Monday, 21 January 2008

Solid as a Rock?

As the festive season passes into feint memory the financial problems of 2007 come to haunt the government. Goldman Sachs have come up with a solution to the Northern Rock problem which isn't quite nationalisation, may be just about palatable to the existing shareholders and gives entrepreneurial golden boy, Sir Richard Branson, an opportunity to turn the beleaguered bank into the UK’s first Virgin Bank. So what’s the trick? Well it’s more of the same that led Northern Rock into its current mess.
The Government has currently loaned the bank in excess of £24 billion to finance its ongoing operations, payback those who thought wandering the streets of Newcastle with their life savings in their top pocket was a better bet than leaving it on deposit at Northern Rock and, made maturing repayments to the money markets on existing borrowing. The plan is that Northern Rock will convert the Government's borrowing to bonds which will be held by HMG until they can be auctioned off at the first available opportunity. So, to put it simply, the Government will be holding a large number of pieces of paper, promising a set rate of interest and a specified maturity date when Northern Rock will pay the borrowing back to whoever holds the pieces of paper at that time. Well – not quite – the debt will not be issued by Northern Rock as such but by a special investment vehicle which is a company established for that specific purpose. So Northern Rock will owe the SIV £24 billion which in its turn will owe HMG £24 billion. The Government will at some stage transfer ownership of the £24 billion of debt to the market through the auction process. Got that?
HMG will also get some additional goodies to sweeten the pill – it will get some warrants giving it an equity interest in Northern Rock which will be worthless if the share price goes down but valuable if it goes up. It also gets a premium rate of interest on the bonds that are issued. The downside is that the Government could be left with a bundle of bonds of declining value if (a) market interest rates go up or (b) the value of Northern Rock's assets fall even further. As a result I strongly suspect that the Treasury will be putting huge pressure on the Governor of the Bank of England to make sure that the impeccably independent Monetary Policy Committee behaves itself and does the decent thing by cutting rates over the next few months. This will also help ensure that any dip in the housing market is corrected nicely before the peak selling and buying season in the spring. The only fly in this jar of Vicks Vapour Rub is that the US fuelled credit crunch shows no sign of abating and this is where the Chinese and the Indians with the very large reserves of currency come into play. Useful that just at this moment our erstwhile PM, accompanied by Sir Richard (Goldilocks) Branson, has been glad-handing the burghers of Beijing and New Delhi. Its wheels within wheels really.

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