bonds, which is the last thing it wants to do.
But, as Northern Rock found out when looking for a buyer this summer, no bank has the confidence to buy Northern Rock and attempt to refinance its balance sheet on the money markets in the normal way.
The world鈥檚 biggest banks are finding it challenging even to fund their own assets in our malfunctioning financial markets. And if they didn鈥檛 want to absorb Northern Rock鈥檚 very substantial balance sheet just a few days ago, they are going to be even less keen now, after so much cash has been withdrawn by anxious Northern Rock customers from their branch, postal and online accounts.
As I said, it is the banking Catch 22 of our time: Northern Rock can鈥檛 be sold without a guarantee of funding from the Bank of England, but the Bank is refusing to provide such funding to facilitate a sale.
Maybe some kind of compromise, transitional arrangements can be agreed.
The Bank cannot have enjoyed witnessing the damage being wreaked to Northern Rock鈥檚 reputation by all those images of anxious and irate customers queuing outside branches.
Northern Rock鈥檚 brand is being tainted, possibly beyond repair.
For all the confidence of the Financial Service Authority鈥檚 confidence that Northern Rock is solvent, its basic long term commercial viability is being eroded. At some point, what starts as a liquidity crisis risks becoming something worse.
So here is the choice that may confront the Bank of England and the Chancellor of the Exchequer soon.
They could choose to continue along the path they have taken. This could see them injecting many many billions of pounds into Northern Rock for an indefinite period. They would in effect be choosing to enter the mortgage business and Northern Rock would almost be nationalised.
Over time, Northern Rock would probably wither as a business, to the detriment of its many employees.
Or the Bank and Chancellor could grit their teeth, swallow their pride and allow public funds to facilitate a takeover.
I cannot predict which way they will jump. When I interviewed the Chancellor Alistair Darling yesterday, he evinced great confidence in the actions of the Bank.
That said, in all the turmoil and uncertainty, Northern Rock鈥檚 share price is probably still heading in a direction that will not amuse its shareholders.
UPDATE 12:15 Withdrawals from Northern Rock are now just under 拢2bn, following yesterday鈥檚 withdrawals. In fact this is a bit less than the authorities 鈥 the Financial Services Authority, Bank of England and Treasury 鈥 had expected. They had been braced for 拢2bn on Friday alone. However, they cannot be sure much more will be withdrawn in the coming days, especially from holders of Northern Rock鈥檚 postal accounts (there was almost 拢10bn in these accounts as of June 30).
One piece of good news is that there does not appear to have been a loss of confidence in other mortgage banks or building societies. Much of the money withdrawn by Northern Rock customers has been put into other mortgage banks and former building societies, such as Alliance & Leicester and Bradford & Bingley, as well as the bigger banks. Although the risk of contagion has not been eliminated, so far there is no great sign of it.
I have also learned that Northern Rock was close to selling itself to another big bank before it finally asked for support from the Bank of England. There were two banks very interested in acquiring Northern Rock. They did a detailed investigation of Northern Rock鈥檚 business and determined that it was fundamentally sound (as it happens, the FSA has to an extent relied on their investigations in its subsequent determination that Northern Rock is solvent).
However these potential bidders were concerned about doing such a big deal at a time when there is turmoil in money markets, when it is difficult and expensive to raise money from other banks and financial institutions. They therefore sought guarantees from the Bank of England that it would supply facilities to fund Northern Rock鈥檚 assets, in the event that money was impossible to obtain on the market.
The Bank refused to provide such guarantees. As I've said, it did not want to be seen to be bailing out Northern Rock鈥檚 shareholders and bondholders. It feels they need to feel the pain and suffer the losses of their mistake in backing a bank, Northern Rock, whose strategy was flawed.
So the bidders walked away. And the Bank decided on a simpler strategy of simply providing emergency loans to Northern Rock as an independent entity.
UPDATE 19:31 The Bank of England tells me that the emergency lending facility would in fact be transferred to any new owner of Northern Rock. However once the facility expires (and the Bank will not give me the expiry date) there is no guarantee it would be extended for the new owner. So most bidding banks will remain nervous about taking on a balance sheet of Northern Rock鈥檚 size with the risk hanging over it of needing to refinance a large chunk of loans from the Bank of England at short notice in markets which may remain frozen. So negotiating a takeover of Northern Rock will not be easy. Even so, I detect a desire on the part of the authorities to see Northern Rock under new ownership sooner rather than later, so long as the strictures of good central banking are not thrown out of the window.
UPDATE 21:30 Sorry, I forgot to mention that - as the Sunday Times says today - Lloyds TSB was the bank which came closest to buying Northern Rock, before the Bank of England agreed the emergency facility. Right now, Lloyds TSB is no longer interested in buying the bank, but that could change.
- Business editor Robert Peston
- 15 Sep 07, 10:17 AM
Northern Rock鈥檚 depositors are nervous. That鈥檚 quite understandable. Some 拢1bn was withdrawn by customers yesterday, much of it from bank branches.
That represents a big chunk of the 拢5.6bn held in what Northern Rock calls branch accounts (as of the bank鈥檚 June 30 balance sheet).
There is a further 拢9.9bn in postal accounts 鈥 and presumably Northern Rock will be learning from today鈥檚 mailbag the scale of withdrawals from these accounts.
Then there is 拢4bn in internet accounts.
Holders of these have been anxiously emailing me saying that it has been almost impossible to log-on to their savings accounts over the past 24 hours, so 鈥 again 鈥 it is unclear what scale of transfer there has yet been out of these.
But just how worried should Northern Rock鈥檚 depositors actually be?
Well there are a number of different ways of answering that.
I am going to start by looking at the support the Bank of England has promised to provide and seeing whether it would be enough to pay out every single depositor, in the unlikely worst case that they all decided to withdraw their cash.
This is not as straightforward as you might expect, because the Bank has given only limited details of the emergency lending facility it is providing.
What I have learned is that the bank is lending against the collateral of mortgages made by Northern Rock.
However, it is not prepared to lend Northern Rock 拢1 for every 拢1 of mortgage pledged to it as security.
My understanding is that it wants more than 拢105p of collateral for each 拢1 it lends.
Now, Northern Rock鈥檚 balance sheet of June 30 this year shows that it has 拢31bn of residential property loans not subject to securitisation 鈥 which in theory are available to be pledged to the Bank.
But a further note to the accounts shows that 拢10.2bn of these have already been pledged, to providers of funds via financial instruments called covered bonds.
So there鈥檚 only 拢21bn of these straightforward mortgages available to the Rock as possible security for loans from the Bank of England. At a 5 per cent discount, the Bank would probably lend just under 拢20bn against these.
That鈥檚 not very encouraging, because retail deposits 鈥 which include the branch deposits, internet accounts and so on that I have already mentioned 鈥 actually total 拢24bn.
Also, there is a further 拢5.8bn described as 鈥渙ther customer accounts鈥. And there are 鈥渄eposits by banks鈥 of 拢3.7bn.
So total deposits are nudging 拢34bn 鈥 which on the face of it is a bit more than assets that could in effect be swapped for hard cash at the Bank of England.
So does the Rock have other assets it could pledge? Well it has 拢6bn of residential buy-to-let loans not subject to securitisation and therefore useable as collateral.
And it has 拢7.8bn of unsecured loans also not subject to securitisation.
Buy-to-let loans and unsecured loans are always seen as lower quality than residential mortgages. So if the Bank is prepared to accept them as security at all, it would probably demand a much greater discount to asset-value than 5 per cent when lending against these.
So I am going to make the heroic assumption that Northern Rock could probably borrower a further 拢11bn or so against its buy-to-let and unsecured book.
That gives us a running total of something like 拢30bn that could be obtained from the Bank, if all this stuff was pledged to it. Which is still not enough to pay out every single depositor in the highly unlikely meltdown case.
Now its June 30 balance sheet also shows that it has other higher quality assets 鈥 but in the past few weeks some of these will have been liquidated or pledged as Northern Rock endeavoured to weather the financial turmoil and looked for ways to finance its lending.
But for what its worth, as of June 30 Northern Rock had securities 鈥渁vailable for sale鈥 totalling 拢8bn and loans to other banks of just under 拢7bn.
Bottom line is that I estimate that Northern Rock has just about sufficient free assets to raise funds in the extreme and very unlikely case that every single one of its depositors wanted its money back.
Which helps to explain why the Financial Services Authority has described Northern Rock as solvent.
But on the basis at which the Bank of England is prepared to lend, depositors鈥 funds seem to be only just about covered by loans that could be provided by the Bank.
That said, there is a bigger political reason why Northern Rock may well now be one of the safest banks in the world.
Here the important point is that the Financial Services Authority has declared Northern Rock to be basically sound, the victim of temporary and exceptional maket conditions.
And the Chancellor, Alistair Darling, has very publicly endorsed the FSA鈥檚 analysis and said there is no reason for Northern Rock鈥檚 depositors to panic.
So in the unlikely event that a black hole did emerge at Northern Rock, the Government would be under enormous moral pressure to pay out 100 pence in the pound to Northern鈥檚 retail depositors, as opposed to the less generous terms available under the official deposit protection scheme.
UPDATE SEPT 15 16:00 It turns out that withdrawals from the website represented the biggest flight out of Northern Rock on Friday, in spite of the technical problems experienced by many holders of online accounts. Which is predictable, in that it is so much less hassle to go online than to queue outside (so long as you are actually able to log on). In an age when funds can be transferred with the click of a mouse, it is even harder for a bank to hang on to funds after any kind of knock to its reputation.
- TV News chief Peter Horrocks
- 14 Sep 07, 10:33 AM
The 大象传媒 News exclusive on Northern Rock receiving emergency funding from the Bank of England threw up some interesting broadcasting dilemmas.
Our business editor Robert Peston had the information well ahead of newspapers (although you'd never know that by reading the papers today, all of whom followed up on his scoop but didn't say so).
Announcing to an unsuspecting public that a major high street name appeared to be in trouble obviously ran the risk of causing depositors to panic and withdraw their funds. So we needed to ensure we broke this dramatic news in a responsible fashion. And, as part of that responsibility, we needed to explain the causes of the crisis in a way that audiences unfamiliar with financial markets would understand. (I won't try to do that myself. Far better to read Robert's account (or watch this piece from the Ten o鈥檆lock News)).
But is it the 大象传媒's job to tell people to be calm and advise them what to do? We are not financial advisers and there are legal limits on what our correspondents can do in terms of offering individual financial advice. We judge it is right for us to report the reassurance being offered by the and the and our correspondents have offered the judgement that those reassurances are legitimate.
But it's not the 大象传媒's job to tell the audience what to do with its money. Whenever we have commentary from financial experts on the 大象传媒 News website we always include this disclaimer: "The material is for general information only and does not constitute investment, tax, legal or other form of advice." Quite right.
- Business editor Robert Peston
- 14 Sep 07, 12:41 AM
The good news is that the , the and the don't believe is an unviable business.
If they thought the Rock 鈥 or Northern Crock as it鈥檚 been dubbed in the markets 鈥 was an intrinisically bad bank, they would not have agreed to rescue it by providing emergency funding.
Such the was unambiguous implication of the Bank Governor鈥檚 statement to the on Wednesday on the circumstances in which the Bank is prepared to act as lender of last resort to a troubled institution.
But that鈥檚 the end of the good news.
What also said is that the Bank will only provide funds to a troubled institution in this way if the risk of a collapse could lead to 鈥渟erious economic damage鈥.
Certainly Northern Rock 鈥 with 拢24bn of retail depositors鈥 funds and 拢113bn of loans and other assets on its books 鈥 is big enough to wreak a fair amount of havoc, were it to fall over.
Anyway, none of us 鈥 not even Northern Rock鈥檚 depositors 鈥 probably need to panic that the Bank has had to step in.
But does that mean that Northern鈥檚 customers and shareholders have no reason to feel aggrieved at Northern鈥檚 management?
Is it anyone鈥檚 fault that Northern fears it cannot raise sufficient funds from its traditional commercial sources right now?
Well, Northern is the victim of exceptional market conditions.
Few could have predicted that problems thousands of miles away in the US housing market 鈥 notably the losses on loans to American homebuyers with dodgy credit histories 鈥 would have made investors and financial institutions wary about financing Northern Rock鈥檚 very different and very British homeloans business.
But actually that doesn鈥檛 let Northern鈥檚 management off the hook.
Banks have to expect the unexpected in the way they manage their balance sheets.
To use the ghastly City jargon, they are supposed to 鈥渟tress test鈥 their businesses all the time to ensure they can survive the market鈥檚 equivalent of a nuclear strike.
Northern鈥檚 stress tests were not stressful enough.
But perhaps the biggest criticism to be made of this bank is it massively increased its mortgage lending at the beginning of this year, when most economists were forecasting a slowdown in the housing market and when interest rates were already rising in a way that squeezed its profit margins.
In the first six months of 2007, its net lending rose 47 per cent to just under 拢11bn. And at June 30, it had a further 拢6.2bn pipeline of loans that had been agreed with customers but not yet delivered.
So it is unsurprising that other financial institutions might feel that these mortgages were provided too late in the housing-market cycle to be quite as rock solid as loans made a few years ago.
What鈥檚 perhaps even more embarrassing for Northern is that in its interim statement made earlier this summer, it was explicit that it continued to lend even as the interest rate environment turned against it.
So Northern Rock may not be going bust.
But its reputation has been badly damaged.
Which normally means that there will be a clear out of top management and also that the business may well be sold.
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