For many years I have puzzled over how to present the story of NORTHERN ROCK. but because it is a very complex story I have not been able to reduce it to basic facts. That is what I am now going to attempt, but because I may have reduced the story to “basics” it is also essential to read all my previous articles and the UKSA Sub-committee Main Report 2017 to fill in the detail.
My justification for making those statements is that, beginning in autumn 2007, I began to write a definitive book about the Financial Crisis, beginning with Northern Rock, that described events on a daily basis as they happened, without the benefit of hindsight. You should be aware that I am not a journalist; I had a career in banking and the regulation of financial activities spanning forty-seven years.
We need to go back in history to understand what has happened. The UK is a country bound by rules, lots of them. We could suggest that it started off with the TEN COMMANDMENTS, a simple list of ten things that as civilised people we should accept. It developed over many centuries into the systems we have now, where we are surrounded, some may say engulfed, by rules about everything, and as if that was not enough, we have numerous “regulators” to “enforce” the rules. Whether or not they do so effectively is an open question.
So, what is the difference between”RULES’ AND ‘LAWS’? Rules can be devised by anyone. Parents set the rules for their children, and so on up, in a spiral encompassing most adult activities. However, LAWS are made by Parliaments, in other words by MPs and Ministers who have been appointed by us in a democratic society as our representatives, to formulate, amongst other things, LAWS that govern our behaviour in many different spheres. Because we are known as a “law-abiding nation”, most of us willingly accept and follow our laws. Our only reservation is that laws should be transparently fair so that we can experience a sense of “natural justice”.
A popular view of Parliament as seen on TV is a person known as “the SPEAKER”, controlling, or trying to control, what appears to be an unruly mob comprised on the one side of THE GOVERNMENT and on the other side a group known as THE OPPOSITION,which may include everyone not a member of the governing party but dominated by the most significant opposition party, currently the LABOUR Party. We have been conditioned to believe that an “adversarial system” is the most appropriate form of government.
This TV view would be completely false, since members of political parties carry out a great deal of work behind the scenes, including the consideration of new laws. Some of those laws may not be popular, but we accept them as being in our best interests. However, there are some laws which do not serve “Natural Justice” as it is generally perceived. That establishes a connection with NORTHERN ROCK; it has suffered from the application of such laws.
So, what were they?
There were two, The Banking (Special Provisions) Act 2008 and its associated Ministerial Order, Northern Rock Shareholders Compensation Order 2008. The Labour Government of the times enacted the first, and its Chancellor of the Exchequer ordered the second. None of those persons actually activated the original thinking behind those two new pieces of statutory law. The idea for them appears to have been produced by an independent firm from the USA, Goldman Sachs. We know that because the firm was the professional adviser to the Chancellor and he announced in a press release that: “The Government’s financial adviser, Goldman Sachs, has concluded from a financial point of view that a temporary period of public ownership meets the government’s objective of protecting taxpayers.”
There are two points to be noted particularly in that statement. Firstly, the advice was given from a “financial” perspective and secondly that it recommended a “temporary”period of public ownership or “nationalisation". However, both pieces of law included mandatory assumptions that were required to be made in a determination of the valuation of Northern Rock shares.
But the story does not end there. The Banking (Special Provisions) Act 2008 and the Order collectively provided for the appointment of an “independent” professional “valuer” to determine the value that should be accorded to the shares in NORTHERN ROCK but at the same time they provided mandatory assumptions that a valuer had to observe, the effect of which was that he could only reach one conclusion, that the shares were valueless and he was obliged to declare a NIL valuation. He was appointed by the Chancellor alone, who also pre-detemined remuneration at £4.5 million and was ultimately responsible for the inclusion of the “assumptions”.
The NIL valuation attributed to the shares was controversial and did not reflect the true situation. Latterly, with the approval of the FSA, NR had pursued the same policies for more than ten years very successfully, although it stretched the normal strategy of short-term financing followed by most other banks, from 40%+ to around 70%. At the same time nobody, even bankers, foresaw the impending financial crisis that exposed the weaknesses inherent in that strategy.
It should be noted that the valuer did not produce an assessed valuation until more than one year after nationalisation.
The valuer managed to produce a NIL valuation by making further hypothetical “assumptions”, namely “I propose to assume that the best quality assets are realised (for assets, read “mortgages”) and that the remaining assets on the balance sheet are of lower quality as they have more inherent risks”.
Why did he do that?
It is significant because, in the Northern Rock (NR) Half-yearly Report published on 25 July 2007 the “equity” in NR, i.e the excess of assets over liabilities, was noted as £3.3821 billion and was subsequently confirmed later in 2007 by Goldman Sachs at about £2.800 billion. In other words, the “hypothetical assumptions” adopted by the valuer resulted in the creation of an apparently insolvent bank, with a deficit of around £2.4 billion pounds. But in reality NR was a solvent bank, a fact that had previously been emphasised by government spokespersons, the FSA and many others.
However, it was the only way in which he could achieve a NIL valuation.
How could these “assumptions” possibly be justified when all the outstanding mortgages, following nationalisation, were transferred to Northern Rock Asset Management (Later known as NRAM) and produced, out of those same assets, a profit amounting to £7.820 billion pounds sterling for HM Government, even after many millions of pounds of legal and other costs and fees had been paid out of Northern Rock funds.
It was, as the valuer was quoted as having said, “an unreal situation”.
Why was it unreal?
Northern Rock was operating normally through its 76 branches following nationalisation. It received deposits, granted mortgages and carried on business as a solvent bank, which it was. Receipt of perfectly legal and legitimate temporary Lender of Last Resort loans, not from HM Government but from the Bank of England the UK Central Bank, fully secured with a margin, ensured that it could remain in business. It has to be recognised that the Bank of England and HM Government are two separate entities, unconnected with each other except as parts of the Tripartite Standing Committee.
The only thing that had changed for Northern Rock was the ownership.
So, what was the problem?
Quite simply, Goldman Sachs offered its advice to HM Government on a financial basis without apparently taking into account the impact of other factors that had a bearing on the political and economic well-being of the UK economy. That was the job of The Chancellor and his Government.
It is very easy today to look back at the financial crisis of 2007/8 and not understand the extent to which it dominated everyone’s thinking and how catastrophic it was, a bit like Covid 19 today. Everyone, the man in the street, the media, newspapers (particularly), supposedly professional bankers and Parliament itself were overwhelmed by the fact that it was not just a UK problem (that started in the USA) but was one that spanned the entire globe. The perception was that it might be capable of causing the whole world financial system to collapse, and it nearly did.
It is against such a background that we have to view the situation as it was at that time. There is no point in trying to find a scapegoat, someone to blame. The scene was one which had no precedent. Nobody, including HM Government was prepared for it, although some financial professionals (including Goldman Sachs) were aware that something was perhaps about to change.
So, what was the real problem in relation to Northern Rock?
In an effort to prevent a “domino effect” crashing the entire banking system of the UK, HM Government decided to “nationalise” NR. The Bank of England disclosed but unfortunately not until five years later: “that while it was true that nationalisation did not itself solve the company's problems, it did open up another option. It would enable a fresh bidding process without the shareholders and with the Goldman Sachs financing option on the table.” (NOTE: The option was a plan to issue bonds, which did not happen).
In itself, that was a product of the times in 2007/8. It is not clear who decided to confiscate the shareholders' interests in NR because, including HM Government, nobody admitted to it. That is the only manner in which an acquisition without compensation in a democratic State can be described and that is what made the shareholders incredulous.
It was a step too far.
As governments formulate laws, they can also, acting on our behalf, amend or change them altogether if they are so minded without recourse to the courts. Far from doing so, successor Conservative governments, who in 2007/8 were very much against nationalisation, have maintained a state of “temporary public ownership” for a period of twelve years.
The original Labour Government plan, after a temporary nationalisation, was to return NR to its investors, perhaps reduced in size and with a revised strategy but nevertheless, still a “going concern”. Under a Conservative government that changed into sales – bit by bit – until NR and its Granite Securitisation Vehicles no longer existed, quite a different policy.
There can only be one reason, the longer NR remained nationalised, the more fees and penal rate interest could be earned by a UK Government. It is a fact that, on average, NR had a gross income of about £5 billion per annum, which normally resulted in a net profit of around £450 million. Whilst it operated as a shareholder owned entity, much of that total sum was paid away as interest on borrowings. However, when its sole owner was HM Government, a higher proportion of that annual sum accrued as profit to the Government and could be used to pay the plethora of fees and costs arising as a result of the Nationalisation, including the discounting of assets for the purpose of achieving sales. Remember, NR was “novated “ to HM Government at no purchase cost and initially it had assets totalling £113 billion, far in excess of the £26.8 billion lent by the Bank of England and therefore “disproportionate” (EU Competition Rules – State Aid - see below).
All the talk of “Taxpayers at risk” or “maximise the return for taxpayers” is nothing more than “rhetoric”, but it was repeated at every opportunity throughout the crisis by newspapers and UK governments. An individual “taxpayer’s” involvement ends when his due tax is paid, after that tax revenue is subject to distribution by HM Government. HM Conservative Government has no intention of refunding taxpayers out of a profitable outcome.
So why did successive HM Governments retain the “free”confiscated shares?
Firstly, HM Labour government recognised (or was advised), at an early stage, that Northern Rock would prove profitable; after all it was a solvent bank that had adopted the strategies of other much larger and more important banks, strategies that had worked successfully for many years for them, except that NR had followed the same strategy too aggressively, possibly egged on by its lawyers and major Wall Street investment banks, of which Goldman Sachs was one. There was also the fact that the Bank of England held security for its LOLR loans, protected from loss by a substantial margin, in fact all the assets owned by NR.
Acquiring NR shares without compensation added to the potential profit for HM Government, as noted above. Disregarding the shareholders altogether, some might say illegally, was part of the plan.
Then the question of so-called “State Aid” had to be considered. This only became important because it involved the EU but eventually the EU Commission determined that as any “State Aid” was for a limited time, it could receive EU approval, provided there was a plan to end it. As the UK Government guaranteed the Bank of England loans and also deposits of any size, it had provided “State Aid” that fell within the EU definition. 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.
The guarantee of deposits was charged a commercial rate fee and therefore was unaffected by the EU rules.
UK governments, both Labour and Conservative, with apparently adversarial views of what might lead to the compensation of former shareholders of Northern Rock, may find it difficult to accept that, but only within the “letter of the law”, the Banking (Special Provisions) Act 2008 and its associated Ministerial Order may have provided legality but they did not produce any measure of “Natural Justice”, in accordance with the Law of Equity as perceived by those whom they purport to represent.
Before a solution can be produced, that last fact has to be acknowledged by HM Government, indeed by Parliament as a whole. Successive governments have, under great pressures without precedent in living memory, committed mistakes. It is not intended that we should attempt to attribute blame but rather to obtain redress.
A primary mistake was not to acknowledge that the liquidity crisis had been resolved by the perfectly legal Bank of England Temporary Emergency Liquidity Aid by means of LOLR loans. Notwithstanding, the government nationalised Northern Rock. It was the only bank subjected to that treatment in the ensuing financial crisis of 2008, except for Bradford and Bingley, which was also nationalised but actually treated in a different manner.
Had Northern Rock not been nationalised, the question of the compensation of shareholders would not have arisen.
There are those who believe that it is a matter to put before a court once again. Court proceedings involve lawyers and barristers both of whom are expensive, therefore one should only resort to the Courts if there is a clear expectation of a win.
HM Government employs 2100 people who are either solicitors or barristers and another 700 supporting staff in what is now known as The Government Legal Service, a part of the Civil Service. Their objective is to help the Government to govern well, within the rule of law, i.e. “the letter of the law”. One can be certain that all advice given by that Service is compliant with the laws formulated by HM Governments. They are also responsible for drafting new laws and revising existing ones.
Courts, although we like to believe so, may provide a legal outcome but not always according to the Law of Equity and therefore not necessarily true justice. That is because we subscribe to a system where two opposing sets of lawyers battle it out and the ones that win are those that appear to produce the most likely scenario. On sheer volume of resources alone, HM Government is almost always assured of becoming one of the winners.
Of course, one has to expect government officials to defend their positions but one does not expect them to keep on doing so when it is apparent to most people that the Government’s case is far from being defensible, in either a moral or ethical sense.
Bearing all of that in mind, does it make sense to believe that a handful of non-lawyers can effectively challenge the government’s Legal Service?
Shareholders, or bodies representing them are unlikely to be able to do so and in any event a claim for compensation is not one that needs to be presented in a court of law. It is a matter of natural justice which, as pointed out above, can be achieved through the Law of Equity and delivered by any Westminster government that has a mind to do so.
1 January 2022
