An Analysis of the principal factors relating specifically to Northern Rock and the non-provision for compensation of shareholders
The average NR shareholder could not be expected to understand the complex financial situation which NR presented. The statement by the Chairman, included in the Interim Accounts, was positive, upbeat and made public on 25th July 2007. The first intimation that the shareholders received that something was amiss, was the premature “leak” by the BBC’s Robert Peston of the news of NR’s approach to the BofE for an LOLR loan before any of the Board of NR, the Bank of England or Government sources made an official announcement. That leak panicked NR depositors generally and there was a “run” on the bank that galvanised HM Government to hurriedly react.
As this is an attempt to include a variety of matters affecting Northern Rock, there is bound to be a repetition of matters that have been addressed in earlier Articles. That is an unavoidable situation if the reader is to be given as clear a picture as possible.
There are two pieces of legislation that applied specifically to Northern Rock. They were not used again after the Labour Government provided for the Temporary Nationalisation of Northern Rock, although the first was drafted so that it would not be a hybrid bill. It is apparent, from the manner in which they were both drafted, that the primary aim in relation to Northern Rock was to acquire its shares, preferably at no cost, because the Bank was capable of providing a profit for Government.
Although it was known that Northern Rock was a solvent Bank with a balance sheet valuation in excess of 110 Billion pounds, admittedly mostly illiquid, against which it only had to repay the Bank of England 26.8 Billion pounds out of an annual interest income of between 5 and 6 Billion pounds without taking into account annual mortgage repayments amounting to 13 Billion pounds or more which meant that the Bank of England loan could have been repaid fully by 2010 , as was intended by the Labour Government, without interfering with the main business of the Bank, which was to grant mortgages.
Although Northern Rock was SOLVENT, the shareholders, who were the owners of the Bank, were not consulted nor were they enabled to vote on the “taking into temporary public ownership”. The Chancellor indicated that: "Temporary nationalisation was only a steppingstone in a return of Northern Rock to private ownership as a smaller but still viable bank."
Minutes of the Court of the Bank of England for 17th September and 10th October 2007 (that were not made public until 2014) clarified the status of Northern Rock as a SOLVENT institution.
There were two pieces of legislation, one by way of Primary Legislation, the Banking {Special Provisions Act 2008and a Secondary piece of legislation, Northern Rock Shareholders Compensation Order which by reason of the assumptions that were included in it also became known as “The Northern Rock Shareholders NO Compensation Order”!
Both pieces of legislation included mandatory ASSUMPTIONS that had to be assumed by a Valuer [supposedly independent but appointed by HM Chancellor of the Exchequeractingalone as provided for in the Banking (Special Provisions) Act 2008]. Why were those ASSUMPTIONS included?There can only be one answer. Northern Rock experienced temporary illiquidity but it was SOLVENT and with B of E Emergency Assistance was expected to recover and was capable of producing a profit when Nationalised that HM Government expected to retain.
The Chancellor of the Exchequer, Alistair Darling, told the House of Commons at the first reading of the Bill on February 18 that: 'The Government have no intention at present to use the Bill to bring any institution other than Northern Rock into temporary public ownership.'
Before we consider, in detail, those two drafts that became Law, it is appropriate to consider other legislation, for example, traffic law imposing a 30mph speed limit. Although entry to a 30mph speed limit is usually clearly indicated, the rule is normally that where streetlighting exists, there will be a 30mph zone, clearly marked by signs on entry and on exit. Most police forces have a tolerance of 10% plus 2 mph above the limit before a speed camera 'flashes'. So, on a 30 mph road, a camera wouldn't normally activate unless a car drove past at 35 mph or faster. However, in legal terms travelling at 31mph constitutes a breach of the law.
Why are we considering this?
Well, we are not ALLOWED to ASSUME that if someone enters a 30mph zone and has an accident involving another vehicle, that he must have been travelling in excess of the speed limit. We must produce PROOF that he was speeding and that was the cause of the accident.
In the case of Northern Rock, we have PROOF that the Bank was SOLVENT and had an excess of ASSETS over LIABILITIES, before and after Nationalisation. Nevertheless, an imaginary situation was created whereby a valuer had to make an assessment on the ASSUMPTION that Northern Rock must be INSOLVENT.
A Lord Justice was quoted with reference to a particular law which created a precedent. I am neither a lawyer nor a barrister, therefore I am unfamiliar with the case. At the same time one can envisage circumstances where it is difficult to determine an outcome that results in justice having been achieved and therefore a Court may ASSUME an outcome which could provide a reasonably just result in all the circumstances of the case.
A Lord Justice should not be expected to ASSUME that certain circumstances exist when there is clear evidence that the reality is quite different. That is an abuse of the principles of Statutory law and is clearly a breach of the Democratic principle of “government of the people, by the people, for the people.”
At this point, someone said, possibly within HMT, “wait a minute, what if someone points out that it is inappropriate to ASSUME something that is contrary to the known facts? eg:
- that all financial assistance provided by the Bank of England or the Treasury to the deposit-taker in question has been withdrawn (whether by the making of a demand for repayment or otherwise),
- that no financial assistance would in future be provided by the Bank of England or the Treasury to the deposit-taker in question (apart from ordinary market assistance offered by the Bank of England subject to its usual terms). (first two of four Assumptions that a valuer was obliged by law to make).
Those cases include any case where the Chancellor of the Exchequer announces that the Treasury "(whether acting alone or with the Bank of England) would, if necessary, put in place relevant guarantee arrangements in relation to the deposit-taker” (however, see below for comment on the role of H M Treasury).
Were there flaws in this approach? There were at least two.
Firstly, because (a) The financial assistance has not been (whether by the making of demand for repayment or otherwise) withdrawn. Secondly, (b) there has been no need for future financial assistance to be provided by the Bank of England or The Treasury because the original loan or the balance thereof remaining was still in place.
On the “belt and braces principle,” as the Primary Legislation had become Law, it was decided to add two clauses to the Secondary Legislation, which dealt only with the Valuation of Northern Rock shares and had still to become Law. No problem (said Goldman Sachs???), the following should do the trick, simply add:
(a is unable to continue as a going concern; and
(b is in administration
Notwithstanding the fact that those ASSUMPTIONS had already been included in the Primary Legislation, the appointed valuer had to observe them, as they wereimposed by law, although they appeared to produce, in his eyes, an "unreal situation". On his own initiative, to ensure that Northern Rock appeared to be "insolvent", the valuer, Mr Caldwell, determined that although the half-year accounts to 30th June 2007 recorded that shareholders' funds amounted to 2,345.3 Billion pounds Sterling and total Equity Funds amounted to 3,382.1 Billion and later Goldman Sachs valued the Equity at 2.8 Billion pounds, nevertheless, he assumed that the Liabilities of Northern Rock exceeded its assets (mortgages) by the sum of 2.4 Billion pounds and on that basis was enabled to place a NILvaluation on the shares, which he confirmed in his final determination on 1st October 2010.
“The impact of theassumptionswas to turn Northern Rock from being a company which was balance sheet solvent (which it had been in reality both when the Bank of England first intervened and also at the transfer time) into a company which, in a hypothetical world, was balance sheet insolvent. As a result of the further assumptions that the valuer made, the balance sheet value of shareholders' funds was reduced from a surplus of about £3,382 billion to a deficiency of about £2.4 billion”, in other words a turnround of about 5,782 billion pounds. That was the inaccurately assumed basis on which the Valuer justified his “NIL Value” conclusion.”
How can that be squared with the 7,820,000,000 pounds profit that HM Government derived from those same assets? It is appropriate for compensation to be reassessed on the facts, as they are now known.
Why were the ASSUMPTIONS required of a valuer included in the Northern Rock Shareholders Compensation Order after its liquidity shortage had been resolved, legally and according to the normal custom of the B of E by the B of E LOLR loan? There could have been no other reason than to ensure that a NIL value could be accorded to the shares of Northern Rock. In which case, why go through a lengthy (two year) and unnecessary valuation process costing a minimum of 4.5 Million pounds.
The Valuer has never made public the basis of his determination. Which method did he use? Which of the following? i). Assessing the security of each mortgage on a LTV basis, since there are many factors which have a direct bearing on the value of the underlying properties.
ii). Use of a formula or algorithm applied to the mortgage pool. If so, what were the details of the formula or algorithm?
iii). A so far undisclosed method
iv). Guesswork
The total cost of valuing the shares is not known because it has never been disclosed but The Chancellor pre-set it initially at 4.5 million pounds.
The text of the Act has made an important point that is dependent on an interpretation of the “letter of the law”. It includes “whether acting alone or with the Bank of England." Note, the reference is to “The Treasury acting alone or with The Bank of England” but the actual sequence of events was that The Bank of England acted ALONE on 14th September 2007 andthe Treasury Nationalised Northern Rock on 22nd of February 2008, (although it may have contemplated doing so prior to that date). The Minutes of the Court of the Bank of England (not made public until 2014) quite clearly confirm that the Bank of England, as "the Central Bank", provided Temporary Emergency Assistance by way of a Lender of Last Resort loan, fully secured by a substantial margin, in accordance with Central Bank normal practice. It also expected repayment of the TEMPORARY loan to begin several months before the Banking (Special Provisions) Act2008 became law.
Is it logical to believe that Northern Rock, which had remained SOLVENT, over a period of ten years as a Bank, should nowin 2008 be declared to be apparently Insolvent?
That was not how the Management, the Board of Directors or the External independent Auditors, Price Waterhouse Coopers, followed by Goldman Sachs had assessed itonly a few months previously. Northern Rock later provided a profit for H M Government of 7,820,000,000 pounds out of those same assets.
It should be noted that the Labour Government, following its victory in 1997, as one of its first changes altered the traditional structure of the regulation of banks and financial services. It instituted a Tri-partite body, the three parts of which were the Financial Services Authority described as an independent non-governmental body, given statutory powers by the Financial Services and Markets Act 2000. It is accountable to Treasury Ministers and through them, to Parliament. It is charged with responsibility for the regulation and supervision of a range of financial services including all individual Banks.
The second player in the Tripartite arrangements was the Bank of England which retained in relation to banks and banking, what it identifies as two “core Purposes” namely Monetary Stability and Financial Stability. There were two further changes in 1997, The B of E was granted independence, it was not an “arm” of Government.
The second change in 1997 was the creation of the Tripartite Standing Committee. Its main purposes were described by HM Treasury as follows: “The Treasury, the Bank of England and the FSA constitute the Tripartite Standing Committee that considers matters of financialstability. A Published Memorandum of Understanding sets out arrangements for co-operation between Standing Committee Members in this field. The guiding principles of the MOU are that there should be clear accountability, transparency, no duplication of efforts and regular information exchange between the three parties.Standing Committee provides a regular high-level forum for such information exchange. It generally meets monthly at deputies level with the possibility that any member authority may call a meeting at short notice if necessary. Have Minutes of those "high Level" meetings been recorded?
A sub-group of Standing Committee also meets monthly to consider work on contingency planning for an operational disruption and financial sector resilience,” of whichno evidence has been found.
Other aspects of the MOU defined the responsibilities of the B of E, including “undertaking in exceptional circumstances, official financial operations in order to limit the risk of problems in or affecting particular institutions spreading to other parts of the financial system” (eg. An LOLR loan to Northern Rock?)
HM Treasury is responsible for “the overall institutional structure of financial regulation and the legislation which governs it, including the negotiation of EU directives”
“HM Treasury has no operational responsibility for the activities of the FSA and B of E and shall not be involved in them."
It appears not to be generally understood that the Standing Committee is not the mechanism through which regulation of banks is undertaken. Its three members each have responsibilities that were intended to be co-ordinated within the aegis of the Standing Committee. What has not been identified is which of the three groups would be the leader responsible for final decisions and that has been the basis of much of the adverse comment on the working of the Tripartite Standing Committee. However, as indicated above, the lead organization appears to be HM Treasury whenever Northern Rock is involved.
It must be noted that on the change to a Conservative led Government in 2010 the Standing Committee was abolished, except in relation to the nationalized status of Northern Rock which remained in place, with the FSA and the Bank of England being wholly responsible for Banking Supervision.
To return to the two pieces of legislation with which we are primarily concerned, here is a summary of those aspects that are incompatible with the reality of Northern Rock's true situation.
1. Is it reasonable and in the Public Interest for thislaw to include the four assumptions imposed upon the appointed valuer? Is it not the case that this piece of legislation could have achieved an objective that was in the Public Interest without the Assumptions?
2. Both Governments continued to defend the inclusion of the ASSUMPTIONS although their only purpose could be to ensure that a Profit would accrue to HM Government rather than to the private sector. That would have been a laudable aim if in fact the public sector, in other words "the taxpayer" had become involved. However, he did not, Northern Rock was SOLVENT both before and after its nationalisation and had adequate funds out of which to settle all the costs and expenses of its nationalised state.
Individual "taxpayers" cease to become involved whenever they pay their due Tax, after that revenue is under the control of H M Government.
3. It was clearly stated in the Treasury Press Release that set out the reasoning behind the decision to nationalise Northern Rock, at paras 3 & 4: "The Government set out its objectives last year that would guide its actions in relation to Northern Rock: the protection of depositors money; protection of the taxpayer; and maintaining wider financial stability". Para 4 read: "The Government has consistently and successfully taken action to meet those objectives. Last year the Government agreed to provide support to Northern Rock because, in the prevailing market conditions, there was a serious risk that other parts of the banking system in Britain could have been destabilised. That support was successful and prevented further contagion. (Did it really do so?) The Government also determined to safeguard depositors' money and took action to put in place arrangements which have been successful in doing so. None of the guarantees have been called and therefore there has been no cost to the taxpayer."
Bearing in mind that those paragraphs were issued on 17th February 2008, just prior to the "Nationalisation" of Northern Rock in a time of considerably uncertainty as to the future of the Banking System in the UK, they need to be re-examined in the light of what we now know to be the true situation.
Firstly, the safeguarding of depositors' money. The Government first acted to protect savers on Monday, 17th September 2007 at about 7.00 pm, in other words, after the banks had closed for business. That evening HM Treasury announced that all depositors' money in the Bank at that time would be guaranteed by HM Government, fully four days after the "run" on deposits, better late than never!
The guarantee was later extended to cover all new deposits placed with Northern Rock.
What was not general knowledge at the time, was that a FEE, said to be based on commercial rates, was charged for the provision of that guarantee, which as noted above, has never been called upon. It follows that when a FEE is charged, the guarantee should not be regarded as "State Aid".
Secondly, HM Treasury guaranteed the Bank of England against loss on its loan to Northern Rock.
Why?
The B of E made the loan as part of its independent function as a Central Bank. The loan was fully secured by all the assets of Northern Rock, with a generous margin. The Minutes of the Court of the B of E (released in 2014) confirmed that the Bank was prepared to lend up to 40 Billion, the maximum sum for which Northern Rock held sufficient security, including at least a 50% margin. In actual fact, B of E lent a total of 26.8 Billion which it anticipated would be repaid in full.
4. In the uncertain times prevailing in 2007 it is conceded that neither the B of E nor HM Treasury could have accurately assessed the amount needed but is it reasonable to believe that the B of E required a Government guarantee? HM Treasury had said that it would provide a guarantee if necessary.
The operations of the B of E, as stated above are by an independent institution unconnected with the Government except as a member of the Tripartite Standing Committee, therefore when the B of E exercises its function as a Lender of Last Resort, that does not constitute State Aid.
5. It is worth examining what constitutes "State Aid" as that expression has different meanings according to who is using it. In this case it is being considered in the context of European Union State Aid. Prior to Brexit the UK observed EU Directives which had relevance in 2007/8. The European Union's (EU) restrictions on member states' use of state aid were put in place only to ensure that government resources were not used to distort competition between member states. It was a fact that NR’s lending activities were confined to the UK and therefore were unlikely to distort competition amongst member states.
6. The UK definition of "State Aid" is different and includes Government guarantees that State Aid would be forthcoming, whether activated or not. Therefore, the UK definition is of much wider application. However, it is the EU version with which we are concerned.
"State Aid" comes from the Westminster Government. Temporary aid in the form of LOLR loans from the B of E do not constitute "State Aid". It seems that the advisors from the USA could not differentiate between B of E LOLR loans and H M Government "State Aid".
7. Lord Justice Lewison, one of the three Appeal Court Justices in a case brought by Harbinger Capital, said “It is important to emphasise that the assistance that the Bank of England had provided was liquidity support; that is to say, the Bank's intervention enabled Northern Rock to pay its debts as they fell due. The Bank's intervention was not designed to shore up Northern Rock's balance sheet. That would have been incompatible with the principles on which the Bank acts as lender of last resort. There is no evidence or finding that Northern Rock's balance sheet was increased as a result of public sector support. As far as the evidence goes Northern Rock had a surplus of assets over liabilities when the Treasury first intervened, when the Bill that became the Act was introduced into Parliament and at the transfer time itself. The consequence of liquidity support was that Northern Rock was enabled to continue as a going concern.”
“Without that support, as was common ground, it would have had to have entered administration or liquidationbut it would have done so on the basis that the starting point of the administration or liquidation was a company whose assets, as shown in its balance sheet, exceeded its liabilities”.
The latter is an important point because it acknowledged that there could be a value to the former shareholder’s shares that has not been accepted by H M Government nor by its professional advisers. At the same time, everybody recognized that NR could not raise loans from other banks (inter-bank market) as it normally did, because that market had shut down completely.
8. Although it may not be directly relevant to NRAM, the Banking Act 2009 Act, Sec.{11.2} states: “In order to strike a balance between public and private interests where property has been transferred compulsorily (for example, as a result of an exercise of the share transfer powers) it is appropriate to make provision for compensation to be paid which is normally required to be an amount reasonably related to the market value of the property in question”.
In the case of NR, “reasonably related to the market value of the property in question” can now be assessed with reference to the extent of the profits and surplus assets finally accruing to HM Government in 2020 rather than to the hypothetical and wrong conclusion that was estimated in 2007/8.
That profit was stated in the Annual Accounts as accruing to the " sole owner" of the Company. It possibly was intended to make Government ownership less apparent!
9. Northern Rock had a substantial annual cash flow which, together with customary remortgaging, meant that it was able to repay the LOLR loans within a reasonable and normal three -year period, not the twelve year or so that the Conservative Government stretched "taking into the public sector" in such a manner that it would emerge as the sole beneficiary.
10. HM Government, not the B of E, subsequently loaned to NRAM a further 8.5 billion pounds but why? The funds were allocated to NRAM, to stimulate the UK mortgage market but NRAM was prohibited from accepting new business, yet it alone was specifically made responsible for repayment, with a penal interest rate, by a ConservativeGovernment.
Those funds could have been made available to any other lender who would have been able to use them, why allocate them to NRAM that was prohibited from using them?
There were several factors that must have been considered before the draft of the two new laws could be put to Parliament, although it was only given a few days to consider matters. Those include the following that concerned NRAM:
a). Why was NRAM exempted from the provisions of The Freedom of Information Act 2000? This Act enables adult residents of the UK to access information relating to most public offices, including Government entities. It is to be noted that whilst the Act applied to the Government owned holding company (UK Asset Resolution), yet it did NOT apply to its wholly owned subsidiary, Northern Rock Asset Management (later known as NRAM) on the grounds that NRAM had a separate Board of Directors operating at “arms-length” from Government. As the Board of NR was obliged to adopt Government policies, the extent of “arms-length” is debatable.
Did that matter?
Yes, it did, because it enabled NRAM to be operated without scrutiny as a Private sector Company even although it was Government owned and effectively controlled, in other words not transparently.
b). Why was NRAM created as a separate company? Because, as such it was subject to the provisions of the The Banking (Special Provisions) Act 2008, It is important to note that this was a temporary Act with a life of one year and that the “Special Provisions” related to theAssumptions that had to be made in the case of Northern Rock only. It was passed as a “stop-gap” because the full Banking Act which followed in February 2009 had not been enacted but could have been enacted in the five months prior to the date of Nationalisation. It was known that there was an awareness of its unavailability. In its place, the “Special Provisions” Act was hurried through Parliament retrospectively in a few days during the week that followed the declaration by The Chancellor of the Nationalisation of NR.
The Chancellor of the Exchequer, Alistair Darling, told the House of Commons at the first reading of the Bill on February 18 that: 'The Government have no intention at present to use the Bill to bring any institution other than Northern Rock into temporary public ownership," and it did not do so.
c). The Banking Act 2009. This Act was a late enactment of the law adopted by all other G8 countries in 2003 but not by the UK until 2009. It was principally an Act to provide for the Resolution of Banks in situations such as Northern Rock found itself. Did it apply to NRAM, a Company created in 2010?
No, because, although its Assets were all derived from Northern Rock Bank, it was regulated by the FSA, not as a Bank but as an Asset Management Company because, included in the definition of a Bank is that it must accept deposits from the public, which NRAM was specifically prohibited from doing. One is left with the impression that the separation of NRAM was deliberately arranged to ensure that it could not be subject to the new Act in early 2009. If one travels forward in time to the plight of The Royal Bank of Scotland, its substantial holdings of assets were not transferred to a separate company. They remained within the Royal Bank in their entirety.
d). A loan was made to NRAM for the purpose of stimulating the mortgage lending market but NRAM was unable to use the money because it was prohibited from engaging in new business. Nevertheless, NRAM was loaned the funds by H M Government and was alone made responsible for repayment, including interest at a penal rate. Why?
e) Novation, an expression used only in the USA, and presumably imported by Goldman Sachs, has no direct UK equivalent, according to the "Oxford Dictionary". In the USA it means that the whole of a transaction, with the approval of the parties to it, can be assumed by a new party, in this case, H M Government. In this manner the B of E is totally absolved and is replaced by H M Government at no cost no either party.
It should be noted, however, that this took place six months after the nationalisation of Northern Rock by the government. WHY? There can only be one credible answer, H M Government wished to have the profits accruing from Northern Rock, as it expected, to accrue to itself. There can be no other logical reason for arranging the "novation".
HM Government is advised on the drafting of new laws by what is now known as The Government Legal Profession. It is comprised of 2000 lawyers and Barristers with about 700 support staff. Is it really believable that not one of them, including those actively involved in the drafting of the two new pieces of legislation, raised a single question in relation to the two new laws?
There is another point that requires consideration. So far I have used the figure of 7,820,000,000 as the final profit accruing to HM Government but I have omitted to include the loan made by the Government of 8.5 billion pounds. That loan was made to NRAM but was not connected to the B of E LOLR loan nor was it made with a view to stabilising Northern Rock's liquidity problems. It was made to "stimulate the UK mortgage market" in general.
In other words, it was not made for the benefit of Northern Rock or NRAM. It was totally unconnected with either Company. It is appropriate, therefor to reassess the profit accruing to HM Government at 16,320,000,000 pounds.
It is possible to offer HM Government a blame free and almost painless way out of its Northern Rock problems.
How can this be achieved?
HM Government can use its existing powers to amend, change or even replace any piece of legislation made by it. By doing so it could achieve a solution that shareholders would readily accept.
Why should it do so?
The answer goes back in time to 1909 when the father of a 13 year old student at Osborne House, a Naval College, was expelled. His father who had complete trust in his son, petitioned the King, who authorised the petition and added the words "Let right be done". The Admiralty withdrew from the case four days later. Right was done.
It seems that a very similar need for "Right to be done" exists for Northern Rock shareholders.
An article for “the Financial Times” on 19th February 2008 by the eminent economist, Professor Tim Congdon contained the following:-
“If Northern Rock does repay the loan in full but its shareholders receive nothing, the British Government’s actions would amount to robbery under the law.”
1 September 2022
