ANY hopes that Alistair Darling had of wrapping up Northern Rock and giving it away to someone else for Christmas have disappeared. The spirit of Scrooge stalking money markets means a deal to rescue the wreck won’t happen before January – and maybe not even then. If market conditions fail to improve, nationalisation may become the only option left.
With the bank still losing deposits and value, it leaves the chancellor and his boss, Gordon Brown, open to accusations of more dithering at vast potential cost to the taxpayer. In a bid to head off this criticism, Darling last week recruited Goldman Sachs to help find new financial backers prepared to back a private-sector solution.
“Speed is of the essence,” said Vince Cable, acting leader of the Lib Dems, who advocates nationalisation. “We cannot continue with the ludicrous situation where a patient is bleeding to death in the operating theatre and the government insists on a full health check before we operate.”
This weekend the two potential buyers for the bank are still attempting to assemble credible bids. Virgin Money, led by Sir Richard Branson and his consortium, and Olivant, a private-equity group led by Luqman Arnold, a former chief executive of Abbey, each claim to be able to salvage Northern Rock.
“At the moment we are still having meetings, and we are confident of raising the money,” said a spokesman for Virgin Money. Its bid envisages borrowing money from Royal Bank of Scot-land, Citigroup and Deutsche Bank and swiftly repaying some £11 billion of the £25 billion already lent to Northern Rock by the Bank of England.
Olivant, which last week won equal status in the auction with Virgin, is also ploughing through due diligence and talking to investors. “One of the things about the Olivant proposal is that we want to get it done fast,” said a spokeswoman. “We are talking to various banks.” It also has the support of Rock’s biggest shareholders, who will back it ahead of Virgin.
At the Bank of England, the chief cashier, Andrew Bailey, is said to be working all hours in the hope of securing a resolution. However, insiders privately admit the hurdles remain huge. “There’ll be nothing settled before credit committees meet again in January,” said a senior City source involved with the sale. “I would say the chances of Northern Rock being nationalised are still somewhere between 40% and 60%.”
Another expert observer said: “The basic problem is that the banks don’t have a lot of money available, and both Branson and Arnold are finding it difficult to get support. The two bidders are pretty lightweight. Branson is the nearest thing in the business world to Princess Diana.”
The bidders find themselves in the curious position of being accused in some quarters of trying to grab Northern Rock’s assets on the cheap, yet struggling to find investors willing to risk a share of the action. Branson’s consortium bid would involve a capital injection of £1 billion, yet end up with a majority stake in a company that was valued at £5 billion before the credit crunch.
Brown and Darling are keen to see a bid because they are desperate to avoid taking on a banking basketcase that could lose them votes. Nevertheless, Treasury officials, led by John King-man, are at work to “keep all options open”. They are preparing the legislation that would be needed for the government to take control of the bank.
Shareholders fear that they would be the losers under nationalisation, but some independent experts believe it may now offer the best hope for all parties.
“It should have been nationalised in mid-September,” said Professor Charles Goodhart of the financial-markets group at the London School of Economics. “This should not be seen as an attempt to keep it in national ownership. The idea would be to take it over, install new management and sell it back to the private sector when markets recover.
“The proceeds could be used to pay off creditors by seniority – taxpayers first, debt holders and if anything is left over, the shareholders. It’s possible the shareholders could get more than from a bidder now.”
The model academics have in mind is the one that was used in Norway, Finland and Sweden in the early 1990s when a lot of banks ran into difficulties.
“There was a major financial crisis,” said David Llewellyn, professor of banking at Loughbor-ough University. “Norway had to nationalise most of its banks. It injected more capital, restructured and then reprivatised the banks. Overall, I think the taxpayers even made a little money.”
However, if the government were to pursue nationalisation, it would face numerous tough decisions and the omens for that are not auspicious, given that Darling is still undecided over how to reform capital-gains tax.
First, the government would have to decide what to pay for Northern Rock. Too much and taxpayers could lose out; too little, or even nothing, and the existing shareholders will almost certainly mount legal challenges.
Yesterday the Treasury was at pains to make it clear that depositors in Northern Rock are fully protected but that it has never made any commitment to shareholders.
“We have said we need to make sure that taxpayers and depositors are protected, but we have never made any comments on shareholders,” said a spokesman.
The question of “moral hazard” also arises. If the government is seen to bail out shareholders of a bank that took too many risks – or indeed shareholders who piled into Northern Rock after the price collapsed in the hope of a quick killing – it will do nothing to discourage future reckless investment.
Once nationalised, the government would have to hire suitably experienced managers to run the bank. “There’s no way people in the Treasury are suddenly going to put on pinstripe suits and run Northern Rock,” said Llewellyn.
The new management, along with the government, would have to decide whether to rebuild the bank or gradually run it down.
Attempting to rebuild it for reprivatisation could fall foul of EU regulations on state subsidies – and Brown won no friends in Europe last week after snubbing other leaders by arriving late to sign a key treaty.
Closing the bank to new business and gradually running down its £100 billion of assets would be a lengthy process.
It’s not clear how the billions required in public support would affect government finances – experts are divided over how the money so far lent to Northern Rock would have to be treated in government accounts.
But to Llewellyn, the biggest problem remains the uncertainty over Northern Rock’s assets and liabilities. Last week Bryan Sand-erson, chairman of Northern Rock, announced that the bank was still on track to make a profit before tax and exceptional items of about £500m this year, but he also revealed further heavy losses from the crisis in sub-prime loans.
A review had revealed that holdings previously valued at £319m in several “structured investment vehicles” had plummeted in value by £118m.
A £167m investment in “collateralised debt obligations” was written down to £36m. Some observers believe further losses are to come.
JC Flowers, a private-equity firm that withdrew from bidding for the bank, is said to believe that Northern Rock is “in denial” about the extent of its losses.
Such hits raise concerns that, under nationalisation, the taxpayer could face losses if financial markets suffer prolonged troubles.
“We just don’t know the true value of Northern Rock,” said Llewellyn. “We don’t know if it is truly solvent. By some measures it is solvent, but only because the Bank of England is propping it up. I’m not sure that’s a good definition of solvency.”
Although Llewellyn believes nationalisation, followed by reprivatisation, could work, he warned that there are risks.
“If there is a serious recession and house prices fall sharply, there will be more defaults and increased losses,” he said. “What happens if the government takes it over and things go from bad to worse? The credit crunch is not the only thing to consider. What if house prices collapse? Northern Rock may find the value of its collateral falls below the value of debts. There’s no guarantee it will be worth more in the future than it is now.”
For Brown and Darling to preside over a bank that was repossessing homes or sacking staff or losing taxpayers’ money would be a political nightmare. And having chosen at the outset to seek a private rescue, rather than take it under state control, it will also be embarrassing for the chancellor to change tack now. The cost to London’s reputation as a global financial centre would also be high.
The same applies to the other option: putting the bank into administration. Shareholders would be wiped out. Depositors might panic, though the government is working on a plan to repay savers quickly to avoid such a scenario. But recovering the money already lent by the Bank of England could be a long and arduous process.
However, repayment will be helped by the fact that Northern Rock expanded quickly in the past three years by issuing highly competitive fixed-rate mortgages and, when these start to expire next year, many will be redeemed.
It is little wonder that a private sale remains the government’s preferred option. But to critics, the longer the Northern Rock saga drags on, the greater the risks for the taxpayer become.
One source close to the negotiations believes that if a deal is in place, it will be in the closing days of January. The timetable is partly set by the date of February 14; this is when the Bank of England has to go to the European Commission to get support to extend its loan to Northern Rock and address the sensitive issue of state subsidy.
Depositors are still withdrawing their funds, despite the government guarantee. Meanwhile, the Bank of England keeps committing funds – at least £25 billion so far. Strictly speaking, this is a loan from the Bank rather than taxpayers’ money. But if it turns out that Northern Rock, in whatever form it ends up, cannot repay the Bank in full, guess who will foot the bill.
