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Goldman's Rock Gambit

Robert Peston | 08:48 UK time, Thursday, 10 January 2008

Northern Rock was laid low in September by its excessive dependence on wholesale money markets, especially the securitised mortgage market, for the financing of its lending.

So it is either apt or appalling – depending on your bent – that Goldman Sach’s solution to the Rock’s current plight would be to securitise the taxpayers’ emergency loans to the Rock.

The £26bn odd that has been lent to the Rock by all of us would be repackaged into bonds, for sale over time to investors.

But in order to make them sellable, these new Rock bonds would need a triple-A credit rating.

And that would require them to be guaranteed – or “wrapped”, to use the jargon – by the government.

In other words they would be the equivalent of gilt-edged stock.

“What on earth’s the point of all that?” you might well ask. “Surely they would remain a public-sector risk. We would all still be on the hook to the Rock’s plight, as exposed as we ever were.”

And you would be right.

What’s more, the Eurocrats in Brussels would doubtless see such a deal as state aid, and therefore illegal.

So this deal will only fly if Goldman can find some other “wrap artists” (ha ha).

It needs to persuade financial institutions called reinsurers to take over some or all of the Government guarantee.

In theory this is do-able.

Reinsurers – such as the one run by Warren Buffett, the world’s most successful investor – still have immensely deep pockets, even after the credit crunch.

But they would charge for taking on the Rock risk from the government, for providing the cherished triple-A rating.

And the big questions, which Goldman has not yet answered, is whether the re-insurers can do this at a price that isn’t excessive and in a way that placates the Eurocrats.

To be clear, this is not some intellectually fascinating bit of obstruse financial engineering.

Goldman’s success or failure in securitising this debt will decide the very future of the Rock.

If the securitisation can be done on sensible terms, it means that a rescue deal with the consortium led by Virgin or with Olivant (or, as a very long shot, the Gooding/Five Mile group) may yet happen.

Virgin – which yesterday gave an update to the Rock’s board – remains remarkably bullish about its prospects.

Which is a bit odd, since the big shareholders in the Rock tell me they are profoundly uninterested in what Virgin has to offer – and those shareholders have the power of veto (much to the chagrin of the Treasury).

The other generic option is partial nationalisation.

Full nationalisation seems to have been more-or-less ruled out.

Instead the Treasury’s fallback plan would effectively be the status quo, except that new senior management would be parachuted into the Rock and the Treasury would take a minority stake in the business (possibly via a warrant or share-option arrangement).

A lot of preparation has been made for this partial nationalisation. A senior banker has been lined up as a possible new chief executive.

For the Treasury, it’s an insurance policy – since a private-sector rescue may turn out to be impossible.

And it’s a realistic option, because retail depositors have at last stopped withdrawing their funds from the Rock: retail deposits have stabilised at something over £9bn, which reinvents Northern Rock as a small-to-medium bank.

Many taxpayers may take the view that a partial nationalisation would make the best of a bad job.

What I mean by that is that we’re all exposed to the Rock to the magnificent tune of £57bn through direct loans and guarantees for other lenders.

Under none of the available options – those proposed by Virgin, Olivant, or the Gooding/Five Mile group – would this taxpayer support fall to some minimal level in the coming weeks and months.

Taxpayers would continue to prop up the Rock for a considerable period.

The big point is that if there is a profitable future for the Rock, it would only exist because we as taxpayers prevented the Rock from collapsing.

But – at the moment – there is no proper reward for taxpayers for all this succour.

And the one benefit of a partial nationalisation is that it would give to the government and taxpayers a slice of any future capital gains generated if the Rock were to become a thriving going concern again one day.

There is therefore an argument that a tweaked, semi-nationalised version of the status quo – which would endure only till markets recovered sufficiently to permit a full privatisation – is the best of the lousy options available to the Rock and the Treasury.

Comments   Post your comment

  • 1.
  • At 09:16 AM on 10 Jan 2008,
  • Jim Urbonas wrote:

So an investment bank advises a solution that involves wrapping, securitisation and more advisory work? Coincidentally this translates into plenty of fees for the banks, no? G&Ts all round!

  • 2.
  • At 09:39 AM on 10 Jan 2008,
  • Brian Anderson wrote:

Do I detect a softening in your attitude to Northern Rock. It is kind of like a boxer who has done his best to knock out an opponent and at the end finds a new found respect for them. Given how vocal you were when LIBOR was rising and the dangers it posed to seeking alternative funding it is interesting that you make no mention of it dropping significantly in your article.

  • 3.
  • At 09:52 AM on 10 Jan 2008,
  • Paul C wrote:

Oh, look! Robert's back on the Northern Rock "story" after a couple of days away. And "major Virgin shareholders" have been talking to Robert too....giving him the opportunity to indulge in the usual self-referential, and unsubstantiated, gossip which passses for journalism with the BBC these days.

What's wrong with something positive on Sainsbury's results. Positive news not really your thing Robert - less opportunity to indulge in your tedious conspiracy theories.

  • 4.
  • At 09:59 AM on 10 Jan 2008,
  • Chris wrote:

How is the repackaging and sale of the government(/taxpayer) debt and the eventual sale at a profit of a residual equity interest a "lousy option". That would be job done in my book, and probably the most likely outcome.

The government and taxpayer making a profit out of the NR shareholders' losses. That is a scenario that really ought to appeal to you and your one-eyed (or is it green-eyed?)regular posters.

  • 5.
  • At 10:00 AM on 10 Jan 2008,
  • Naresh Sharma wrote:


So the Govt lent £57bn to NR to stop it going bust. But the shareholders retain the power to veto any rescue.

What a joke.

I think the £57bn should pulled and THEN the shareholders can retain the power to veto any rescue.

  • 6.
  • At 10:02 AM on 10 Jan 2008,
  • Ron McLaughlin wrote:

Was not the wrapping of mortgage debt into securitized packages the major contributor to the sub-prime crisis in the first place. That debacle shows the financial institutions are not half as smart as they like to think they are.

  • 7.
  • At 10:12 AM on 10 Jan 2008,
  • John Pitchford wrote:

I don't understand why the option of liquidising the bank isn't available to the government. The government could withdraw the loan and when the Rock couldn't pay, call in a liquidator.
The liquidator would sell off the mortgages and presumably the BoE has first call on any mony raised.
At least the threat of such action would focus the minds of the shareholders. The depositers are safe since the government has guaranteed the deposits.

  • 8.
  • At 10:12 AM on 10 Jan 2008,
  • Chris wrote:

How is the repackaging and sale of the government(/taxpayer) debt and the eventual sale at a profit of a residual equity interest a "lousy option". That would be job done in my book, and probably the most likely outcome.

The government and taxpayer making a profit out of the NR shareholders' losses. That is a scenario that really ought to appeal to you and your one-eyed (or is it green-eyed?)regular posters.

  • 9.
  • At 10:34 AM on 10 Jan 2008,
  • dr.james smith wrote:

With the housing market going into a dip and the "Rocks" worth falling by the day the bonds will need some "wrapper".
A bit of "bog paper", another word for Government Guarantee may not be enough. Everybody knows what a Government Guarantee is worth.

Happy New Year.

  • 10.
  • At 10:49 AM on 10 Jan 2008,
  • Chris S wrote:

I believe the term reinsurance is normally used for financial institutions that insure insurance, ie. take on wholesale insurance risk from retail insurance or take chunks of a larger single risk. I think the term used for Warren Buffet's type of company is bond insurance?

#2 Brian - the LIBOR has dropped due to massive Central Bank intervention, surely it's a little premature to say the problem has been fixed?

  • 11.
  • At 11:13 AM on 10 Jan 2008,
  • Bryan McGrath wrote:

Gordon Brown and his "bag carrier" Alistair Darling continue to resemble rabbits caught in the headlights of a car. Robert Peston states that the deposit base of Northern Rock has stabilised at about £9 billion; however, I believe the Bank of England are still increasing the amount of money loaned to Northern Rock by approximately £500M per week as more wholesale market deposit unwind on the due maturity date.

An attempt to reinsurance the securitised debt would be prohibitively expensive, which would have to be found by the taxpayer.

Full nationalisation is the only sensible solution, with the shareholders receiving a token payment of, say, 5p per share. The quality of the loan book has already been questioned, hence this latest little rouse from Goldman Sachs.

Gordon Brown has run out of luck. You can fool some of the people all of the time and all of the people some of the time, but you can't....etc,etc.

  • 12.
  • At 12:03 PM on 10 Jan 2008,
  • Andrew H wrote:

Erm... given that the whole problem was started by slicing and dicing bonds backed by mortgage securities where the mortgages proved to be largely worthless, who exactly does Goldmans think will be stupid enough to buy at this particular point in time at anything like a reasonable price?

I suspect that we are seeing proof positive that investment banks are largely one trick ponies who haven't accepted that no-one's interested in their trick any more. CF the three bank 'rescue fund' that was to be set up to buy CDOs on the cheap, but never quite materialised.

  • 13.
  • At 12:06 PM on 10 Jan 2008,
  • Simon Stephenson wrote:

Aren't we in danger of over-complicating this affair?

The truth is surely that the Bank of England loans to Northern Rock are not worth pound for pound the amount at which they are stated. No one is prepared to offer nominal value for them, and all this guff about "reinsurance" is just camouflage for the fact that the BofE is going to have to take a hit from being forced by the politicians into putting money into a dead duck.

The only way in which this will not happen is if the BofE takes over NR lock, stock and barrel, refloats those parts that are self-sustainable, and retains the management of the run-out of the loan-book. Hoping against hope that the defaults of the future are significantly below those which the market is pricing into the current loan-book value.

  • 14.
  • At 12:17 PM on 10 Jan 2008,
  • Paul Amery wrote:

There is an old English saying that should be applied by those in charge of Northern Rock (ie Messrs Darling and Brown) - "when in a hole, stop digging". The idea that some financial engineering is going to get us out of the hole is ridiculous - as this was what caused the mess in the first place. I can see why the bankers support this, as it promises them more fees as they reshuffle loans once again, but I can see no benefit to the taxpayer from stringing this out for longer. Northern Rock should be put into administration immediately.

  • 15.
  • At 12:39 PM on 10 Jan 2008,
  • Joe Postin wrote:

How amazing that the very triple AAA ratings that have caused so much trouble in the repackaging of risky sub prime home loans is now seen as the answer to the problems it created.
This beggars belief and demonstrates the money men do not have a grasp on reality.
Finally this last point loses me, how can so many home loans be responsible for a risk to the nation of 57 Billion pounds with only 88,000 mortgagers on its' books. That would equate to an average of 647,000 per loan.
If this is the case, then the money men really are fools to allow such a situation to arise, it must surely border on criminality.

  • 16.
  • At 12:54 PM on 10 Jan 2008,
  • Ken wrote:

Agree entirely with post #7, liquidate the company with creditor(s) receiving the assets. Shareholders get whats left if anything. Shareholders were happy to take divends in the good times, they elected the board and approved the business model, when that model fails they should stand up like a man and take the consequences. The assets now in the creditors hands back up the massive loan and across time will be re-distibuted to other mortgage lenders. Personally I think the BoE should take this opportunity to become a goverment sponsered high street bank offering not only mortgages but pensions and insurance as well.

Oh, and by the way, well done BoE for keeping your eye on inflation rates and now bowing to pressure from the poor old retailers who would have us borrow more in order to inflate their profits. Frankly couldn't care less if half the retailers went bust but I am concerned about keeping inflation under control, the banks number 1 remit.

  • 17.
  • At 01:13 PM on 10 Jan 2008,
  • Mark wrote:

Where's Paul Daniels ? The reason that the Rock had to borrow the money from the BoE was because no-one will lend to them. Along comes Goldman Sachs and all of a sudden, the same institutions will be asked to buy the bonds which are now risk free.

Converting the debt to bonds will dilute the influence of SRM and RAB, as the bonds could be converted to equity like Marconi and Eurotunnel.

How about making PM, Chancellor and Labour Party personally responsible ? It was their bailing out of the Rock to make it politically convenient for the election to go ahead.

  • 18.
  • At 01:14 PM on 10 Jan 2008,
  • Richard Marriott wrote:

It is clear that Northern Rock should not have been rescued by the Government for political reasons - they are playing with taxpayers money which should be far better spent. The deposits had to be guaranteed to stop the run on the bank, but it should then have been broken up and its valuable bits sold off. Instead, Brown and Darling decided to placate Labour voters in the north of England by trying to keep Rock going at taxpayer's risk.

  • 19.
  • At 01:33 PM on 10 Jan 2008,
  • Chris wrote:

Consistently interesting reading, Robert.

Regarding the proposal that UK government's exposure to NR (secured against a cross-section of NR's mortgage book) is securitised via a wrap - in terms of the credit involved wouldn't we be dealing with something very similar to obtaining wraps on a large volume of Granite paper already in the market (Granite being the securitisation brandname used by NR).

Given the very light volume of trading in either physical mortgage bonds or insurance against these (CDS), it would strike me as being both extremely difficult and certainly market-moving to put together a deal of this sort?

And that's before we start talking about the monoline wrapping market being in the worst shape anyone can remember...

  • 20.
  • At 01:47 PM on 10 Jan 2008,
  • Bryan McGrath wrote:

Gordon Brown and his "bag carrier" Alistair Darling continue to resemble rabbits caught in the headlights of a car. Robert Peston states that the deposit base of Northern Rock has stabilised at about £9 billion; however, I believe the Bank of England are still increasing the amount of money loaned to Northern Rock by approximately £500M per week as more wholesale market deposit unwind on the due maturity date.

An attempt to reinsurance the securitised debt would be prohibitively expensive, which would have to be found by the taxpayer.

Full nationalisation is the only sensible solution, with the shareholders receiving a token payment of, say, 5p per share. The quality of the loan book has already been questioned, hence this latest little rouse from Goldman Sachs.

Gordon Brown has run out of luck. You can fool some of the people all of the time and all of the people some of the time, but you can't....etc,etc.

  • 21.
  • At 03:50 PM on 10 Jan 2008,
  • Andrew H wrote:

#17 Mark.

Marconi and Eurotunnel were very different scenarios. They were both insolvent restructurings, i.e. they had the debt, but couldn't service it, which is why bondholders were forced to take equity in the company.

Northern Rock is a very different scenario - the Rock can (currently) service its debt, except no-one, except the Bank of England will fund Northern Rock, as they have significant concerns about the ability of the bank to repay the capital on the loans.

Typically, in a non-BOE lender situation, the lender would be in no position to dictate a debt-equity swap at this point. Its just that the BOE doesn't want to get into a position whereby it is in a position to dictate, because that would mean they weren't getting anyhting currently, let alone in the future.

  • 22.
  • At 04:07 PM on 10 Jan 2008,
  • Andy wrote:

A standard securitisation along the lines of Granite would get over 90% of the bonds a AAA rating anyway, without the use of a monoline, provided that the mortgage assets are not the >100% LTV loans (and even then 85% or so would probably get the top rating). As Chris points out, the monolines are in trouble themselves and are being hauled over the coals for stepping beyond their original job of insuring municipal debt.

Perversly, once the loans have been securitised, the AAA notes are eligible as repo collateral at the Bank of England window, so we could end up lending them the money anyway! Alliance and Leicester did £10bn of this in October, all notes retained by the bank and used as collateral.

  • 23.
  • At 04:20 PM on 10 Jan 2008,
  • Bryan wrote:

"But in order to make them sellable, these new Rock bonds would need a triple-A credit rating."

The main rating agencies are hopelessly compromised at the moment anyway, and any attempt to tag these new psuedo-Granite bonds as AAA will be brushed aside by the markets. This story is going to run and run and the end game will be certainly be worth watching!

  • 24.
  • At 05:34 PM on 10 Jan 2008,
  • Andy wrote:

A standard securitisation along the lines of Granite would get over 90% of the bonds a AAA rating anyway, without the use of a monoline, provided that the mortgage assets are not the >100% LTV loans (and even then 85% or so would probably get the top rating). As Chris points out, the monolines are in trouble themselves and are being hauled over the coals for stepping beyond their original job of insuring municipal debt.

Perversly, once the loans have been securitised, the AAA notes are eligible as repo collateral at the Bank of England window, so we could end up lending them the money anyway! Alliance and Leicester did £10bn of this in October, all notes retained by the bank and used as collateral.

  • 25.
  • At 05:36 PM on 10 Jan 2008,
  • Alexander wrote:

I can see where Goldman Sachs are coming from on this. And where the Government hopes that it is going. But given that the danger for the British financial system has now passed is there really any need to prolong this further? Nationalisation might even be a positive message to send to the markets at this juncture.As long as the North East of England is not rebranded New Virginia with an outpost on my local high street (unnecesarily reminding me of Branson on a daily basis) I don't much care now what happens.

  • 26.
  • At 08:37 PM on 10 Jan 2008,
  • phil wrote:

It makes me really angry that Gordon Brown makes the taxpayer keep bailing out failed capitalists. And still we dont get told the full story.

The fact is that NR is bankrupt - a basket case. It cannot continue to function without subsidy. No commercial concern is willing to buy it without massive sweeteners from the government. It is not just a liquidity problem it is kaput.

We can only speculate about the level of the excess of its debts over its assets. This is partly the public does not know how much junk CDOs etc it holds, and partly because it is so difficult to discern how much bad debt through bad lending it holds.

Also, NR was borrowing on the international money markets. If there are substantial debts outstanding which are not denominated in pounds, then the slump in the pound which is just getting going will mean big losses. For instance 10 billion pounds borrowed in Yen 3 months ago would cost £11 billion to repay now.

There is a lot of talk about the strength of the NR loan book, and that it has an LTV ratio of around 60. But this is meaningless because it averages across borrowers. I am sure there are a lot of very sound borrowers at NR from when it was a Building Society. However there are also a lot of recent reckless loans. What we need to know is how much unsecured loan there is, and how much there would be if the property market falls by 30%, as is quite likely.

It will not be easy to gain an accurate figure given that NR was indulging in the now common industry practice of not enquiring too closely into the true value of the properties against which its mortgages are secured.

It is factors like these which Virgin, Olivant and co will be trying to unravel.

However it looks extremely unlikely that even with tens of billions of State money they will be prepared to take it on.

Goldman Sachs is taking the p***. As are the hedge fund shareholders. They seem to reckon the government is so incompetent, and so deep in the sh*t that there may be more government money sloshing around which they can extract. Unfortunately they may be right.

  • 27.
  • At 09:02 AM on 11 Jan 2008,
  • affa wrote:

All said, stakeholders should meet.

Lender of Last Resort (LLR) is not a state aid. It is therefore legal and can continue (as long as borrower's operation is profitable)

LLR facility is part of monetary policy (rather than fiscal policy).

Sterling Monetary Policy falls outside Euro Monetary Union and European State Aid rules.

That may be why the other borrowers of LLR facility can remain anonymous and can continue under "other assets" category on Balance Sheet

  • 28.
  • At 11:34 AM on 11 Jan 2008,
  • Martin wrote:

"the big shareholders in the Rock tell me they are profoundly uninterested in what Virgin has to offer – and those shareholders have the power of veto"

Robert, why don't you tell it as it is - these 'shareholders' took a gamble by buying after the crisis took hold and in one case has continued to build up its holding.

As the lender we can (the Government) can call in the debt forcing a sale of the business on any terms a court sees fit to impose or could simply pass legislation to nationalise it.

The shareholders do not have a veto in such circumstances.

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