Safe as houses - part 2

They think its all over

The sign of the times? The sign of the times?

As articles are published in date order part 1 appears below

Some brave souls tried to find reasons for the mess, alas the old joke that 'if you need three opinions on the economy, then ask two economists' came back in force, for complicated it was, with statistics aplenty. We were told that 8% of UK mortgages could be termed sub-prime, that the US has lower dollar reserves than India, Singapore and Brazil and also the world's largest trade deficit, while the UK has the third largest deficit. However, the cynic in me raised a smile when the news came that UK banks would no longer lend money to each other. Now that was funny, as the banks, by contrast, have lent so much money to the nation's credit card holders. In looking for a culprit for the sub-prime mess, first criticising, then blaming hedge funds became the preferred option; even if one hardly had a clue as to what they did for a living. Only knowing that in the past, hedge funds had been given a hard time by trade unions and a Parliamentary Select Committee alike.

So what do hedge funds do, and how did it all start? No less an authority than the International Monetary Fund claims that they are an American idea from a Mr A.W.Jones, dating from 1949. From the outset they were designed to circumvent the legislation applied to conventional banks; being beyond regulatory authority they can do what they like and this status also gives them a high level of privacy. And, what with being daring, this, it would seem, 'led them into temptation'. In short some were greedy and got caught out. In turn the very nature of hedge funds, according to some authorities, means that they have been implicated in all financial upheavals since their inception. However, if the credit-crunch does turn into a full scale recession, then some hedge funds will go broke, or hedgerupt, as bankrupt, I suggest, is not the right term here!
Not as solid as it seems Not as solid as it seems
Through September and October the blame game had shifted to new targets, namely people. From the start it was clear that the Northern Rock chief executive, Adam Applegarth, would have questions to answer, but Mervyn King would have to explain himself as well. These two names were, at this stage, the only prominent ones. Sir Callum McCarthy of the Financial Services Authority (FSA) was as good as unknown. The FSA derives its powers from Acts of Parliament enacted in 2000, just after the Bank of England was given its independence. From the FSA website we learn that the FSA is funded from the companies it regulates, interesting, but impartial, of course. Over time there were opportunities for the big names to speak to a Treasury Select Committee, plus the opportunity to give interviews to the media. From the start Applegarth portrayed himself as a victim, it was as if some unfortunate accident had befallen him and the Northern Rock, the tone was very much 'if only'. By contrast Mervyn King seemed a deeper and more serious soul. It was he who brought us the term 'moral hazard', and seemed, for some, the easiest to blame. McCarthy was quiet, but seemed to be of the same opinion as Alistair Darling, in that NR was to be 'saved' regardless of cost. In that respect it was Applegarth, Darling and McCarthy in the one box, with King, on his own, in another.

To me the interview of highest value was given by King to the BBC's reporter Robert Peston, who had, hitherto, been harsh on King. The transcript of this radio interview runs to 12 pages, and here, in what I assume was a recording studio one-to-one with Peston, King seems to speak from the heart and in doing so reveals a great deal, and not only about himself. Such is the value of radio, with its intimacy, as opposed to the television approach in such circumstances, with its attendant exposure. King for example, reminds us that he spoke about liquidity in the money markets, upon which NR depended, in June 2007 while delivering a speech at Mansion House. In June the credit problem was in its infancy so the reporting of this speech was slight. One cannot imagine that King just happened upon this a subject for that evening, this had been a concern of the Bank of England for a long time. And so into November.
It's behind you!         It's behind you!

This was when the would-be buyers of NR turned their intentions towards creating formal bids. In amongst this came further detail on the dire position of the property market both here, in the USA, and its further implications. In previous weeks the reporting had been of the "it's bad, but not that bad" type. As time moved on the tone became "it's very bad, and we hope it does not get worse". As to the bids, the first bid was from Lloyds TSB, and this had been made public as soon as the position of NR became known, but this came and went very quickly. The reason given was that the Bank of England was, according to Mervyn King, being asked to finance a takeover, which King did not see as the BoE's role. This Lloyds TSB potential takeover was mentioned by David Cameron at Prime Minister's Questions on the 16th January 2008, and I heard Gordon Brown deny that it had happened, do you think the man is mad? The bid had been so well reported you begin to wonder. And the four bidding groups in the running were: Cerberus, an American private equity group, Flowers, another US based private equity group, Olivant, an investment company based in London, and finally Virgin, best known for the airline and shops of the same name. Each of these adopted a strategy to woo both the onlookers and the important alike, but to suit the image it wished to project. So Cerberus, Flowers and Olivant were silent and Virgin placed adverts in papers showing Branson stroking his beard looking thoughtful and caring. What details of the bids that did break the surface were general in nature and did not take into consideration the views of the NR shareholders. On the one hand, the feeling all along had been that those who had savings in NR, the customers, deserved our sympathy; by contrast the investors, the shareholders of NR had to face up to the fact that buying shares carries a risk and it was their lot in life to lose their money. Naturally they had other ideas.
Sinking, time to act Sinking, time to act
There were at least two Hedge Funds each holding sizeable chunks of NR: SRM Global and RAB Capital, and if they acted in concert, and with other shareholders, they could exert considerable influence over the future of NR. In other words real market forces in action, and with a potential to lengthen the whole process of finding a solution. Not what Darling, or Brown, the one pulling the stings, would want at all. Eventually it was December, the grey month, when the end of the year looms and a mix of weariness and longing for the holiday break sets in. All this does tend to have an effect on even the most hyperactive folk. In the case of NR, most of what the commentators needed to say had already been said, some of it several times. The weariness was more than just 'end of year blues', it was also based on the notion that time had run out for NR. It seemed at times as if the whole NR thing was the script from a Second World War film; a version of 'In which we serve', the 1942 film starring, Nöel Coward (based on Lord Mountbatten) but dealing with banking instead of battleships. In such a war movie at least half of the running time will be after the calamity has occurred. In the NR version rather than wallowing engineless and rudderless and vulnerable to more attack it just drifted on sinking lower in the headlines. As an aside, it seems that Mountbatten's friends and family did not all hold the film in high regard, some dubbed it 'In which we sink'! In fact Alistair Dalek, 'the safe pair of eyebrows', did attempt a bit of high drama himself, miffed that the NR shareholders were getting chippy he indicated that the shareholders would not "stand in his way" to find a solution to the NR problems. Subsequently it was pointed out to him that he could fall foul of the Human Rights Act if he attempted to take assets from them at less than their true value.
It's a deal It's a deal

And do remember that the Chancellor was a member of the Scottish Bar, but then when has New Labour and a legal training ever stood in the way of progress? So much for the posturing, and while Gordon Brown tried, and failed, to project himself as the big clunking fist, poor old Alistair Dalek looked, like Peter Hain, just another incompetent minister, and a bog standard one at that. As December drew to a close it was clear that there was a further slow down in some areas of the the property market, and the high street shops had not all been doing well over the holiday period. January 2008, we are told that, due to falling property prices in general and house prices in particular, the valuation of NR assets is hard to get right; this introduces yet more risk into any decision, (due diligence for example), about the future of NR as the exact worth of even the 'good' business is elusive. While we in the UK wondered where it was all to end, the Bank of America bought Countrywide and Financial, the company deemed to be at both the start and the heart of the whole messy credit crunch. CwF was sold for about 80% of its original market value.

The Northern Rock's EGM was not too well attended but those who went made it plain that yes, they were a chippy lot, and unlikely to simply roll over and take any offer that came along. Then Alistair Darling appointed Ron Sandler to be the boss of NR, should it need to be privatised. This move was, according to the Treasury, just in case, but taken by many to mean that plan 'A', to sell NR to someone, anyone, was not going well. We were also told that Sandler was a good friend of Gordon Brown, this once again emphasised who really was in charge of the NR rescue, and perhaps who intended to take all the credit if the sale went well. It also looked as if the original four bidding groups were now down to two: Olivant and Virgin. But with the two largest shareholders in NR, SRM Global and RAB Capital, of the opinion that they could mount a rescue of NR 'from within', a sort of Pheonix option. Then there was the trip to China, Gordon Brown and Sir Richard Branson went on a trip to promote UK - Chinese business links, and did not speak to each other about the NR rescue either on the long flight there or back, or while 'promoting'; and if they both say so, then that is what happened. Later, and with a little help from US investment bank Goldman Sachs, (how much did that cost?) Alistair Darling announced the NR rescue plan. It was a sale of Bonds partially backed by the UK government.
In the red, in the black? In the red, in the black?
Some may say that this scheme is not at all complicated, so then why did it take months to sort out? Well only Alistair Darling could give the answers to that. Naturally the devil is in the detail and, while using NR's assets as the base of the Bond issue is a way out of the problem, the nature of the risk to: NR, the Bond buyers, the rescuing group and the Treasury, which is to say the UK public, is still not clear, especially in such a volatile period as this. Proof of the volatility came soon after the plan was announced, when on Jan 21st, a public holiday in the US to celebrate the birthday of Martin Luther King Jr, the US stock market suffered a massive downturn. Martin Luther King made the now famous remark, "I have a dream", but on Wall Street Jan 21st was, for many, a nightmare. Fears of a US recession spread from the US around the world markets, with similar results. To add to the misery of the financial world on Jan 24th the second largest bank of France, Société Générale announced that it had been the victim of an internal fraud by an employee to the tune of a sum reported at between £3.0bn to £5.0bn. The effect on the NR rescue plan? Well to quote a once trusted UK politician, "it's too early to say". But with all banks writing down assets following the sub-prime crisis, and a world-wide volatile if not falling stock market, is it a good time to be trying to sell Bonds in a failed bank? The deadline for NR bidders is Feb 4th. Perhaps when Alistair Darling announced his Bond plan he thought it was all over, that I doubt. My suggestion to Ron Sandler? Stick around and don't wander off.