大象传媒

On the first day of Xmas, the chief executive of a leading store chain told me to ignore the pictures of crowds doing their last minute shopping 鈥� retailers have slashed their prices in early sales and promotions, so profit margins are being squeezed till the pips squeak.

On the second day of Xmas, the same chief executive said that trading conditions were worst in furniture and furnishings, followed by men鈥檚 clothes and then ladieswear. Only the food retailers are doing okay, he said 鈥� because they are massively discounting petrol on their forecourts and because many of us are eschewing restaurants, to save a few bob, and eating more at home.

On the third day of Xmas, retailers started to praise the farsightedness of investment analysts making the gloomiest forecasts 鈥� in the hope the market would cotton on, and they wouldn鈥檛 have to issue formal profit warnings.

On the fourth day of Xmas, the head of a restaurant chain complained that turnover was well down.

On the fifth day of Xmas, an investment analyst 鈥� Mark Brumby of Blue Oar Securities 鈥� pointed me towards statistics showing that the collapse in beer sales at pubs is getting worse. He said national figures showed that in November there was a 9.7 per cent fall in those sales (premium ale was down 6.9 per cent and stout dropped a staggering 10.6 per cent). The smoking ban surely can鈥檛 account for the entirety of that reduction.

On the sixth day of Xmas, the owner of several hundred pubs dotted around the country said that turnover in his pubs in the early weeks of December was even worse.

On the seventh day of Xmas, a private equity tycoon was rung up by advisers to a company having difficulty refinancing itself, asking him if he wanted to buy the company at a knockdown price.

On the eight day of Xmas, that private equity tycoon said no 鈥� and told me he thought the proffered company would be in administration under insolvency procedures before too long.

On the ninth day of Xmas, the head of a large bank told me that although evasive action by global central banks had eased the tightness of money markets, he thought all prudent banks would continue to hoard cash and charge more for loans 鈥� because of the risk that falls in commercial and residential property prices would lead to a sharp increase in loan losses.

On the tenth day of Xmas a distressed debt specialist reminded me that the debt of some well known companies, notably retailers and estate agents, is trading at less than a hundred pence in the pound 鈥� and therefore the equity in those business should in theory be worth nothing.

On the eleventh day of Xmas, the world鈥檚 canniest investment banks, hedge funds and private equity firms were raising many billions of dollars to buy distressed debt and assets at knockdown prices. They scent huge profits from the pricking of a bubble, which was inflated in the first place by their frenetic creation and trading of genetically re-engineered debt. They won on the way up, and they hope to win on the way down.

On the twelfth day of Xmas, I apologized to all readers of Peston鈥檚 Picks for being in a bah-humbug strop. But I feel compelled to sing as I find.

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• - What's this?

There is a rush for the exit from funds invested in commercial property, as fears grow that bricks-and-mortar for commercial use will be one of the more serious casualties of the credit crunch.

The managers of property funds have reacted in different ways.

, the investment arm of , the leading bank, has this week reduced the unit price of investments in its life and pension property funds by a staggering 19%.

That represents a fall in the value of the 拢2bn odd in its property funds of about 拢380m.

Some investors fear that Clerical Medical has reduced the unit price more than is strictly necessary, in order to stem redemptions by worried investors.

But the magnitude of the collapse of confidence in commercial property is hard to exaggerate.

Another manifestation of the sector's woes was a six month freeze in withdrawals from a 拢1.2bn fund by .

Friends felt it had no choice, because too many investors in the fund have been demanding their money back and cash balances in the fund have fallen to worryingly low levels.

The flight from property is a pronounced trend. Friends is the first fund to prevent retail investors cashing in, but other fund managers, including and , have put a block on withdrawals by institutional clients.

Their behaviour is rational, if alarming.

Unless investors' demands for redemptions are stemmed, there would be forced sales of substantial properties. And such forced sales would precipitate a vicious, self-reinforcing downward spiral in property prices.

Most at risk are the tycoons who have borrowed substantial sums to acquire properties on their own account as the property bubble inflated in the last few years - and second in the queue for pain are the lenders to such tycoons.

For banks and other financial institutions, the next wave of losses after sub-prime is likely to come from direct and indirect lending to commercial property.

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• - What's this?

Whoops.

Yesterday's decision by to downgrade the credit rating of one specialised bond insurer, place four others on "negative outlook" and one more on a downgrade review, is bleak news.

These insurers underpin the prices of trillions of dollars of bonds, both plain vanilla municipal bonds and the concocted CDO variety.

They insure the bonds so that they are classed as AAA rated and more or less of the same quality as the best sovereign debt.

This allows the most risk-averse investment institutions 鈥� certain pension funds, banks and other collective investment funds 鈥� to buy them.

So if the bond-insurers鈥� own respective ratings were downgraded, there would be a knock-on to the rating of the bonds.

That would have two painful consequences.

It would lead to sharp falls in the prices of those bonds 鈥� forcing huge losses on their holders.

And it could also lead to forced sales of those bonds by institutions which for regulatory or contractual reasons are simply not allowed to hold lower quality bonds 鈥� precipitating a further downward spiral in bond prices.

The consequence would be a further serious erosion of banks鈥� capital and losses for those of us dependent on pension schemes and insurers for future retirement income.

Or to put it more starkly, the weakness of these specialised insurers 鈥� known as monolines 鈥� is a potential threat to the soundness of the global financial system, at a time when the confidence of banks and financial institutions is already at a low ebb.

The weaker insurers are trying to raise new capital to prop up their credit ratings.

And it鈥檚 in the interest of banks and funds to supply this capital 鈥� since the cost to them of not doing so, in the form of a bond-market crash, would be devastating.

Reason dictates that a commercial solution will be found.

Bankers tell me they are confident the worst can be avoided.

But if the monolines can鈥檛 be recapitalised by the private sector, batten down the hatches and pray that the US Government will fill the breach.

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• - What's this?

The story of Morgan Stanley鈥檚 $7.8bn is gripping.

The leading Wall Street firm correctly predicted that sub-prime related securities would fall in value over the past year.

And its clever-clogs traders shorted the equity and mezzanine tranches of those blessed CDOs.

That was a brilliant bet. Because as US homeowners with poor credit histories started to cease making payments on their sub-prime loans, the value of the mezz and the equity collapsed 鈥� which yielded big bucks for Morgan.

But those traders also took out a hedge, just in case sub-prime recovered a bit.

It took a long position in super-senior AAA bonds.

Although these are 鈥� in theory 鈥� top investment quality, they are created in a magical way (using credit default swaps) out of the lower grade BBB tranche of CDOs.

Anyway the investment worked for months.

As the price of the mezz and the equity tumbled, that of the super-senior AAA held up.

But then disaster struck.

Delinquency rates for subprime borrowers 鈥� those beleaguered US homeowners 鈥� started to deteriorate way beyond what any precedent had suggested was possible.

And that led to a sharp fall in the value of the super-senior AAA stuff.

Now the important point to understand is that subprime CDOs of the 2005-7 vintages were priced with the 2000 subprime pool as the reference point.

And when delinquency rates started to exceed by a mind-boggling margin the delinquencies relating to the 2000 loans, the value of the super-senior AAA bonds imploded.

Here鈥檚 the terrifying statistic.

Morgan Stanley has now valued the super-senior AAA securities at between 30 and 35 cents in the dollar.

That鈥檚 a two thirds write-down for an investment which was supposed to be investment grade.

No wonder John Mack, Morgan Stanley鈥檚 chairman, thought it would be inappropriate to accept the modest bonus he was offered by the bank鈥檚 remuneration committee.

And a big hello to China鈥檚 sovereign wealth fund, which has exploited Morgan鈥檚 big boo boo to acquire a strategically important 9.9 per cent stake in what remains a world class institution.

UPDATE: By the way, the Morgan Stanley super-senior writedowns are significantly greater as a percentage of principal than those announced by Barclays and RBS 鈥� so in theory the Stanley losses could presage further losses for those British banks on their subprime positions.

However, not all super-senior AAA securities are the same quality. So it鈥檚 theoretically possible that the Barclays and RBS charges are sufficiently conservative. We鈥檒l see.

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• - What's this?

It鈥檚 moot whether the whole of the Granite bond-issuing programme should be included in an assessment of the incremental support provided by the Treasury to Northern Rock this morning.

The Granite programme would implode if the Treasury had refused to guarantee the Rock鈥檚 mortgage-repurchase obligations under that programme.

Which could lead to colossal redemptions of bonds.

To that extent, the Treasury has today underwritten Granite 鈥� which is why I calculated that taxpayer exposure to the Rock has escalated from 拢40bn to 拢100bn.

And, to be clear, that number has not been knocked down by the Treasury, the Rock or its advisors.

However, the Treasury is not promising holders of the Granite bonds that they would receive 100p in the pound, in the way that it has given such a promise to other retail and wholesale lenders.

So I think, on balance, it鈥檚 reasonable to cite a different number for total taxpayer exposure in the form of loans and guarantees.

Having looked at the accounts and spoken to bankers, it's clear that taxpayer exposure is now between 拢50bn and 拢60bn.

In fact I'm told by a banker involved in the Rock rescue that the precise exposure, as of this second, is 拢57bn.

It鈥檚 risen by almost 50% from 拢40bn odd.

So each of us as taxpayers is exposed to the Rock to the tune of two grand.

Now there鈥檚 no possibility of all that being wiped out.

But in any prolonged housing recession, even impairment charges of a few percent adds up to meaningful losses for the Treasury and all of us.

For the Treasury today there was at least some comfort to be taken by Mervyn King鈥檚 enthusiastic show of solidarity with it and the , the City watchdog.

He has made the rational decision that they should all sink or swim together.

But their collective hopes of paddling off into calmer waters weren鈥檛 helped by his disclosure that all three of them had identified in 2005 and 2006 an urgent need to reform the mechanism for rescuing troubled banks.

The importance of such reform was minuted in 2006. But we鈥檙e still waiting for it.

And that, according to Mervyn King, is why Northern Rock is in the mess it鈥檚 in.

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• - What's this?

The Treasury has this morning massively it is providing for Northern Rock.

The Rock feared that there would be demands for huge repayment of loans it has received from financial institutions, when they fall due on December 31 and January 1.

And there is a risk of further lumpy demands for cash from lenders and depositors in the coming weeks.

So today the Treasury has provided reassurance to those wholesale lenders, by saying that they will not suffer losses if they leave their cash in place.

It means that most of the Rock's balance sheet is now covered by government guarantees.

In a technical sense, it means that the gross exposure of the taxpayer is more than 拢100bn.

Or to put it another way, the public sector is now directly or indirectly funding all of the Rock's mortgage lending.

The important point is that there is no economic difference for the Treasury between providing a direct loan through the Bank of England or providing a guarantee against losses to someone else who has provided a loan.

So in order to calculate the financial exposure of the public sector to the Rock, you have to add together the 拢26bn of tax-payer backed loans actually made to the troubled bank and the commercial loans and deposits that are now subject to a Treasury guarantee.

And on the basis of the put out this morning by the Treasury, more-or-less the entirety of the Rock's business has been underwritten by all of us.

But don't be too alarmed.

It doesn't mean we're at risk of losing 拢100bn.

Most of the Rock's lending is underpinned by assets, in the form of the houses owned by its customers.

Even so, today's announcement by the Treasury shows how high the stakes have become.

To many it will look like nationalisation.

But funnily enough the Treasury has provided the additional guarantees to increase the chances that the Rock can avoid formal nationalisation.

Without the stability that this extension of the government protection should bring to the Rock's finances, the bank could have collapsed early in the New Year.

The chancellor is tiding the Rock over, to facilitate a last-ditch attempt in January to steer the bank into the embrace of one of its putative rescuers.

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• - What's this?

There鈥檚 been a bit of creative thinking at the Treasury to improve the prospects of a commercial solution to the Rock鈥檚 ailments.
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It has made its own financial adviser, Goldman Sachs, available to the Rock, to find funding for the troubled bank that would replace some of the 拢26bn of taxpayer-backed loans.
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And if Goldman succeeds in raising, say, 拢11bn or so of bank finance, well those facilities would be made available to either of the Rock鈥檚 putative rescuers, Olivant and the consortium led by Virgin.
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Which means that Olivant and Virgin are now on a wholly level playing field, especially since the Rock has agreed to reimburse Olivant鈥檚 expenses 鈥� in the way it had already agreed to do with Virgin.
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That should reassure the Rock鈥檚 shareholders, many of whom feared Olivant was getting short shrift from the bank鈥檚 board.
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The timetable for Goldman to report back on whether the money can be raised is mid January. Which, by implication, is the date at which the Rock would be nationalised, if neither Goldman or Olivant or Virgin succeeds in procuring substantial committed facilities from private-sector sources.
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So the Treasury and the Rock have bought a bit of time. And all of us as taxpayers can perhaps take a little comfort that if this bank is ultimately nationalised, the commercial alternatives will have been explored and weighed in a rational and proper way.

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• - What's this?

Having noted my broadcasts and blogs for the past few weeks, a banker asked me last night why the Government is planning to nationalise the Rock, as a fallback if a commercial solution were to prove impossible.

What he could not understand is why the Treasury would not allow the troubled bank to collapse into administration under insolvency procedures.

The answer is simple.

In administration, the Government would have little direct control over the bank鈥檚 future, which would be in the hands of a court-appointed administrator.

More specifically, the Treasury could not be certain that all retail depositors would have instant access to their savings 鈥� and that could prompt a serious panic, with the risk of contagion to other smaller banks.

One of the flaws of insolvency laws, as it pertains to banks, is that retail deposits rank right at the bottom of the queue of creditors.

So it could well take a while for an administrator to allow the Rock鈥檚 retail customers to draw on their precious savings. And even after months of withdrawals, they still have between 拢10bn and 拢11bn of their cash deposited at the Rock.

That said, the Treasury has guaranteed that no Rock depositor will lose a penny.

But the guarantee does not eliminate the risk of high anxiety among those depositors if they were unable for a while to actually get their mits on the wonga.

So administration is simply not an option for the Treasury.

However nationalisation is a very real possibility, as I鈥檝e been saying for some time.

Nationalisation is not the Chancellor鈥檚 preferred option.

He would much rather have a commercial solution to the Rock鈥檚 serious ailments.

But a commercial solution hinges on the ability of one of the putative rescuers to secure a jumbo loan of around 拢11bn to repay a portion of the taxpayer-backed loans to the Rock 鈥� which are around 拢26bn.

And the tightness of money markets means that the prospects of obtaining such a loan have been receding in recent days.

On the plus side, in an emergency meeting with the Rock and its advisers yesterday, Olivant was persuaded not to abandon its rescue attempt 鈥� largely because the giant US bank Citigroup was prevailed upon to finally meet with Olivant and discuss the provision of a possible loan.

What that means is that both of the possible rescuers, the consortium led by Virgin and Olivant, have some residual hope of persuading the duo of Royal Bank of Scotland and Citigroup to provide committed facilities that would allow a deal to be done.

What are the realistic chances of the banks eventually providing those committed facilities?

No better than 50:50, according to one of the rescuers.

Which means that the odds of nationalisation are about the same.

But the Chancellor would not dare to push the nationalisation button unless and until the last rites have been said over a possible commercial rescue.

And his plan is to wait and assess the health of credit markets in the new year, before making his momentous decision.

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• - What's this?

鈥淒o they know something we don鈥檛 know?鈥� That question was always bound to be asked about by five leading central banks to alleviate the painfully tight conditions in money markets.

With both the and the announcing a serious volte face, by providing loans against a far greater range of collateral 鈥� without the imposition of a penalty interest rate 鈥� some investors were bound to conclude that the central banks had evidence that the problems at commercial banks are even greater than we all fear.

If both the Fed and the Bank of England no longer wish to be seen to be punishing the banks for their foolish lending and investing, it may mean that they believe the banks have been punished enough 鈥� or it may mean that at this delicate stage of the cycle, such punishment would turn out to be capital punishment.

In Asia overnight, they drew the gloomiest conclusions and stock markets fell.

So what does it all mean for our friend ?

Well, in theory, if the central banks have succeeded in persuading the commercial banks that they feel their pain and are on the case, that can only be good news for the Rock 鈥� in the sense that it may yet be possible for the consortium led by Virgin to raise a jumbo loan from a banking troika (Royal Bank of Scotland, Citigroup and Deutsche Bank) to repay part of the massive taxpayer-backed loan to the Rock.

But, apart from that, all news from the Rock right now is pretty scary news for the Treasury and the Rock鈥檚 board.

Here is a quick recap of where we are:

1) , Olivant is furious about the decision of the Rock board and the Treasury to delay until January any decision on which of the two competing rescue proposals to recommend or whether to recommend either of them. And because Olivant, led by Luqman Arnold, believes the Rock is frustrating its own plans and giving unfair help to Virgin, it has threatened to walk away 鈥� unless Arnold himself is immediately appointed executive chairman of the Rock.

2) Adam Applegarth has quit as chief executive of the Rock some six weeks earlier than expected. Although he鈥檚 been replaced temporarily by another Rock executive, Applegarth鈥檚 departure will simply add to the sense that bits are still falling off the Rock edifice.

3) A pair of powerful hedge funds, SRM Global and RAB Capital, are moving full steam ahead to summon an extraordinary meeting of the company, at which they will endeavour to impose restrictions on the room for manoeuvre of the current board.

4) The Treasury believes it can nationalise the Rock at any time, with emergency legislation that could be rushed through Parliament in a matter of an hour or so (and apparently there is a device for doing this, even during the Christmas recess). If the Treasury felt the continued uncertainty around the Rock鈥檚 future were damaging the interests of depositors and increasing the risk of losses on taxpayer-backed loans that are now well over 拢25bn, it would press the nationalisation button.

5) Some Rock shareholders seem to believe that the Treasury would not dare to seize their company. However I鈥檝e spoken to senior Tories, LibDems and ministers about what the Government should do, and none of them evince much support or sympathy for the investors. The politicians aren鈥檛 enthusiastic about nationalisation, but they appear reconciled to it as a possible necessary evil.

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• - What's this?

It is difficult to know whether to feel elated or alarmed by by the world鈥檚 great central banks to bring down money market interest rates.

The good news is that they are working overtime to ward off the prospect of possible recession.

But their action is without precedent 鈥� which therefore demonstrates that the stakes are high.

What concerns them, as I wrote this morning, is that the rates which banks charge each other for funds, which ultimately determines what we all pay for credit, are refusing to fall much 鈥� even though the US Federal Reserve and the Bank of England have been cutting their policy rates.

This has become a particularly acute problem in the sterling money markets.

Broadly the five central banks are doing three important things.

鈥� They are acting in concert 鈥� which demonstrates that they regard the risks and challenges as common ones.

鈥� They are pumping money in slightly different ways into the parts of their domestic money markets that are perceived to need the additional funds, reflecting structural differences in their banking markets.

鈥� Also, both the Bank of England and the Federal Reserve are broadening the range of collateral they will take for loans provided in normal money market auctions, without the imposition of any interest rate penalty.

The last point is really important.

It at last removes stigma from banks which need additional three month money from the Bank of England, but lack the highest quality collateral to obtain it.

With any luck it will reduce the propensity of banks to hoard their cash 鈥� which has been driving up interest rates. If they can count on central banks to lend to them, then they too may be prepared to start lending to each other again.

And that should bring down the rates we all pay.

What鈥檚 the risk?

Well if it doesn鈥檛 work, the authority and credibility of the central banks will have been undermined 鈥� and we鈥檒l all be struggling to see how a serious global slowdown can be averted.

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• - What's this?

Interest rates charged by banks to each other, or money market interest rates, have barely come down at all since by the Bank of England in its policy rate.

The gap between the benchmark rates 鈥� the 鈥� and the Bank of England鈥檚 base rate has widened very considerably.

Thus, as of yesterday, three month Libor 鈥� which is crucial to the pricing of mortgages 鈥� was 6.63 per cent, much more than 1 percentage point greater than reduced base rate of 5.5 per cent.

And the price of one month Libor was 6.74 per cent.

The Bank of England tells me that it doesn鈥檛 target these so-called term rates with its base rate.

But what should alarm it is that the overnight Libor rate at 5.7 per cent is still way out of whack with the base rate.

It鈥檚 symptomatic of what the chief executives of the banks describe to me as a structural shortage of sterling 鈥� for which they blame the Bank of England and the way it pumps liquidity into the banking system.

The Bank of England says they are just wrong about this, that they simply don鈥檛 understand its system for supporting the markets.

There is a very basic contradiction here, which I have been struggling to reconcile with the facts.

For example, Mervyn King, the Governor, told me when I interviewed him a few weeks ago that the Bank of England had pumped just as much liquidity into the sterling market in proportion to the market鈥檚 size as the European Central Bank and the Fed had done.

And the Bank continues to make this point.

But the uncomfortable fact for the Bank of England is that the gap between sterling money-market rates and its base rate is considerably wider than the gap between the equivalent euro interbank rates and the ECB鈥檚 policy rate.

That is evidence of conditions in the sterling markets being considerably worse than those in the euro ones.

And, to be clear, this matters to all of us.

It means there is a risk that Britons will pay considerably more for credit than the Bank of England would like us to do, in the context of its mandate to keep inflation low.

So what is going on?

Well, this may sound absurd but even our biggest banks have become very frightened of the Bank of England 鈥� and our smallest ones live in terror of it.

Their concern is not primarily the amount of liquidity pumped into the system by the Bank of England in its planned operations, although they would like the Bank to accept a wider range of collateral for the funds it provides, along the lines of what the ECB does.

But their fears are really about the attitude of the Bank of England as and when one of them is forced to borrow a bit more than they鈥檝e agreed to do or expected to do.

They think that the Bank itself views any request for funds under its standby facility as a sign of management incompetence by the requesting bank.

Although the names of banks drawing on the facility are not published, the banks fear leaks.

In the summer, for example, Barclays drew on the facility and promptly saw its name splashed all over the media. The implication was that there was something seriously awry at Barclays, which was not the case but wreaked considerable reputational damage on it.

The consequence is that the standby facility 鈥� whose point is to provide comfort in a time of crisis such as the one we鈥檙e living through now 鈥� has been used much less since the onset of the credit crunch than in the normal market conditions that preceded it.

Which is crazy.

Similarly, no bank dared to draw on the special three-month facility put in place by the Bank of England after the Northern Rock debacle, because again the banks thought that to do so would be seen as a sign of weakness.

Think 鈥淣orthern Rock鈥� and you鈥檒l understand their neurosis about requesting funds at the punitive rate which the Bank demanded for this three-month money.

The consequence is that all banks are accumulating cash as if the bomb were about to drop, to avoid even the faintest risk that they might have to do an Oliver Twist and ask the Bank of England for a bit more than their agreed portion.

It may be that the banks deserve their plight, that they should feel humiliated and ashamed for the way they underpriced risk in the bubble conditions of the preceding few years.

And there is no doubt that the Bank of England during the summer felt it was wholly appropriate to punish them for their imprudence.

But I find it difficult to believe that remains the attitude of Mervyn King.

To be fair, there is a comparable problem in the US money markets - but the Federal Reserve appears close to reforming the way it provides liquidity, in an attempt to lessen the the stigma for banks of requesting incremental funds.

Right now, if Mervyn King is punishing the banks, he is also punishing all of us - in the sense that we all depend on the banking system to price money efficiently, and that鈥檚 not happening right now.

There needs to be a new entente between the Bank of England and the banks, to sort this out.

And the sooner the better.

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• - What's this?

On October 1, UBS losses from sub-prime would wipe out third quarter earnings but the giant Swiss bank was very confident it would make a substantial full-year profit.

Just over two months later, that annual profit has been consumed by the sub-prime inferno.

A on investments linked to the dodgier end of the US housing market is a humiliation for the pride of the Swiss financial system.

After all, this is a bank whose great claim has always been that it is more conservative than its rivals.

So the sub-prime write-down represents more than a monetary loss for UBS. It鈥檚 a serious blow to a valuable brand 鈥� which had already become tarnished by the way it was burned a decade ago in the last great money-markets debacle, the collapse of the giant hedge fund, .

That UBS has felt the need to raise a staggering $17bn of new capital is all you need to know about the gravity of what has occurred, both for UBS and for the world financial system.

If you want perspective on that, note that Northern Rock requires about $1.5bn to $2.5bn of new capital for whatever reconstruction will turn out to be its ultimate fate.

On that measure, the Rock鈥檚 plight doesn鈥檛 look quite so appalling.

UBS isn鈥檛 鈥� of course 鈥� being propped up by the Swiss government.

However it has been bailed out by another sovereign state, Singapore 鈥� whose investment arm, the , is providing more than half of UBS鈥檚 new capital.

It is not cheap money from Singapore either. UBS is paying 9% a year for up to two years, until the new convertible notes are converted into shares.

Admittedly that is a bit less than the 11% being paid by Citigroup for the $7.5bn it raised from the .

But all that tells you is that Citi鈥檚 problems are even worse than UBS鈥檚.

That UBS should have to pay near junk-bond rates to shore up its balance sheet is quite extraordinary.

What does it all mean?

First, it鈥檚 further evidence of the transfer of financial power from the Western economies to the great cash generating economies of Asia, Russia and the Middle East 鈥� which are able to dictate the terms on which they prop up our important institutions.

Second, if there is a price paid specifically by UBS and its shareholders, we are also all paying for the foolishness of that bank and its peers.

They are now ruled by fear, they are pushing up the price of the credit they provide to us, and we will all feel poorer.

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• - What's this?

Northern Rock has been advised by its lawyers that it鈥檚 in the 鈥渮one of liquidation鈥�.

Which sounds scary, but it鈥檚 really just a statement of the bloomin鈥� obvious, in that the Rock cannot fund its operations from normal commercial sources and is in hock to the taxpayers to the tune of 拢25.5bn.

The significance of being in that unappetising zone is that the board has to put the interests of its creditors ahead of those of its shareholders.

And that鈥檚 why the board cannot simply approve 鈥檚 rescue plan, even though Olivant鈥檚 scheme is much friendlier to the interests of shareholders than the takeover proposal from a led by Sir Richard Branson and Virgin.

Or to put it another way, ultimately it鈥檒l be up to the chancellor 鈥� as proxy for the lead creditor, all of us 鈥� to decide what happens to the Rock.

Alistair Darling鈥檚 priority 鈥� apart from maintaining the stability of the financial system and protecting depositors 鈥� is making sure that we, as taxpayers, get our money back.

And what鈥檚 scary for him (and, frankly, for all of us) is that conditions in money markets are as bad as anyone can remember.

Virgin is no longer confident it can raise a jumbo loan of 拢11bn to repay a chunk of taxpayer-backed loans from the Bank of England 鈥� which currently total 拢25.5bn.

In theory, that undermines the Virgin proposal.

Except that Olivant too cannot give a cast-iron guarantee that it would be able to raise a comparable sum. All it can offer is hope that it will be able to repay somewhere between 拢10bn and 拢15bn within the next two or three months.

The Treasury had wanted to make a decision on the Rock鈥檚 future by mid December 鈥� which in reality means by the end of next week.

The options have narrowed to nationalisation versus two potential commercial solutions that are not yet wholly nailed down.

How is the chancellor to make a rational choice when money markets are so unstable?

What he needs to think about, and fast, is whether he genuinely believes the Rock is a going concern.

If it is, then there鈥檚 no ambiguity about what he should do.

He should back the Olivant plan, since the Rock鈥檚 shareholders, its owners, are shouting very loudly that they like it.

But if he loses confidence in the ability of Olivant or Virgin to raise a meaningful sum on acceptable terms from the money markets, then it will be nationalisation or bust.

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Record profits and projections of incremental gains from a massive takeover. That鈥檚 the message from this morning. So what happened to the credit crunch and the global banking crisis?

Well, the storm raging through money markets affects banks in different ways 鈥� and if you are a large, diversified international group like RBS, not all of the impact is deleterious.

RBS has been a beneficiary of the withdrawal of cash by depositors from institutions, like Northern Rock, perceived to be vulnerable.

Worried savers鈥� money has to go somewhere. And both individuals and companies appear to have identified RBS as a safe haven.

says that it has 鈥渆xperienced strong deposit growth鈥�. And I understand that more than 拢800m of additional liquidity has gushed into its accounts over the past few months.

At a time when the rates charged by banks for lending to each other is hitting record levels, this inflow of deposits represents cheap money.

So unlike 鈥� which recently warned of a squeeze in net profit margins 鈥� RBS鈥檚 profit margins are improving. Which may, to an extent, offset the expected slowdown in the US and UK economies next year.

RBS has another advantage over banks with a predominantly UK focus. It鈥檚 been able to tap the generous liquidity provided by the and the .

The bank has therefore been less vulnerable to the perceived structural shortage of liquid funds in the sterling money market 鈥� for which the Bank of England鈥檚 conservative approach to the provision of cash to the banking system has been widely blamed.

But let鈥檚 not get carried away here.

RBS has been bashed by the debacle in structured finance and in the US sub-prime market.

In the second half of 2007, it has incurred write-downs of 拢950m on its holdings of assorted securities created from loans to US homebuyers with dodgy credit histories.

At the bit of the Dutch bank which it has bought, there are anticipated write-downs of 拢300m.

And there鈥檚 a further 拢250m impairment charge on RBS鈥檚 holdings of loans made to private-equity buyouts.

Not nice, but a long way from lethal.

Only a few years ago 鈥� before a takeover spree 鈥� damage on that scale would have killed RBS. Today it means that RBS鈥檚 pre-tax profits for 2007 will be a fraction under 拢10.5bn, a new record.

However that鈥檚 no grounds for complacency.

The coming year will be tough for all banks.

And RBS has residual holdings of collateralised debt obligations linked to sub-prime with a book value in excess of 拢5bn.

They are not worthless. But with the US housing market crumbling, further impairment charges may be unavoidable.

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One of the participants in the auction of Northern Rock will drop out today.

It鈥檚 not a devastating blow to the rescue of the Rock, since the possible bidder 鈥� the Tyne Consortium, which includes the US private equity house, 鈥� was not a front runner.

But it鈥檚 indicative of the huge obstacles in the way of a commercial solution to the Rock鈥檚 financial crisis.

Tyne, as I understand it, became increasingly frustrated by the uncertainty over whether the Rock鈥檚 future is being decided by its board or the Treasury (the confusing answer is that, in theory, the Rock鈥檚 directors are in charge 鈥� though no deal can be done without approval from the chancellor).

Also prospects for the UK housing market are deteriorating fast, with from the Halifax only the latest in a bad-news glut 鈥� which reduces the value of the Rock鈥檚 assets and undermines its business model.

What鈥檚 more, there isn鈥檛 a level playing field for the putative bidders, in that only one of them, the , is having some of its expenses met by the Rock (up to a maximum of 拢5m plus VAT).

The justification for recompensing Sir Richard Branson and his chums is that the Rock believes any jumbo loan raised by Virgin could be used by the company, even if the Virgin bid flops.

Unfortunately, that jumbo loan 鈥� from Royal Bank of Scotland, Deutsche Bank and Citigroup 鈥� looks more and more elusive.

These banks have made no firm commitment to provide the 拢11bn which Virgin thinks it can raise.

And, as I pointed out yesterday, the banks would only provide the loan if all the Rock鈥檚 plum assets are pledged to it 鈥� which would leave the taxpayer lending between 拢15bn and 拢16bn to the Rock secured against less attractive assets whose value looks set to fall for some months.

Just as disturbing, those running our biggest banks are deeply concerned that there鈥檚 now a structural shortage of liquidity in the sterling money market. The normally sanguine head of one was extraordinarily pessimistic last night when I saw him.

That liquidity shortage can only be exacerbated if 拢11bn is taken out of the system and provided to the Rock to pay off some of the taxpayer-backed loans from the Bank of England.

So in going for a commercial solution to the Rock鈥檚 problems, the Treasury could worsen the credit crunch that is wreaking havoc to our growth prospects.

It鈥檚 a mess of considerable size and complexity. Which is why, as I鈥檝e been boring on about for weeks, nationalisation of the Rock may yet turn out to be the best of some unattractive options.

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There could not be a worse moment to sell and refinance its balance sheet.

The interest rates charged by banks and financial institutions for lending to each other 鈥� the now-famous 鈥� are soaring.

So bin the idea that the taxpayer-backed loan provided by the to the Rock is at some premium or penalty rate.

In current market conditions, the 7 per cent interest on it represents a remarkable bargain.

And don鈥檛 forget that, as I disclosed last month, only 5.75 percentage points of that is payable in cash.

The rest is rolled up and converted into subordinated debt, held by the .

Now the cash interest rate for strong banks that want to borrow from other banks for just a month soared yesterday to more than 6.7 per cent.

And the three-month bank-to-bank rate (as calculated by the ) increased to 6.62 per cent.

Those are the rates available to top-notch institutions: the Rock would have to pay more.

So what is the market price for a jumbo loan backed by the kind of mortgage-collateral which the Rock can provide?

Well , the medium size mortgage bank, has just borrowed 拢4bn for just two years from banks led by .

I am told that A&L is paying materially more than 7 per cent per annum in interest, if upfront fees are included in that rate (though bankers are refusing to confirm the rate, citing commercial confidentiality).

This matters, because all the possible rescue deals mooted for Northern Rock involve borrowing from banks to pay back a portion of the 拢25bn which taxpayers have lent to the Rock.

The , for example, says if it owned the Rock, it would raise 拢11bn; JC Flowers, the private equity house, would borrow 拢15bn if it owned the Rock.

If debt on that scale can be obtained in current tight market conditions 鈥� and that is by no means a certainty 鈥� they would kill the Rock鈥檚 profit margin.

There are four other possible rescuers: , , the Tyne Consortium (led by ) and (which would take only a minority stake in the business).

However none of them are in any better position than Virgin or Flowers to find a loan for the Rock at anything other than crippling interest rates.

In theory that should not bother the Treasury, so long as it gets some taxpayers鈥� money back now and all of it in a few years.

But here鈥檚 the thing: market mayhem is wreaking havoc with an element of any rescue package that is essential for the Treasury.

Under EU rules on state aid, the Bank of England鈥檚 loans to the Northern Rock can only be continued after February if they can be deemed to be on commercial terms.

And the easiest way to prove that they are on commercial terms would be for the Rock 鈥� if controlled by Virgin 鈥� to borrow its 拢11bn from banks, and reconstruct the residual 拢14bn or 拢15bn of taxpayer loans so that they are on identical terms to the bank loans.

This means that the collateral underpinning the bank loans and the taxpayer loans would have to be identical: the banks lending to the Rock could not cherry pick the best and soundest Rock mortgages as their security.

That seemed achievable only ten days ago.

Not any more, I am told.

Banks lending to the Rock want its best assets as collateral 鈥� which would leave the taxpayer in a weakened position in respect of its remaining loans.

Here鈥檚 the big problem for the Chancellor, Alistair Darling, and the Treasury.

A deal that handed all the best assets to the lending banks might not just be illegal under EU rules, it might also undermine Darling鈥檚 determination to ensure taxpayers don鈥檛 suffer any losses on their loans to the Rock.

On any scenario, the taxpayer will continue to have massive exposure to the Rock for two to three years.

And plainly the risk of losses on a residual 拢14bn or 拢15bn would be higher, if that loan were backed by less attractive assets.

All of which is to explain why the Treasury has retained the option of nationalising the Rock.

Nationalisation is not the Treasury鈥檚 preferred option.

No Chancellor in his right mind would choose to become the de facto chief executive of a commercial mortgage bank.

But the commercial solutions on offer may not work.

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