Safe as houses - part 3

Taxpayer beware

One year old One year old
There's blossom on the trees so Spring is here. Soon the sub-prime crisis will be one year old, an ideal time for the last of the three part postings on the sub-prime/Northern Rock saga and, as before, it is also in date order. And what a year it has been. As pointed out in the first post on this subject:Safe as houses - part 1- In the beginning the origins for all of this lay far away in the South and mid-West of the USA. Here in spirit sub-prime was born and raised, or was it? Perhaps the desire to have more in general and, in particular, to own property at any cost is more global in nature and not just part of the American dream. But it was in the US that the flaws in this desire gave way to pressures impossible to contain, so cracks began to appear.

Globally, for many domestic borrowers the basic question behind borrowing namely: can I pay it back? fell out of favour and was no longer heard, to be replaced by the notion that borrowing was a form of income. Individuals in this position, who 'over-reached themselves' were joined by many of the major world banks who did likewise. But the banks will hide their mistakes behind a different form of words and for them it will be 'market adjustment'. However, it is the former, the domestic borrower, who as always will come off worse and not just in the US.

Here in the UK we might think that this crisis is a UK/US affair, this would be wrong. For example the Spanish property market was far from being in fiesta mood, nor was it having a siesta. No, it was wide awake and in crisis, a bit like Spain itself. Writing on January 29th 2008 in The Daily Telegraph Ambrose Evans-Pritchard summed up the position on Spanish banks who had used the European Central Bank, ECB, as a source of funds so as to 'step over' the crisis thus -

Reliance on the ECB window appears to have kept the mortgage sector afloat despite the sharp slowdown in the Spanish property market and the de facto closure of the capital markets for this type of business, allowing Spain to avoid the sort of mishap suffered by Northern Rock in Britain and Countrywide in the US. The data appears to confirm suspicions that the EU authorities have carried out a covert rescue of the Spanish mortgage banking system. It may equal the taxpayer rescue of Northern Rock in Britain and possibly exceed it in proportion to the overall size of Spain's economy. The key difference is that the ECB rescue operation in Spain has been disguised. A veiled method is necessary since the eurozone lacks a clear-cut lender of last resort. The IMF has warned that this gap in the architecture of the single currency could prove serious in a crisis. Traders say the Spanish authorities are quietly turning a blind eye to the use of the ECB window and in some cases may be encouraging banks to go to Frankfurt - a claim denied by the Bank of Spain.

And the bit I suggest you memorise is -

The IMF has warned that this gap in the architecture of the single currency could prove serious in a crisis.

For 'Fortress Europe' try as it might, is not going to behave as an entity until there is full political unification. An ever closer union may be the aim for the future but the crisis is now. The Spanish economy has always been a thing of wonder - how does it keep going? A number of observers have commented on the high levels of corporate debt and how, under EMU, it could lead to a hard to solve problem should it all go pear shaped. Too much debt, or deuda, is bad for a nation, so is too much of the wrong sort of regulación. For the one size fits all type regulation cannot be right for all the countries of the EU and their diverse economic structures. And this is, based on experience, what will happen. Europe will end up with an over-prescriptive regime rushed in to 'correct' problems better left to the Nation states to solve.

Laughing all the way.... Laughing all the way....

Having dealt with domestic borrowers who 'over-reached themselves' above, it is fair to recall that at the start of 2008 the complex manoeuvres between Alistair Darling and the would-be suitors for Northern Rock were still in progress. The fancied front runner, Virgin, did their own thing, so to speak, and overvalued themselves in the process. Virgin Money claimed it was worth £250 million but was thought to be worth more like £90 million. So while Brownie and Clever Ali fancied Virgin, the Northern Rock shareholders were less than impressed. The job of the new Northern Rock chairman, Ron Sandler, might, it would seem, be to sell off as much of NR as soon as possible and as there seems to be tension between Virgin and the shareholders perhaps Virgin are out for good. In which case who will buy it, or if it is sold in parts, what parts will be sold and who will be left with the junk? Did I hear you say the tax payer? In another posting on this subject, Safe as houses - part 2 - They think it's all over. there was a brief look at Hedge Funds and these are now being caught up in the storm of the credit-crunch sub-prime crisis. As mentioned before there are many people who blame Hedge Funds for the crisis so these people might rest easy with the fact that many will not survive the turmoil. Should we mourn the loss? Not according to Jon Moulton the head of Alchemy. Those of us who live in the Midlands will remember Moulton and Alchemy as the private equity company who tried and failed to take over the Rover factory at Longbridge, so Moulton is well able to talk about success and failure. In an interview with David Litterick in The Daily Telegraph Feb 2007 he said -

"There will be large private equity failures this year. Absolutely guaranteed." -

Moulton blamed industry players themselves for throwing out normal standards of due diligence and risk assessment.

"Buyouts were done on mythical numbers like pro-forma, adjusted, normalized EBITDA, which almost always turned out to be 20pc higher than they should be," - - "It's the same thing that was going on in the US sub-prime market."

(EBITDA = Earnings Before Interest, Taxes, Depreciation and Amortization. )

Moulton took aim at public relations' executives, industry associations, accountants, mega funds, regulators, unions and politicians, however, he saved most of his criticism for the banks.


"They bought all this rubbish themselves, most of which their senior managers didn't understand and they have been left holding the baby with unsaleable, overpriced, overenthusiastic debt. They are in trouble themselves. It's the same as the sub-prime salesman. They will sell anything to anyone, and they did. If you pay enough bonuses, people will do anything." END

This was rather in contradiction of much else being said in the press. While generally silent on this subject the Chancellor of the Exchequer did once, not so long ago, suggest that the basic UK economy was "strong" - reassured?

The comments on the Buy-to-Let market in the earlier posts got tutted at by 'an expert'. Well how about this then? BBC News - Wales Feb 2008 -


One of the biggest buy-to-let investment companies in Wales has gone into administration. Cardiff-based A & A Property had more than 250 houses and flats on its books in different areas throughout Wales. The National Association of Estate Agents in Wales believes more could go under as banks harden lending policies. END

It was the same in Spain where the property company Colonial was in trouble despite, or perhaps because of, its investment in just about every property sector possible. It had lost over half its quoted value in just months. So it would seem that the diversity counted for nothing while the attitude to borrowing (Colonial had truly massive debts) counted for all. Motto: Let the borrower beware.
Newcastle Building Society Newcastle Building Society
Then at the very end of Feb 2008 came good news from the North East home of Northern Rock and it was all to do with The Newcastle Building Society. This was doing very well because, it would seem, that it had a business model far removed from the one used by Northern Rock and so could state that it had no sub-prime type risks to deal with. By contrast the woes of Northern Rock continued including the revelation that NR, just weeks before meltdown, bought the Newcastle Falcons' Rugby team ground in a deal that put neither the bank nor the club in a good light.

As the details of what was now being dubbed "the Rock" seeped out, so Rock watchers had to learn new skills and tricks and this certainly applied to Granite an offshore company based in Jersey. This was to be the means by which the finance gap, the lack of traditional depositors' funds on the one hand and the need for cash, was bridged. The UK company sold parts of the mortgage book to Jersey who in turn sold bonds that were backed by the mortgage book. The income from these bonds helped the Rock grow using this extra wealth to do more business. And so it went, round again and again. The non-banker may see all this as no better than the children's party game 'pass the parcel', but that is because such people lack what it takes to succeed in the world of financial services. "And when the music stops?" I hear you ask, well yes indeed, and there were tears. You may also wonder why the Rock could not sell bonds itself and from here in the UK under the auspices of the FSA! Time will tell if a bank, now nationalised and so the property of the UK taxpayer, has any hold on an offshore company. There was also the involvement of a charitable trust in Granite, all of this adds up to either the cleverest idea, ever, or a muddle.

Now into March and for several days in a row European stock markets slid down. The reports in the US press were not gleeful just blunt. Warren Buffet said: [i]"the party is over" as his Berkshire Hathaway company fell 18%. Buffet is not simply very rich but regarded as just about the smartest stockmarket player in the world so, if it's hurting him, who's next? March also brought further gloom for the wider property market. After the fall of the Berlin Wall, slowly at first but then at a rush, there was a move into property in the former Eastern bloc countries. Now the direction is the other way, out of these deals. The pace is quickening and, according to Daniel McLaughlin writing in The Independent, investing foreigners complained of: "shoddy workmanship and trouble finding buyers and tenants for their properties"; what did these people expect?

By mid-March came the news, in response to a Freedom of Information Act request, that five out of the seven FSA officials who had been close to the Rock during the FSA's supervision period had resigned. It seems odd that The Times had to ask for this information. Was somebody trying to hide it? Surely over the long time between the Rock going down, the admission of the FSA's failure and The Times' FOI request, there was at least one good day on which to 'bury' this news? Also in mid-March our old friends the Hedge Funds were back in the news, these were 'Hedge on the edge' times and it was clear that, eventually, some would go over. Not only were Hedge Funds facing the long drop, the US investment bank Bear Sterns was in trouble. Again there was a link here to Hedge Funds and this contributed to a loss of confidence leading depositors to withdraw funds from Bear Sterns so that at one point the shares had lost half of their value. Eventually, and despite the 'help' from the Federal Reserve, Bear Sterns was bought by JP Morgan Chase at an enormous discount. However, while this caused an equally enormous upset in the US financial markets the contrast with the UK and the collapse of the Rock was clear. There is the quick and brutal US method of dealing with this sort of thing or there is the UK big dither approach.
Hedge trim time Hedge trim time
Following the problems of Bear Sterns it was the turn of the UK with HBOS, the Halifax Bank of Scotland, one of the UK's largest mortgage lenders with a fifth of the market and also the largest savings bank of the UK. In this case the shares only fell by 17% but did so on a rumour of difficulty within the bank. What happened was that traders bet on the shares falling, which they did, and this is entirely legal. Even so this upset has prompted the FSA into holding an enquiry. So much for 'free' markets unhindered by regulation, unless that is, the wrong sort of people make all the money. After all, the major banks have been happy to go along with the general rough-and-tumble of the market place as it suited them, namely to be bankers for the Hedge Funds who are by definition outside the rules of normal banking; but when it goes wrong? It was even suggested that some workers at HBOS were buying company shares when they were down. Was this supporting the company with their own money, or grabbing a bargain?

And yet more news from the FSA, Siobhan Kennedy in the Times 20th March wrote about Clive Briault loosing his job at the FSA -

Mr Briault is the first high-profile regulator to leave the FSA over Northern Rock’s near-collapse. His departure comes ahead of an internal report by the FSA’s auditor on the regulator’s dealings with Northern Rock in the run-up to its downfall. It is welcome to see a regulator paying the ultimate price for the FSA’s failure to supervise its charges. But how high is the price really? Mr Briault is believed to have received a £380,000 payoff to soften the blow of unemployment and he is unlikely to be unemployed for long. City firms pay big money for former regulators who know their way around the arcane ways of the FSA – even ex-regulators tainted by a bank run.

Then a few days later the same source carried an article with the title -

FSA admits Northern Rock handling was unacceptable

It was a lengthy article and full of detail, but title said it all. Again a few more days on and in the Times another lengthy article this time from Iain Dey with the title:

FSA pleads guilty to Northern Rock errors

And this was gruesome reading. Obviously no regulator can work miracles and, if the people being regulated are fools, and the Rock hierarchy were stupid, then it all goes wrong. However, both the Rock and the FSA look foolish now the truth is out. But the line that really stands out is -

But the FSA stopped short of issuing an apology.

So, what have we learnt from all this grief and what will change? This has not been the first banking crisis so cannot be the last either. This sorry mess is not so much to do with clever people, regulators and trust but more down to human nature, that is, we DO NOT trust the industry that looks after our money quite like we did a year ago. Jeff Randall writing in The Telegraph in late March said:-

When the Rock started to disintegrate, first its directors, then the regulators and finally the Chancellor insisted that the business was sound. But depositors called their bluff and the company's finances crumbled. The bank exists today, thanks entirely to the taxpayer. Something not dissimilar happened at the Bear (Bear Sterns). As the Rumour Mill began shaking the bank's foundations, Alan Schwarz its chief executive told CNBC that the firm's position was "strong", describing it as "virtually unchanged" from the end of last year. A few days later - whoosh! The cash surpluses were gone and with them went the business. Schwarz's promises were empty.

All very true.

Bring back Nanny Bring back Nanny
We should remember the queues that lined up outside Northern Rock branches, some of these depositors had brought camp chairs and were sitting in the rain as the press filmed them and so it was the 'little people' who showed themselves dignified and worthy, in direct contrast to the big names. In another article by Randall with the title -

When the going gets tough, banks yelp for nanny - he wrote:-

Remarkable, isn't it, just how quickly champions of laissez-faire solutions can become advocates for state intervention. All it takes is for their gravy-train to break down. When freedom to play with barely any restrictions was making them rich beyond imagination, big-shot financiers applauded "light-touch" regulation. The looser the rules, the louder they cheered.
Now, however, as credit is crunched, losses mount and prospects for lucrative employment come under threat, many titans of unfettered enterprise are suddenly crying out for nanny.

We would all do well to remember that the FSA grew out of the Securities and Investment Board (SIB) which was set up to deal with the aftermath of the Barings Bank failure. The name change to FSA was in late 1997 and it took on the role of regulating mortgage banks in late 2004. So a certain Gordon Brown should have been up-to-speed on all of this, and this is the same Gordon Brown who, as Chancellor, gave the Bank of England its 'independence' thus creating the awkward and stucturally over rigid and inflexible tripos of: the Bank of England, the FSA and the Treasury with each part tending to wait for fear of treading on another's toes and unsure of 'whose were who'. This was a creation that was incapable of acting quickly and decisively in the face of the credit crunch and the near collapse of Northern Rock. So all this was allied to the fact that the prospect of the Rock going out of business was considered an unacceptable outcome. Yet, in the real world business failure is a fact, a risk that has to be faced.

But perhaps in the North East, a NuLabour bantustan, with Newcastle upon Tyne the home town of the Rock and on the same page of the map as the holy shrine of Sedgefield, reality takes on a different shape as it is pulled by a mixture of shame and hope. What if the headquarters had been Henley on The Blairs' home The Blairs' home Thames? Another map now doing the rounds shows the parts of London most likley to go into negative equity and they are all NuLabour heartlands. Again let me remind you that the man who claimed, on behalf of NuLabour, to have put an end to 'boom and bust' was Gordon Brown. And funny how it goes but his then boss, a certain Tony Blair, has a huge mortgage in one of the districts not so affected. Perhaps there is such a thing as divine intervention after all.