Michael Meacher - Labour's Future

The catalogue of mishandling of Northern Rock must be almost without precedent.

When collapse first became apparent last August, it could have been taken quickly and cleanly into temporary public ownership, thus saving the taxpayer £25bn in loans and £30bn in depositor guarantees. Six months was spent in delaying the inevitable, which damaged the reputation both of the Government and of the City. The reason it was not promptly taken into public ownership was not, as the Government has claimed, to look first at all the other alternatives (it was clear even at the outset that there really weren’t any), but to try to avoid any cost – even £55bn – any hint of a return to Old Labour nationalisation.

Since Gordon Brown was finally forced on 17 February to accept, amid gnashing of teeth, that temporary nationalisation was unavoidable, in just 3 days a whole new series of problems and uncertainties and mistakes have surfaced:

* There is an unanswered question about how the Bank will be regulated to prevent it distorting the market and having an unfair competitive advantage because of its State-backed guarantees. The Government claimed that EU State aid rules would achieve this, but did not indicate how, and declined to say whether the OFT would have a role.

* Though repeatedly pressed, Ministers have refused to set out the Government’s strategic objectives for the Bank. Is it to run down the bank and sacrifice half the existing 6,000 jobs, or is it to build it up and consolidate further its position in the market, with an eye to the most profitable future sale?

* There several different objectives which are clearly incompatible: making the Bank a profitable concern, reducing taxpayers’ exposure, protecting jobs in the North-East, satisfying EU rules, playing fair by other banks, to mention just some. Since it can’t achieve all, to which will the Government give priority?

* It is suggested the bank will be run at arm’s length from the Government. In that case, why did Gordon Brown appoint his former chief of staff, Tom Scholar, to the board?

* It is proposed that the bank should be exempt from the Freedom of Information Act. Why? This does not encourage confidence.

* It now appears that Granite, the offshore component of Northern Rock, is being excluded from the nationalisation, on the grounds that whilst it is on the bank’s balance sheet, it is a separate trust. However, it now appears that if Northern Rock fails to supply new continuing mortgages into Granite to refresh its package as some of its mortgages are redeemed or repair, Granite will default and its entire securitised debt obligations will implode and have to be sold off on a fire sale basis. The seller’s share held by Northern Rock will also be part of the fire sale, and its value will fall well below its stated asset value in the books. Thus, by excluding Granite from this nationalisation measure, the Government is putting the taxpayer at risk of another huge bill.

* Almost worse, it is now becoming clear that the assets held by Northern Rock outside Granite, including those worthlessly pitched at 125% of value, are what the Government has acquired, whereas the high-valued assets are separately stored away in Granite. Once again, the Government has socialised the losses while allowing the smart money to privatise the gains.

Posted by Michael Meacher at 10:45 PM | Permalink | Comments (0) | TrackBacks (0)

The Rt. Hon. Gordon Brown M.P.
The Prime Minister
10 Downing Street
London SW1

Dear Gordon,

Thank you for your response regarding the financial collapse of Northern Rock at yesterday’s PMQs. However, I feel that this issue cannot simply be resolved by finding a new buyer for the troubled firm, for the following reasons:

1. The means by which Northern Rock and other banks turned profits, by buying and selling mortgage bundles to other companies which may not have fully understood the terms of such loans, signal a remarkable and alarming shift in the banking industry. While previously the emphasis was placed on long-term investments and success, there is now a demonstrated pressure within the financial services industry to turn quick profits at any cost. This change in perspective must be reversed industry-wide, if we hope to prevent another bank failure of this scale.

2. The Northern Rock crisis has cost the British financial services industry dearly, and may still cost a great deal more has been so far acknowledged when Ben Bernanke has already estimated the losses from bad mortgage loans at $150 billion, a figure that may itself substantially grow when no less than $1.3 trillions of sub-prime loans were set up in the two years to 2006, nearly half of which may be irrecoverable. Our economy cannot withstand another blow of this magnitude, considering mortgage and credit card debt already now amounts to some £1.35 trillions. In order to truly protect lenders and buyers, immediate action to improve regulation of the financial services sector is clearly overdue and very necessary.

3. It is evident that Northern Rock was able to conduct business in this matter because of the lack of an independent, regulatory agency that could effectively monitor individual financial transactions. The Financial Services Authority, it has emerged, does not have inspectors dedicated to the regulation of banks or to monitor potentially worrying investments or to test financial products against risk of serious public detriment. This urgently needs correcting.

4. No regulatory agency had demanded transparency and no auditor had condemned the securitisation process on the grounds that it confounded the valuation of risk. What is now needed is a Committee of Inquiry into the governance, accounting and auditing of the banks. This should investigate offshore structures, complex derivatives, the lack of accounting transparency, and the overriding need to align commercial incentives with public accountability.

I very much hope you may now decide to set these reforms in hand.

Yours ever,

Rt. Hon. Michael Meacher M.P.

Posted by Michael Meacher at 04:29 PM | Permalink | Comments (2) | TrackBacks (0)

The really big question about Northern Rock is still not being asked. It’s not just about £25bn loans and £30bn guarantees from the taxpayer and how they can be redeemed, nor even about whether temporary public ownership at the outset would have been a better solution. It’s about what caused this systemic failure in international financial markets, and how it must now be put right.

Northern Rock’s specialty had been its use of well-stocked wholesale markets to fund its huge expansion in mortgage lending, and then using the same markets to offload dodgy loans which had been worryingly granted to borrowers even at a 6:1 debt-to-income ratio. The mortgage loans were sold off in exchange for a lump sum via complex financial investments such as structured investment vehicles (SIVs) and collateralised debt obligations (CDOs) – a process known as securitisation. The scale and intensity with which Northern Rock pursued this strategy turned it from being less a conventional bank than an SIV itself, selling its loans forward through its Granite offshore operation. The plan failed when the commercial markets on which it depended for its funds dried up in the credit crunch induced by the US sub-prime housing market collapse.

There are several aspects of this saga which show how systematic the breakdown of financial market operations has now become. First, the new exotic securities in bonds and derivatives were generated because they offered the prospect of turning property lending, previously seen as a long-term business, into a short-term business with instant profits. Instead of waiting 20-25 years to recoup the loans, SIVs enabled banks to regain their funds straightaway so that they could lend them out again and make even more money. This process was repeated endlessly, with hedge funds, pension funds and insurance companies joining in frenzied rounds of buying and selling re-bundled mortgages, and thus widening the repercussions of the crisis when it finally broke.

Second, SIVs and the labyrinthine CDO pooling structures which contained them were not understood even by those who dealt in them, and perhaps were devised precisely with that intent. Repeated repackagings left what were always complex instruments bearing little or no value comparable with the original asset taken as collateral. Moreover many SIVs have been set in offshore havens with a reputation for secrecy and light controls. Yet no regulatory agency demanded transparency and no auditor condemned the securitisation process on the grounds that it confounded the valuation of risk.

The crisis has also exposed the financial industry’s relentless drive for quick profits, irrespective of long-term security, in an environment woefully lacking in public accountability. Speculation has been carried to new heights without apparently any thought as to how newfangled complex instruments might fail. The present dominant enterprise culture locks remuneration for chief executives, directors, markets and investors to short-term gains and creates perverse incentives for reckless behaviour. The rewards of Northern Rock’s directors over the last five years are a case in point: the £30 millions they made in salaries, share incentives and bonuses were profit-driven, though the losses are now accruing to the taxpayer.

This crisis is not, as some have sought to make out, a temporary glitch which can be got over as soon as a satisfactory buyer can be found for Northern Rock. The monumental scale of the losses, present and future, belies that. Bernanke, the chairman of the US Fed, has already estimated the losses from bad mortgage loans at $150bn, and that may grow given that a staggering $1.3 trillions of sub-prime loans were set up in the two years to 2006, of which nearly half may be unrecoverable. In the UK, HSBC has already announced losses from its sub-prime business of nearly £1bn, and other British banks have yet to make clear their write-downs which must foretell a tightening of credit. When the British economy has long been kept afloat by easy credit – mortgage and credit card debt now amounting to some £1.35 trillions, greater than the country’s entire GNP – the knock-on effects of this crisis will stretch far beyond the perpetrators in the financial sector.

Finally, as the enumeration of actual and potential losses reveals, the de-regulatory, light-touch, unfettered markets regime that underpins the neo-liberal ideology that has dominated the international economy since the 1980s has sustained a severe reverse from which it will take long to recover, if ever. It may be seen as a repetition, writ even larger, of the secondary banking crisis of 1974. The lessons of that have clearly not been learnt, and have now returned with a vengeance – lack of prudential controls, regulatory capture, obscure accounting, absence of auditor independence, and an economic elite driven by reckless short-term profit-making at the expense of the taxpayers who have to bail them out.

No doubt intense lobbying from the City, the dominant arm of today’s financial capitalism, will exert every sinew to minimise reform. But the risk downsides of unregulated markets have now been shown to be far too great, and it is clear the market cannot of itself establish the necessary supervision. Investors in loan-backed securities have not sought tougher monitoring because they were captured by the allure of the yields on offer, which Alan Greenspan has compared to cocaine abuse. Auditors have been only too happy to offer a clean bill of health to companies in which they may have an interest. The Financial Services Authority, it has emerged, does not have inspectors dedicated to the regulation of banks or to monitor potentially worrying investments or to test financial products against risk of serious public detriment.

In view of this systemic failure in the financial sector and its kickback across the whole economy, what is now needed is a Committee of Inquiry into the governance, accounting and auditing of the banks. This should investigate offshore structures, complex derivatives, the lack of accounting transparency, and the overriding need to align commercial incentives with public accountability. Otherwise the same problems will recur again, only with the adverse consequences ratcheted up still further.

This article appeared in The Tribune on 29 February 2008.

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