In his third article on Northern Rock, Bill Brown summarises the current position, especially for those less familiar with the case.
As has been mentioned in an earlier article, the circumstances concerning Northern Rock are quite complicated.
The main concern of these articles is to determine why Northern Rock shares were assessed as having no value, particularly when various sources in Government, including the Chancellor of the Exchequer and other ministers, although they spoke of a “failed” bank, still referred to it as operating normally (even after nationalisation) as a “going concern”.
That implied a contradiction in Government statements since the only law
that was available at that time for Government use, in the absence of an applicable Banking Act (which was not passed until February 2009), was the Insolvency Act 1986. It was officially well established that Northern Rock was not insolvent, therefore before the Insolvency Act could be utilized the artificial creation of a state of “effective insolvency” had to be created (but which was not provided for in the Act).
This was achieved by declarations in the Northern Rock Compensation Order 2008 that it had to be: assumed (by a valuer) that: a) Northern rock was unable to continue as a going concern, and b) that it was in administration. (Had the bank been in administration, administrators would have wound it up and the surplus assets and income would have been paid to the shareholders.)
The consequence of those two assumptions, written into Law, reinforced by a statement that Bank of England or Government support would be immediately withdrawn and would not be renewed, was that Northern Rock shares would be valueless. That was the Government’s first mistake.
Why was it?
Firstly, because the original issued share capital of Northern Rock of £124 million comprised 496 million 25 pence shares and that same amount of capital funds still formed part of the capital (equity) value of NRAM* in 2020, yet all the shares had been declared worthless in 2007, notwithstanding that Goldman Sachs had attributed a value of £2.8 billion to equity in the bank.
Secondly, because it was based on assumptions which did not reflect the true situation, namely that Northern Rock Bank was operating normally as a “going concern”. It continued to receive deposits and issue mortgages.
Thirdly, The Public Accounts Committee in 2012/13 stated: “The Treasury (HMT) did not have sufficient capacity or the skills to understand and respond to the crisis when it began”. It therefore relied on its adviser, Goldman Sachs, a US company. Following that advice resulted in a valuer being obliged by an inappropriate law to declare a “NIL” value for the shares, more than one year later, even although he was quoted as saying that it was an “unreal situation”.
We tend to forget that our Parliament is made up of ordinary people who become Members of Parliament and as such are charged with governing the country. But we need to remember that in a democracy, we expect to have “government of the people, by the people, for the people”. What that implies is that the people, you and I, should expect to be governed fairly. Depriving shareholders, in a solvent bank, of their shares without compensation is not what we expect. It is particularly unfair when compared with aid that was made available to other UK banks in 2008, none of which were nationalised.
There is no question that the Emergency Assistance, by way of “lender of last resort” loans from the Central Bank – the banker’s bank -- was acknowledged to come from the UK central bank, the Bank of England. Those loans were made available to a solvent bank, were fully secured with a substantial margin and were not “state aid”, although they were referred to as such in the media and by Government long before nationalisation of the bank. LOLR loans from a central bank are considered, worldwide, to be a standard and lawful method of providing emergency assistance to a bank that is solvent but undergoing a liquidity shortage.
Included as “state aid” were the Bank of England LOLR loans; the guarantee (by government) of deposits (for which fees were paid by NR) and other involvements by Government.
The Bank of England loans were “novated” to HM Treasury in August 2008, more than five months after the bank was nationalised. “Novated”, an expression used in the USA, implies a transfer of the loans to Government on the same terms and conditions. Despite the fact that there was no cost to Government, they became “state aid”. The EC Financial Services Directive dealt with questions of “state aid”, but this was a complicated situation and bearing in mind that nationalisation took place in February 2008 the EC considered the matter until October 2009 before it could reach a conclusion, which in fact was no more than a retrospective, token approval.
The “novated” Government loans which by August 2008 had been reduced to £15 billion. According to the figures issued by the Government-appointed Chairman of Northern Rock, they were on schedule to be reduced further by 31 December 2008 to £8.9 billion, which would have meant that as at that date, only four months after the loans had been “novated” to Government, no more than £8 billion pounds would be outstanding. Even after all the original LOLR loans from the Bank of England had been repaid, there would remain under Government control, surplus gross assets amounting to £78.2 billion , which we now understand may have been sold off at a discount, much of it to foreign buyers. The Government paid not from public funds but out of the assets and accrued income of Northern Rock, advisers, experts, lawyers and even bidders, plus other disbursements. In other words, “taxpayers” were not involved.
A requirement of the EC Financial Services Directive (2002) is that actions must be “proportionate”, balancing the rights of private persons and public interests. How can it be considered “proportionate” to secure loans of £15 billion against assets of £78.2 billion with a resulting profit to the Government, believed to be £7.8 billion, after temporary nationalisation which lasted 12 years.
Throughout the period since September 2007 successive Governments have failed to acknowledge the deficiencies of the Financial Services Authority. The following are quotes from the RBS report, (Treasury Select Committee- 2012/13) and demonstrate that the government played a substantial role in setting the basis of bank regulation: “the FSA’s philosophy and approach to supervision prior to the financial crisis was set within a context which included: a sustained political emphasis on the need for the FSA to be a light-touch regulator in order to retain the international competitiveness of the UK’s financial system”. No wonder that the government is unwilling to acknowledge that the FSA, for one, failed in its duties.
A statement was made by Gary Hoffman, CEO, made after his appointment in October 2008, to the effect that: "Northern Rock has made good progress against the Business Plan objectives laid out in March 2008. The Government loan has been reduced significantly, and the deposit base of the Company has grown as customers have returned to Northern Rock. (Total deposits - £20 billion pounds). We can now return to what we do well - mortgage lending. [...] We have an exciting opportunity to help consumers in the mortgage and savings markets and to secure the long-term future of the Company, while protecting the interests of the taxpayer. I am confident that we will deliver on that opportunity."
Why was Mr Hoffman not allowed, by Government, to carry on with a plan that could have repaid all Government loans within a year or possibly two?
Northern Rock operated only as a mortgage bank. Formerly it was a Building Society and its management and directors were not qualified bankers. A significant difference between the two types of institution is that building societies cannot borrow, they rely on customer deposit accounts, whilst banks in addition to customer deposits can borrow from a variety of sources but must have regard to the extent of their borrowing.
Until about the 1970s, banks did not engage in mortgage lending, viewing it as unwise to mix deposits and mortgage loans by “borrowing short to lend long”. Mortgage loans until then had an anticipated life of 20-30 years. However, lawyers devised many new types of mortgage loans, including so-called “teaser” loans for, say, three years at a fixed rate that was generally lower than for loans whose interest rates fluctuated with changes in the bank rate to which most interest rates in the UK are tied. Those changes attracted the Clearing and Scottish Banks into mortgages and this introduced competition into the mortgage markets.
The main attraction of mortgage lending, and this also must have influenced the decision to “nationalise” the bank, is that it produces a steady, reliable flow of cash income, based on the value of existing mortgage loans that in the case of Northern Rock originally exceeded £100 billion. That income, denied to shareholders, increased Government profits.
The “Freedom of Information Act” was passed in order to achieve “transparency” of public body transactions, particularly those of Government departments. However, on the basis that NRAM had its own Board of Directors and senior management officers and had been declared as operating at “arm’s length” free of Government intervention, NRAM was officially deemed to be a privately owned Company, specifically not subject to the “Freedom of Information Act”. At the same time, the Company required Government approval of its strategic plans. It publishes annual accounts but was it really free from Government intervention? After all, in 2010 its policies were changed to meet a government initiative to stimulate mortgage markets.
Annual reports and accounts only reflect the overall status of a company, in this case a Bank, on a given day each year. Furthermore, they are prepared in accordance with widely accepted accounting standards which can mean that the picture of the bank that is presented may reflect the picture that the management and directors (with a degree of approval from its external auditors) wishes to present. One sum calculated in accordance with accounting standards is “statutory profit” that is not necessarily the same as actual profit. The annual report and accounts of Northern Rock for 2008 ran to 94 pages, of which 47 pages were notes to the Accounts. NRAM’s annual report and accounts normally run to approximately 70 pages, of which 40 pages are of explanatory notes which many accountants would have difficulty interpreting. In other words, there is a lack of transparency concerning the transactions, interest rates etc. that happen throughout the year.
Because there is such a lack of transparency, it has been difficult for anyone to assess the true status of NRAM throughout its existence. However, it is a fact that the longer Northern Rock remained under Government control, the more gross income and fees accrued to Government, even although no meaningful estimates of them could be deduced, because they were never published.
The only justification for the “novation” of the Bank of England loans to HMT must be that it was known from a very early time that Northern Rock would produce a surplus which, despite the constant references to “taxpayers’ interests”, will accrue to a Conservative Government.
The Annual Directors’ Report supports the theme that Government’s concern is always to protect “taxpayers’ interests” and the overall aim as stated in several NRAM Annual Reports is to “maximise value for the taxpayer”. But why should this be a concern? Northern Rock was expected from an early stage (actually before the Banking Special Provisions Bill became law) not only to repay the Bank of England loans and interest at a penal rate within an acceptable period (two to three years being considered appropriate for LOLR loans).
In fact, the only body concerned with “maximising value” was Government due to the “novation” of the LOLR loans from the Bank of England to it. The Government also added to “the maximisation” of its returns by ensuring that shareholders would be deprived of their shares without compensation.
Any shareholder compensation will not be paid by the Government or by the taxpayer. It will be paid out of Northern Rock surplus funds and may still leave the government holding a substantial profit.
Please contact UKSA (officeatuksa@gmail.com) if you are interested in the campaign for compensation.
* Northern Rock (Asset Management) plc became NRAM plc, a British asset holding and management company which was split from the Northern Rock bank in 2010.
