Monday, November 19, 2007

Channelling John Profumo

'Oh what have you done?' cried Christine
'You've wrecked the whole party machine!
To lie in the nude
May be frightfully rude,
But to lie in the House is obscene!'
The fallout over Northern Rock becomes more serious daily. Alastair Darling today had to make a statement clarifying the situation whereby the tax payer is standing as effective guarantor for Northern Rock - a commitment that is already equal to approximately £24bn, a figure that is rising inexorably as the value of Northern Rock diminishes. That's a lot of money, and MPs are understandably jumpy about the prospect of its being repaid. So Darling gave, on the floor of the House this unequivocal guarantee:
Speaking in the House of Commons, Mr Darling insisted that the government-backed loans given to the bank - currently worth about £24bn - must be repaid - and said that the lending was all guaranteed against "quality assets" including mortgages.
Which all looks OK. Although we're on the hook for a considerable amount of money, that loan is secured against Northern Rock's assets - which are hopefully sufficient to cover a loan of equivalent size to the Government's annual spending on primary schools. Except that it isn't true. One of the conditions for the Bank of England lending the money to Northern Rock in the first place - in a capacity according with its role as lender of last resort - was that it be lent at a 'punitive rate'. The Bank is not supposed to be a regular lender, and the 'moral hazard' argument requires that there be a powerful disincentive from using it as such.
But Northern Rock aren't able to pay this rate. So, apparently, a deal has been done whereby Bank rate is paid, and the punitive premium of 1.25% is nominally charged and accrued on an effective loan that is repayable in five years. According to Robert Peston, this debt is owed to the Treasury not to the Bank. Further, it is ranked as subordinated debt - very very low in the debt rankings in other words. And we're not talking peanuts either:
If, for example, the Northern Rock's loan from the Bank of England averaged £20bn over two years - which is a realistic scenario - the rolled up interest would total £500m.
That's getting close to being serious money. Barings Bank, for example, collapsed after making losses of £800m. And it's effectively unsecured debt - the next thing to equity. So when Alastair Darling said, in Parliament, that all the lending is secured against quality assets he wasn't telling the truth. It may be, charitably, that he is unaware of a five year Treasury commitment of up to half a billion pounds - although that's hardly a good thing in a Chancellor. If, on the other hand, he has kept up to speed with the most serious financial crisis in over a decade, then he has been lying to the House. At least John Profumo got a quality shag out of it.

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