Rock and central banks
“Do they know something we don’t know?” That question was always bound to be asked about by five leading central banks to alleviate the painfully tight conditions in money markets.
With both the and the announcing a serious volte face, by providing loans against a far greater range of collateral – without the imposition of a penalty interest rate – some investors were bound to conclude that the central banks had evidence that the problems at commercial banks are even greater than we all fear.
If both the Fed and the Bank of England no longer wish to be seen to be punishing the banks for their foolish lending and investing, it may mean that they believe the banks have been punished enough – or it may mean that at this delicate stage of the cycle, such punishment would turn out to be capital punishment.
In Asia overnight, they drew the gloomiest conclusions and stock markets fell.
So what does it all mean for our friend ?
Well, in theory, if the central banks have succeeded in persuading the commercial banks that they feel their pain and are on the case, that can only be good news for the Rock – in the sense that it may yet be possible for the consortium led by Virgin to raise a jumbo loan from a banking troika (Royal Bank of Scotland, Citigroup and Deutsche Bank) to repay part of the massive taxpayer-backed loan to the Rock.
But, apart from that, all news from the Rock right now is pretty scary news for the Treasury and the Rock’s board.
Here is a quick recap of where we are:
1) , Olivant is furious about the decision of the Rock board and the Treasury to delay until January any decision on which of the two competing rescue proposals to recommend or whether to recommend either of them. And because Olivant, led by Luqman Arnold, believes the Rock is frustrating its own plans and giving unfair help to Virgin, it has threatened to walk away – unless Arnold himself is immediately appointed executive chairman of the Rock.
2) Adam Applegarth has quit as chief executive of the Rock some six weeks earlier than expected. Although he’s been replaced temporarily by another Rock executive, Applegarth’s departure will simply add to the sense that bits are still falling off the Rock edifice.
3) A pair of powerful hedge funds, SRM Global and RAB Capital, are moving full steam ahead to summon an extraordinary meeting of the company, at which they will endeavour to impose restrictions on the room for manoeuvre of the current board.
4) The Treasury believes it can nationalise the Rock at any time, with emergency legislation that could be rushed through Parliament in a matter of an hour or so (and apparently there is a device for doing this, even during the Christmas recess). If the Treasury felt the continued uncertainty around the Rock’s future were damaging the interests of depositors and increasing the risk of losses on taxpayer-backed loans that are now well over £25bn, it would press the nationalisation button.
5) Some Rock shareholders seem to believe that the Treasury would not dare to seize their company. However I’ve spoken to senior Tories, LibDems and ministers about what the Government should do, and none of them evince much support or sympathy for the investors. The politicians aren’t enthusiastic about nationalisation, but they appear reconciled to it as a possible necessary evil.
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The schizophrenia of the financial world is rearing it's ugly head at the moment - every indicator is screaming that a massive slowdown, or even crash, is imminent.
Yet the US stock markets are nearly at an all-time high, the BoE is trying to make it even cheaper to borrow money, and the government hasn't got a clue what to do.
It's the last gasp (or grasp) of a dying system. Someone had better step in with a cunning plan PDQ, or the Rock will be the least of anyones worries.
It seems that the casino of the last few years has run out of chips so it's time to borrow some off the tax payer.
$516 trillion of deratives and other exotic financial guff, many of which are based on defaulting loans, is starting to bring the banking system down.
Do they really think £50 billion will turn this around? Maybe delay things until after Xmas but it seems the end game of whatever this mess is looms large.
What happened to the great free enterprise market driven utopia? Banks signing-on for welfare payments using worthless assets as collateral!
The ongoing delay over the future of NR is making a bad situation worse. All markets are psychologically driven and uncertainty is surely the last thing that is needed now.
Whatever the eventual outcome, tough decisions will have to be taken - this is not a win/win situation. I believe the Treasury should be decisive and act immediately. NR is draining any remaining confidence.
Looks like the whole sorry saga is going to continue to Rock on
I dont think making (printing) more money available is going to help one bit. Easy money started the problem and is like pouring oil on burning water. In any case you cant make people borrow more money when they are already having trouble servicing existing debts. So the Banking system has added liquidity but that is useless unless they can 'safely' lend it to borrowers.....And inflation is going to explode...We aint seen anything yet. Batton down the hatches and lets see how the politicians/Central bankers, wriggle out of this one. Oh and Where is Mr Greenspan who presided over this economic catastrophe ? And other leaders who happily kept interest rates too low for political gain. Own goal I think.
I remember that we destroyed British industry and promoted financial services based on the lie that we wouldn't have to subsidise any more. Ah, happy days...
Mr Preston, most of the major banks and financial institutions are currently technically insolvent which is why the central banks liquidity moves are nothing but a temporary measure and at best a PR stunt. The world economy is facing a depression and the storm clouds are gathering. The seven years of famine are about to start.
I'm glad the banks are ' hoarding money', and so should anyone be who has funds with these banks.
My observation re. NRock is that all parties seem to be between a ROCK and a hard place!
The goldsmith bankers of seventeenth century England engaged in the seemingly innocuous practice of holding precious metal coins on behalf of their depositors. In return for each deposit of coins, a goldsmith would issue the depositor with a paper receipt that promised redemption on demand. If a particular goldsmith was well trusted, many merchants would be happy to accept his receipts in payment for goods and services. A large proportion of the public therefore came to see goldsmiths’ paper not as receipts for money, but as money itself. Accordingly, depositors came to seek redemption of their receipts in ever decreasing numbers. Why bother going to the goldsmith to withdraw gold coins, if shopkeepers would accept the paper in payment anyway?
The goldsmiths soon realised the incredible business opportunity implicit in their customers’ behaviour. Instead of acting as mere safe-keepers of gold, they now offered their services to the public as money lenders. But when the public came to borrow money, they would be loaned paper receipts not gold. From the perspective of these early bankers, such a policy had one great advantage. Unlike gold, paper money could be created in the back office at almost no cost.
Naturally, many businessmen wanted to join in this new game of banking. What easier way could one find of earning a living than creating money with a printing press, and then lending it at interest? "The Bank hath benefit of interest on all moneys which it creates out of nothing", said William Paterson upon founding the Bank of England.
In those early days of banking, some commentators argued that if a banker issued a receipt promising the payment of a certain amount of gold, then he should keep that amount of gold in his vault to honour the promise when so required. The bankers argued differently. They said that because the majority of depositors did not come to the bank to claim their gold in any one period, it would be safe to issue receipts in excess of their gold stock. With this argument, the bankers attempted to justify their creation of multiple legal claims of ownership for each unit of gold in their possession.
The reserve of gold to paper in issue came to be known as the "reserve ratio", and today many major banking organisations operate a reserve ratio of less than one twentieth. Hence "fractional reserve banking". For example, HSBC’s 2006 Annual Report shows that its customers held in aggregate some £168 billion of sight deposits, yet at the same time the bank held only £3.5 billion of cash to honour requests for withdrawal of those deposits. If all of HSBC’s customers asked for their money in cash on the same day, the bank would be in a rather similar position to that of Northern Rock. The same is true for all commercial banks because the holding of a fractional reserve is the essence of their business model. They survive only so long as depositors are sufficiently confident not to ask for their money back.
Realising that heavy withdrawals might bankrupt them, early bankers made arrangements to borrow reserves of coins from one another when necessary. However, these arrangements didn’t work well in times of crisis when every bank was in need of extra reserves. It would be so much more convenient if the money of the realm could be redefined as a piece of paper, rather than a piece of gold or silver. It could then be printed in whatever quantities were necessary to satisfy calls for reserves by the commercial banking system. The government duly obliged. In 1833, Bank of England notes were made legal tender for all sums above £5.
Today’s banking practices are of course more sophisticated, though the principles remain the same. Modern commercial banks create money by crediting the borrower with an electronic entry which shows up as a balance on an account statement. But as with the goldsmiths’ paper promises of old, if all of a bank’s customers try to convert these balances into cash, the bank will soon find itself in need of extra reserves.
There is another more important similarity between these modern and early forms of banking. Whether it is a goldsmith issuing a newly printed paper receipt to a borrower, or a high street bank crediting a customer’s current account with a ledger entry, money supply increases every time a banker makes a loan. Money has become the balance sheet counterpart of debt at the macro-economic level. Therefore, widespread attempts at reducing debt also cause reductions in the supply of money and lead directly to recession. In short, society cannot repay its debt and have a job.
Given that commercial banks have the power to create new money at zero cost, it is an obvious business strategy for them to maximise the amount of money created within the existing regulatory regime. The greater the amount of money created, the greater their interest revenue and the greater their profit. The overall trend is therefore for a growth in money supply (and hence debt) over time. As a result of this tendency, every modern nation suffers from inflation. In more recent times, this inflation has been disguised by various statistical techniques. For example, although houses are the most expensive item that most individuals ever buy, they are excluded from the common measures of UK inflation.
Monetary reformers argue that the legal privilege to create money should be removed from private entities such as commercial banks and placed instead in government hands. Others go further, citing the tendency of governments to issue money for their own political advantage, and propose a commodity money system based on precious metals. Put simply, this is a system in which money is created by those who dig for it.
The American founding fathers adopted exactly this approach. Their objective was to ensure that America would not fall prey to the money creating usurers of England, amply evidenced by Jefferson’s statement that "banking establishments are more dangerous than standing armies". Gold and silver were duly enshrined as the only lawful forms of money under the American Constitution, but the struggle with the banking lobby had only just begun. Soon, Jefferson felt compelled to warn the American people against giving the banks control over their currency. Then during an address to the American people in 1837, Andrew Jackson accused the Bank of the United States of having created a recession by contracting the money supply, and this in order to damage him politically. Almost thirty years later, President Lincoln proposed measures to ensure that democracy could rise above the "Money Power". But in the long these efforts were insufficient against the power of the banking lobby. It was Woodrow Wilson who finally conceded to the demands for a central bank by signing the Federal Reserve Act into law in 1913, a manoeuvre that effectively passed control of the American monetary system to private interests.
Alas, the coup de bank is now global. It is the culmination of some three centuries of concerted effort by a small clique of men whose interests have never coincided with those of humanity at large. These are men who were once imprisoned for their usury, and who now rule over us from the comfort of their central banking boardrooms. From here they can change the value of our money with a single announcement, and there are few greater powers than that ...
With strict oversight this could be very good news.The public purse can carry the uncertainty attached to this debt much more effectively than the individual institutions and in the fullness of time the current mark to market values will be seen to have been a typical over reaction.
So,this is a potential win win.
Now the bad news.
If the money pumped in goes into continued high pay packages for the industry ,or is diverted for investment purposes in a way that does not relate to solving the issue then it will be wasted. By solving the issue I mean it should restore the balance sheet and allow continued investment within the boundaries of the public purse that is funding this exercise.
Pay to management/shareholders ,or to buy derivatives in oil/commodites/asian factories etc etc will bring no benefit to the underlying public purse.
Frankly,I can't see how this funding will be regulated to prevent these possibilities so we'll just have to wait for phase 2 of the rescue package.
Interesting times we live in. Remember back to the crisis in Japan where the high priest of the free market where prescibing "let it burn"? Now that the chicks have come home to roost in the US/UK/EU, free market suspended and bailouts galore. Maybe a case of a standard for the others, but nor for us...
I did suggest a few weeks ago that if the saga of Northern Rock was allowed to continue it could easily conflate with something even more unpleasant. It now has; so much for prudence!
Nationalise it now: without compensation.
Northern Rock should have been left to go to the wall. Instead, Darling has got himself into a terrible mess with a quasi-nationalisation, through the B of E's support loan, now exceeding £25bn, and the issuance of a state guarantee to depositors. All that to stave off the potential loss of a few MP's in the vulnerable NE, should NR's shareholders have been cleaned out.
The Sage of Omaha, Warren Buffett, has been referring to the "toxic waste" of derivative and exotic financial instruments for some time now.
Whether the actions of Central Banks, in injecting liquidity into the markets is sufficient to contain the problenms, will be seen over the next few months.
I suspect that the old adage about banks and drunks will be proven and that with trillions at risk more money will have to be thrown to sort this mess out.
The hit that Northern Rock took on its US sub prime investments must be very worrying for other banks which hold such investments. A write down of 80% is quite amazing. I do think they are very upfront and prudent with there figures. The US Sub prime lending is a complete mess.
Here are some facts that you will not find in the media.
1. In the private bankers debt-based money system that we are made to use, 97% of our money is created by borrowing at interest.
2. No borrowing in the system would mean no money.
3. Obviously there will not be enough money to pay the interest as it has to come fom the same source. National debt rises and the interest due also rises with time.
3. For government, taxing the people helps pay the interest bill and that is why taxation is always rising. Our taxes go straight into the pockets of the super-rich international bankers.
Privatisation is no answer because companies also have to borrow AND make a profit.
4. Banks are allowed to create money OUT OF NOTHING and charge interest on it. Look into "fractional reserve banking." Google "Money as Debt."
People have to get their money out of the banks and put it into mutual societies to send a message to the bankers that we have had enough of their greed. Buy gold if you can afford it, that's what the rich do. We demand of our government a fairer money system. Money creation must be taken out of the hands of the money masters and into the hands of the people, "where it properly belongs." (Abraham Lincoln)
Google "Money as Debt" to watch a 50 minute animated film. Then act.
By far the most worrying financial statistic of recent days is the fact that we can only afford to give our policemen a 1.89 per cent annual rise instead of the 2.5 per cent that they were promised. There just isn't the £40 million in the kitty. The government has to find north of £650 billion to keep the show on the road each year and how they are going to do that in 2009 and 2010 is much more worrying than how they get from here to there with the Rock.
Given this, it was unintentionally hilarious listening to the crisis what crisis discussion on the Today programme this morning. As the late JK Galbraith pointed out, no one who wants the respect of their peer group in the financial world ever talks down market sentiment -- step forward Professor Congdon. The Money Week editor's refreshing candour was no doubt lost on her publisher and his advertising boys out schmoosing clients this Christmas, but her unguarded analysis was welcome at this juncture.
Tarek - a very lucid and informative post. However I would like to make one important point - commercial banks no not have the power to create money at zero cost. They can only lend the money that they actually have. Of course, unlike you or me, they can get money from the bank of England to make loans, but they have to pay the bank of england base rate of interest on this money - currently 5.5%. The BoE can of course print money for free in more or less the way you describe, but only to the extent that this does not cause inflation (because that's its job).
Liquidity / money supply is of course created in many other ways in an economy, but banks can't do it for free - governments keep that power to themselves.
The basic truth remains - if the banks don't trust each other enough to lend each other money, then why should we trust them? I think the NR depositors who got out early may well be shown to have been prescient.
The failure is the same one that seems to hit every generation or so. People beleive the banks when they say they can self-regulate. The disciplines hold for a little while, then the "opportunities" of the bubble take over, and everyone ends up in the crap. Regulation comes back, end everyone say they have learnt the lesson - for about fifty years.
Re Posting #10
Tarek,
I would like to thank you for a very enlightening lesson explaining the current financial markets in terms of the initial basic first principals. My understanding has grown markedly as a result. Perhaps the ̳ should offer you a blog as well!
I am still amazed that the captains of business who have been reckless in their lending are still managing to pull to wool over the eyes of most central bankers in to world and forcing them into lowering rates, while still not parting with any of their own money! (I haven't seem any pronounced shift in the Libor curve recently.)
At the end of the day, these captains will go home to their mansions and holiday houses all over the world - thus escaping any meaningful taxation and the burden of their greed will be spread on the shoulders of 'Joe Taxpayer'
Jeeepers tarek (10), how long did that take you?
On another topic I'm very sorry, i realise that mamny pension funds may have invested in the rock etc. But the shareholders come way down the list of priories IMO. The taxpayers come first. Id rather it were not nationalised, but if we get more of the money back that way so be it.
The injection is to tide banks over until they have had the chance to reorganise their balance sheets - i.e. it is to stave of insolvency...not to get rates down so that everything can carry on as before as you suggest in your blog.
No matter how much money the BoE lends to the banks:
Borrowers do not want to borrow to pay for assets falling in value.
Lenders do not want to lend when they need to conserve capital and they have a heightened sensitivity to the default risks.
We are looking at orderly deflation not reflation of the economy.
For me one of best examples of "City" and government collusion in an attempt to make money out of nothing which also achieves nothing in the process is so called carbon trading..
It has pretty much zero impact on global carbon emissions but the traders are making a fortune in commissions. In fact one of my colleagues estimated they've made around one billion euros so far. None of this of course flows back into sensible things like developing new clean technology and in fact it can't.
I asked some Treasury bloke last year whether I could set up a not for very much profit carbon trader which invested the monies that companies paid for carbon credits in UK clean tech companies and projects and they said no.
"18. Dondon wrote:
Tarek - a very lucid and informative post. However I would like to make one important point - commercial banks no not have the power to create money at zero cost. They can only lend the money that they actually have"
Not quite. They don't lend money which they have, that is their reserve. They create new money and lend it to you. How else do you explain being paid interest on a bank account deposit which you can take out on demand? As well as that same money having been lent out to someone else? It can't be in two places at the same time. New money is created at the point of a loan. The fractional reserve system, creates money (credit). The cost to the bank is the interest rate on the deposit say 4%. Their takings are the interest rate on the loan, say 8%.
As the loans are deposited, credit created and loaned out, the banks make the difference 4% on each expanding run round the spiral. It's obviously in their interest therefore to loan as much as they can out to everyone they can. Here, it works out about 30 times, the reserve ratio averages about 3%.
Tada... Easy money boom. Soaring inflation. House prices 9 times the average salary.
Course, it's all debt based. Debt always pays more interest than deposits so the mathematical certainty is that it ultimately must deflate, and there must be repossessions and bankruptcies because there can never be enough money to pay all the debts.
Which is why I find this all so hysterically funny. Central banks are pumping more credit into a system which is having problems with too much credit. It's almost identical to a Ponzi scheme, more people must always take out larger loans. If they stop or run out of credit worthy people to loan to (sub prime), the debt interest being larger than deposit interest makes it deflate faster than it inflated. Boom and bust is built into the very money we use.
Hmmm... Perhaps a different kind of money... Where the supply of money was constant rather than expanding and contracting... People might actually be able to live their lives without worrying so much about how "the economy" AKA "supply of money" is doing (14% increase last year... Next year? Hmmm).
Of course. An apple is an apple and has the same value to the customer whether the price on it is 10p or £250. So what's money really worth?
Banks' don't create money other than the central bank.
Primary banks create credit based upon their monetary reserves which are a netting off of deposits and liabilities.Has not helped that many banks of course have manipulated their balance sheets lending ability by shuffling off items that would in effect have reduced their ability to create credit. Now they have to recognise them it likewise reverses that process and reduces their ability to create credit.That is ,lend to each other ,or indeed to corporate ,or retail.
That is what this central coordination is supposed to be about.
It should 'loosen' up the balance sheet to enable further creation of credit.
Has nothing to with creating money out of freshair as it is actually based upon lending against collateral.
Wish people would get their facts straight.
Tarek - great post. Dondon - the devaluation of currency by the introduction of paper money (and the abandonment of the gold standard some time later) is mirrored now by the free availability of credit. In the UK this was signalled by Nigel Lawson's banking reforms in the 1980s which permitted banks (who had plenty of depositors but were limited in their lending opportunities) to lend on property, and building societies (who had the reverse limitation) to take bank deposits.
The expansion of both money and property values that followed this showed how the effective money supply increased despite the keen 'monetarist' in control.
The key point being, that easily available credit allows the same paper banknote to be spent many times by different individuals before it has to be reckoned. Over 90% of my income is spent without me ever seeing banknotes. Electronic transfer of credit IS money in effect, whatever the nominal amount of paper currency is in circulation.
So the question 'What is money' has no easy answer, and the related question 'How much of it is in circulation' likewise.
Hence the current preoccupation with controlling inflation by setting interest rates, as these are considered to be the main lever the governments can use to control the credit-inflated money supply, inflation, and growth.
Of course the control is under-determined (too few levers for the variables to be controlled) but it has worked well for a while.
Unfortunately all economic systems evolve in response to the control method applied, and all control systems eventully stop working as expected. This is partly because the economic system necessarily includes the beliefs of the people who live in it and make decisions based on them - any reliable economic model must therefore include the effect of its own existance!
Many economic models work perfectly well in theory until they are used to make practical decisions by the central bank - but once this happens the system is changed.
The sea change in risk assessment and use/abuse of credit instruments that is happening now will doubtless force another change in the economy's behaviour and perhaps control methods too. Restriction of credit means a large cut in the available money supply which (aka Keynes) leads to recession. Time for some old-fashioned demand management?
Fortunately central banks today seem more aware of the issues than in previous generations, and quicker to intervene.
The questions are, do they know what they're doing, and whose concerns do they have most at heart? And, I suppose, who gets hurt in the process, and how much?
Or to put it another way, what are the mental models in the heads of the people who are making these critical decisions?
Nice post Tarek on how ludicrous the banking system actually is. A lot of people are simply not aware of this, and believe that the money they have in their pocket actually counts.
However I would like to make one important point - commercial banks no not have the power to create money at zero cost.
No they don't, which is why a handful of individuals pressured Wilson into signing over to the Federal Reserve in the US. Wilson later allegedly said "I have unwittingly ruined my country". It's an official sounding name that makes it sound very much like a part of the US Government doesn't it? It isn't. It is a consortium of private banks and somewhat dubious individuals. They then actually profit from the US national debt. Nice work if you can get it! If you leaf through the US constitution, you can very plainly argue that this is a constitutional violation........
Who are these people? Well, at a rough estimate:
1. Rothschild Bank of London
2. Warburg Bank of Hamburg
3. Rothschild Bank of Berlin
4. Lehman Brothers of New York
5. Lazard Brothers of Paris
6. Kuhn Loeb Bank of New York
7. Israel Moses Seif Banks of Italy
8. Goldman, Sachs of New York
9. Warburg Bank of Amsterdam
10. Chase Manhattan Bank of New York.
There are also other individuals who have control and not inconsiderable influence over the FED districts as they have stakes in all these banks. This isn't a conspiracy - the Federal Reserve is simply not a part of the US Government.
Beyond that, things are shrouded in secrecy, uncertainty and hearsay with links possibly going back to many London based, extremely private banking houses. You'll find many conspiracy theories going way, way, way beyond what we actually know everywhere on the internet. Just for fun.
Letter number 10 from Tarek makes facinating reading but misses the key point that banks only care about themselves and their greed nknows no limits. The trillions of dollars of derivitive debt products make the input of $50 billion pretty inconsequential which is why the markets are not doing what the assumption was they should.
It all comes down to transparency and what the banks purport to have as assets in their name.
Central banks should insist all off balance sheet 'assets' return to the balance sheet and are marked to market not at the book rate deemed sufficient to guarantee a bonus yet which hold no real time credibility.
Further Central banks should restrict the selling of derivitive products where there is no intention to have any after market.
Directors of parties that buy these exotic products must show in their records why they have done it and how they can unwind the risk.
It is the ultimate irony that banks expect total transparency from their customers yet they are the least wanten to let on what they are up to. Perhaps it is because they have passed the point of their accepted mandate and are now abusing client money to speculate as a principle which they were never meant to do.
If the Clients want to speculate with their own money then no one should complain if controls are in place but for banks to allow proprietary desks to speculate using customer funds was never the basis by which those custoemrs deposited their money.
The old boy network canute approach doesn't work because principles and ethics which helped halt errant parties,have evaporated totally to be replaced by limitless greed which by definition has no ceiling.
Banks in Europe and the USA will need to be brought to account and if dividends need to be slashed and staff numbers reduced to save the ability of industry as a whole from being crusified then so be it.
Transparency is now the rule of thumb and every bank director should be trembling in their seats insofar as what they knew, and if they didn't why not.
We must hope although it is totally unlikely that all bonus payments are cancelled, for to pay them will serve no purpose to banks searching desperately for sympathy.
Please don't forget UK banks earned over £50 billion pre tax last year a huge proportion of which was generated from their over zealous charging of personal and business users in the UK.
The party is over for them and they will need to eat humble pie and cut their outrageous margins for some time to come to get the public and business on side., and quite franlky after 10 years its not before time.
#15
NR is a mortgage bank which simply borrows money (from commercial banks)and lends it on (to mortgage buyers). It makes its money on the difference between the two. And it has been good at this recently and given time, it will be again under whichever guise it assumes once liquidity conditions improve.
It did/does NOT have any US sub-prime investments. It is not an investment bank! Lots of other [commercial] banks have been burnt this way and have since refrained from lending on to other banks, hence cutting off NR's money supply.
A limited funding model is to blame for its woes not bad investments (or reckless lending for that matter!).
Normally, when there is a failing company, there are questions of its auditors. Why are these questions not being asked in this case?
Back in my gloomy days of audit, we had to form an opinion as to whether a company was a going concern i.e. it had enough available financial resources to ensure it could trade for 12 months.
Did the auditors question NR's business model? If not why not, and if so how did they statisfy themselves that such a model could ensure going concern?
It may appear that the auditors drastically failed to correctly assess the risks associated with NR's business model, and that they failed in their
duty to NR's shareholders.
This is about banks lending money at a rate that reflects what they believe are true risks.
For the past 10 years they have simple got away by lending money at too low a rate. The cost of money has gone up because banks are now being more realistic about risk PLUS we are at the point in the growth cycle where there is high inflation and the retail end of the economy is over heating meaning higher interest rates.
Banks are simply reflecting the reality of the situation - there is nothing wrong now, there was before but the banks simply got away with it.
Its so public school , all the naughty boys lined up outside masters office in the freezing cold
They know what theyre in for but no one will squeel
Makes you proud to be british does it not.
What is interesting about this whole debate is the reality that Virgin has the support it needs to rescue NR, is the preferred bidder and is moving fast to secure it. I suspect they will pull the rabbit of the hat, restore confidence and value. Everybody said Branson was an idiot when he started an airline.
At a share price of 92p vs £12 barely six months ago the opportunity for new investors looks tempting if Branson pulls it off.
Good God Robert- you really are obsessed aren't you.
A huge story about central banks collaborating to try and solve the global liquidity crisis and you turn it into yet another NR bashing exercise. You seem to have led some folks posting here (such as 13) to believe that the global crisis was CAUSED by NR for goodness sake!
The real story here is whether the NR crisis could have been averted had the BoE acted sooner (the other central banks provided lending facilities to their own banks ages ago).
When one gets down to it, "credit" is just a label that describes the ability to pull foward expected future earnings into the present to be spent now.
The problem being that the people whose futures were being pulled into the present effectively had no earnings in that future.... with which to pay the debt they had incurred.
The old fashioned idea of Shakespeare's (an obscure economist from the era of Tarek's original Goldsmith Bankers who may come back into fashion!); "Neither a Borrower or a Lender be", has been right out of favour---- to the point where the 'Neither' has disappeared completely in the Financial Services industry.
It might be significant that the chain of credit; the credit securitisation and the re-selling of the debt obligations, and the further re-selling of the re-sold securities ...etc... is made up of people often doing nothing else but lending money to other people, who promised they would be able to pay them back because THEY had promises themselves from others which would provide the funds needed...and so on.
Especially so, as when tracked down the line this money is finally exchanged by everyone for a building (residential in Iowa or Manchester,or commercial in a City centre or Office Park) that isn't worth as much as everyone thought it was.
Deprived of one's profit and possibly even some of the original loaned cash, AND holding a building that can't be sold, because no-one wants, or is able, to buy it, makes it difficult to pay one's own debts of course.
A building whose price is even falling because ...... well, in the words of an old song describing a vicious circle-- " There's a hole in the bucket...!"
Liquidity seems at present almost to be a synonym to stand for "confidence"; and "confidence" requires "Trust"....
And trust needs...? Well, there's an even bigger "bucket" with a bigger "hole"!
Letter number 10 from Tarek makes facinating reading but misses the key point that banks only care about themselves and their greed knows no limits. The trillions of dollars of derivitive debt products make the input of $50 billion pretty inconsequential which is why the markets are not doing what the assumption was they should.
It all comes down to transparency and what the banks purport to have as assets in their name.
Central banks should insist all off balance sheet 'assets' return to the balance sheet and are marked to market not at the book rate deemed sufficient to guarantee a bonus yet which hold no real time credibility.
Further Central banks should restrict the selling of derivitive products where there is no intention to have any after market.
Directors of parties that buy these exotic products must show in their records why they have done it and how they can unwind the risk.
It is the ultimate irony that banks expect total transparency from their customers yet they are the least wanten to let on what they are up to. Perhaps it is because they have passed the point of their accepted mandate and are now abusing client money to speculate as a principle which they were never meant to do.
If the Clients want to speculate with their own money then no one should complain if controls are in place but for banks to allow proprietary desks to speculate using customer funds was never the basis by which those custoemrs deposited their money.
The old boy network canute approach doesn't work because principles and ethics which helped halt errant parties,have evaporated totally to be replaced by limitless greed which by definition has no ceiling.
Banks in Europe and the USA will need to be brought to account and if dividends need to be slashed and staff numbers reduced to save the ability of industry as a whole from being crusified then so be it.
Transparency is now the rule of thumb and every bank director should be trembling in their seats insofar as what they knew, and if they didn't why not.
We must hope although it is totally unlikely that all bonus payments are cancelled, for to pay them will serve no purpose to banks searching desperately for sympathy.
Please don't forget UK banks earned over £50 billion pre tax last year a huge proportion of which was generated from their over zealous charging of personal and business users in the UK.
The party is over for them and they will need to eat humble pie and cut their outrageous margins for some time to come to get the public and business on side., and quite franlky after 10 years its not before time.
To see who the real goodies and baddies are in this big mess just follow the money:
Your average hard-working british punter has probably got a 300K mortgage on some bricks and mortar with an intrinsic value of about 75K.
Where has this 225K gone? To the banks who have paid out a large proportion to their directors and high fliers.
Even now we see Goldman Sachs getting ready to fork out another massive bonus to staff, while nurses, policeman and the like get less than inflation.
Savers have been accepting a derisory interest rate for some time, and now find their deposits are probably not even safe.
Now we also see the stock-market beginning to collapse, which may wipe out our pensions as well.
The way the economy and banking have been run over the last decade has basically been a massive scam perpetrated on the public by some very selfish and immoral people.
The recent action of the central banks will make no difference whatsoever, other than inflating the debt bubble a bit further.
It is rare in the couple of weeks I have been following the posts here to see someone's post replied to or mentioned. Well done TAREK!! Alas, although I can't claim any expertise or oratory I am not convinced by your argument. We are a world away from gold as the last place to hide. Value is now in someones head and that is tricky stuff to deal with.
Post 31. NR's auditors are PWC who actually made three times as much on consultancy work as they did on the audit.
Perhaps it was all the securitisation and offshore work.
It begs the question that has been raised several times before over auditors and consultants from the same firm and the need for auditors to be truly independent.
Funny thing is though Mr Peston this injection of tax payers money by the Bank of England has done nothing to lower interbank borrowing. As a result thousands of mortgage lenders are going to move from a nice 3% to a scary 7% in January and the collapse of the housing market will be in full swing.
The BofE was irresponsible to think the Northern Rock could lend it's way out of a crisis (I am sure Mr King and Mr Brown would be more than happy to lend a single mother, unemployed with a heroin addiction £1million) as they knew full well that if the house prices dipped then the Northern Rock held nothing but devaluing property.
I am sick to death of the BofE and this Prime Miister thinking debt is the solution to the problem. They would be better to be reminded that the Germany economy relies on econmoic export and as such will weather the current financial storm with little damage compared to the UK.
Oh and I am sure those PFI projects aren't a drain on the UK's coffers at all.
Why should the tax payer keep having their saving devalued to bail out irresponsible givernment lending and building projects? Why should any of us pay for idiots who cannot conceive interest rates going above 10%.
Why should the tax payer pay?
Another problem with debt and credit based on the value of property, is assessing the 'true' value of the asset. With most commodities (at least those which operate in a free market, obviously excluding oil) the long-term value of the asset is closely related to the costs of extracting it and transporting it, rather as used to be the case with money in the days it was formed from gold and silver.
But what is the value of a house? Conceivably this might be related to the cost to build it but in the UK at least this is not true. My insurance company estimates the cost of rebuilding my house to be one fifth of its current market value, the difference being accounted for (essentially) by the value of the land and planning permission attached.
Obviously this value is heavily dependant on the relative supply and demand of housing. With a rising population and strict planning laws tthe value has been rising much faster than inflation for fifty years.
But any circumstances which make a great deal of difference to supply or demand would greatly change this value. So in that event what happens to all the credit money-go-round based on the value of loans on property?
We like to think of investment in property as being much safer and higher yeilding than anything else (shares or pensions, at least!), and so long as the market is rising, we're right. But not if the balloon collapses . . .
The similarities with pyramid-selling schemes are too awful to contemplate.
And even if it doesn't collapse immediately, the smart money may leave property, which would surely impact its value longer term.
It might be nice if the clever financial wizards chose to invest in manufacturing industry instead of ever-more esoteric financial vehicles, but this seems a forlorn hope.
Tarek (#10), I read your post with much enthusiasm and growing enlightenment. BUT the last paragraph blew it and almost descends into conspiracy theory. The conclusion seems tinged by Islamic antipathy to the charging of interest (early usury).
Capitialism is the greatest invention for continuous improvement of human living standards. What is the fundamental difference between the rich West and poor Africa? It is that in the West all assets and debts can be easily securitised safely within a legal framework to protect ownership and minimise the cancers of kleptocracy and corruption.
The re-lending of money as you detail so lucidly is the *oil* in the cogwheels of capitalism. It works well. What has gone wrong is that the whole financial system has become much more sensitive to appropriate interest rate levels - and these have been radically monkeyed with. After the dotcom crash and 9/11 the US Federal Reserve basically panicked in reducing rates to 1% then ramping them back to 5%. A complete rollercoaster ride just when the Internet and modern lending practices removed the visibility between lender and borrower. Even worse, just when sophisticated derivatives, CDOs and CLOs became mature investment products totally dependent on long-term stable interest rates.
A perfect storm - as has been noted before.
Thank you to Tarek, Condon and Tony for a fascinating ride through the mysteries of fractional reserve banking. As Tony says so well, what we believe affects the system. So, if nobody minds, hallelujah for that!
Segedunum, on the other hand, is much more problematic. Is it mere coincidence that, of the many, many banks that now have some share in the federal reserve system, you choose nine names that are famous for their Jewish founders, then as a tenth the anachronistic 'Chase Manhattan Bank of New York' who of course today form part of JP Morgan Chase.
This is fearfully unbalanced - indeed it's precisely the kind of presentation that legitimately makes Jews and many others fearful. And thus the very important subject in hand in tainted and avoided. Is that your purpose? Or do you believe the whole of fractional reserve banking is a Jewish plot? If so, please come out and say so. Or listen to these judicious words from Antony Sutton, talking of the medal Henry Ford received from Hitler in 1938 as a reward for an earlier generation of Jewish conspiracy theory fantasizing:
The Nazi medal issue was picked up in a Cleveland speech by Secretary of Interior Harold Ickes. Ickes criticized both Henry Ford and Colonel Charles A. Lindbergh for accepting Nazi medals. The curious part of the Ickes speech, made at a Cleveland Zionist Society banquet, was his criticism of "wealthy Jews" and their acquisition and use of wealth:
"A mistake made by a non-Jewish millionaire reflects upon him alone, but a false step made by a Jewish man of wealth reflects upon his whole race. This is harsh and unjust, but it is a fact that must be faced."
Perhaps Ickes was tangentially referring to the roles of the Warburgs in the I.G. Farben cartel: Warburgs were on the board of I.G. Farben in the U.S. and Germany. In 1938 the Warburgs were being ejected by the Nazis from Germany. Other German Jews, such as the Oppenheim bankers, made their peace with the Nazis and were granted "honorary Aryan status."
Re: Post #30 - It is not only investment banks that are at risk of losing money on complicated products in the current squeeze.
I do not think we are yet anywhere near understanding just how far these losses have spread - whether to Northern Rock or elsewhere. The investment banks are past masters at selling on complicated products to less sophisticated investors. If you want an example, look at:
Credit squeeze spreads to Norwegian towns on
To quote from the article:
Narvik, along with three other similarly isolated towns of Hemnes, Rana and Hattfjelldal, has become the latest community to discover just how directly even the most remote places can be affected by the financial turmoil after it made multi-million dollar bets on complicated US-linked financial products.
The towns invested about $96m (€65m) in complex products linked to unspecified municipal bonds in the US, designed by Citigroup, and sold to them by Terra Securities, the investment banking arm of one of Norway's leading banking groups.
Now representatives of the towns have admitted that recent market movements linked to the credit crisis had destroyed most of the value of their investments.
Need any help Darling?
He has three choices, Nationalisation, Virgin or Olivant.
If he nationalises the Rock, then taxpayers are never going to get their money back as it will be run by the existing incompetents or some new government appointed 'experts' who will at best run it as all the old nationalised industries were run, ie with no incentive to be efficient at all. This new management with the cost of nationalisation will just compound the losses still further and the only thing they will be sure of is a certain exit from office at the next election.
So he has a clear choice, Olivant or Virgin. A quick comparison.
Virgin will try to repay £11bn.
Olivant £10-£15bn.
Virgin will take 3 years to pay back the BofE loan.
Olivant will only take 2.
Virgin will be taking up to a massive 96% of the bank if existing shareholders don't fully take up the rights issue and 55% if they do.
Olivant will only take 15%
Virgin will have to do a time consuming and expensive takeover.
Olivant can walk through the door the following morning after receiving the go ahead.
Clearly the option for shareholders is the Olivant bid, but what about the tax payers. Darlings best chance of getting back the tax payers money and showing the voters that the government is capable of keeping calm in a crisis and making a wise decision not a knee jerk popular one at the time, is to let someone who knows what they are doing nurse the bank back to good health.
Mr Branson is obviously an accomplished businessman in many fields but in the financial sector he is comparatively inexperienced.
Mr Arnold however has known nothing but the financial sector, he has an impeccable record and successfully turned Abbey around.
Given the facts alone, I see no reason why Mr Darling doesn't give Mr Arnold the green light immediately so he can get to work. The Rock could be on it's way to recovery and taxpayers getting billions back in early to mid Jan, long before the Rock has even finished it's strategic review by the end of Jan.(It's beyond me why the board are even bothering.)
In conclusion, Mr Arnold is more qualified and experienced, has already saved Abbey, can start immediately without any takeover expense, will have support of shareholders, will satisfy taxpayers as well or better than anyone else could and may even help Mr Brown in the opinion polls.
So go on Darling, Unleash Luqman and have yourself a stress free Christmas.
"26. s wrote:
Banks' don't create money other than the central bank.
Primary banks create credit based upon their monetary reserves which are a netting off of deposits and liabilities.
[snip]
Has nothing to with creating money out of freshair as it is actually based upon lending against collateral.
Wish people would get their facts straight."
That'd be nice wouldn't it. Money is just a medium of exchange. Once it was gold and silver, then paper and now entries in a ledger. Credit IS money.
Banks create credit. Create money, and they do it at the point a loan is taken out. It didn't exist before the loan agreement was signed and appears in a bank account after it has been signed. The credit, the money, has been created. From nothing, by the bank.
Banks create money, from nothing.
As Peter Donaldson put it way back in 1965:
"The essence of banking is thus to conceal or minimise the difference between currency and bank deposits. So long as the public has sufficient trust in bank soundness, they will not bother to distinguish between cash and deposits. Banking turns out to be a highly sophisticated confidence trick"
Some truths never change...
if you were as good as your p.r you would be at Goldman sacs ,but seriosly the obviose deal is abuy by Llyods tsb who tried but were rebuffed ,labour need the votes ,and to defend the jobs ,in the north east,Lloyds need adeal; and have abalance sheet to do it ,the market6 needs good news
a business editor ran asory which cost billions and he needs a happy ending as welln
regards
simon
apologies no spell check
Comment 34 : Simon
I hate to disillusion you but there's no way that Branson and his buddies are in this to "rescue" Northern Rock, in the sense of putting the whole of it back on its feet again as a going concern. What they can scent from this deal is a window of opportunity to make a great deal of money for themselves, at the expense of the UK Treasury. If there was really a chance of the BofE loans being straightforwardly repaid in a few months/years time then there would have been proper financial institutions ready and willing to take over Northern Rock in the interim.
Is the Treasury savvy enough to prevent the Branson gang from taking them for a ride? I don't think so. There's too much politics involved that they have to work with, but which the sharks can ignore or, worse, manipulate in their favour. No, they'd be on a hiding to nothing.
In which case the Treasury should seek to move things along by:-
1. Putting together a saleable package of the branches, their deposits and a matching portfolio of mortgage loans.
2. Taking over the management of the run-down of the remaining mortgage loans, paying off pari-passu their own £25 billion and whatever other inter-bank deposits remain outstanding.
The management of the loan book run down could, I'm sure, be done by a couple of accountants, a few clerks and half a dozen computers - although no doubt the involvement of the public sector would lead to a payroll 25 times as large - but this would still be a small cost in comparison with what's actually being collected. Just like a long-term liquidation, really.
At the end, anything left could be distributed to shareholders.
Some of the posts about how banking works and who its major player are verging on paranoiac. In the first place, the 'old' model of banking was far from optimal - just look at the history of interest rates and collateral trends. Money making requires risk. the banks are not in business for their customers but their shareholders. The FED is the US central bank - legally constituted as such by an Act of Congress. Allegations that the FED has 'dubious' board members or that its representative member banks are part of some long standing world domination plot put me in mind of some of the nastier pieces of banking folklore such as The Protocols of the Elders of Zion. Anyway, I digress. The 50billion is unlikelyt to find its way into the hands of investment banks but will hopefully aid some high street banks overcome punitive LIBOR ove the coming months. The next bigh loan thrashing cycle will begin Feb/Mar when the Xmas and New Year splurge leave borrowers over stretched and seasonal layoffs will kick in. I would be very surprised if any party takes over NR in the next two months. There is no gut feeling for when the credit 'crisis' will end. A better picture will emerge in mid Summer 08, but it may take until Spring 09 for share prices to come up to Febuary 07 levels. Two years in other words from peak to peak.
It certainly looks as if Mother Brown is allowing the SS Northern to drift onto the rocks. Will it be sunk by a collapse in UK house prices? Will it be sunk by Ally D waiting for the boss to tell him what to do? Will it be sunk by the global credit squeeze? Will it try to borrow £40 billion from us or will the sky be the limit? There is no serious private sector offer for the Rock and the band plays on. Is it fair for mutual building societies who have been prudent in the market to have the Rock as a taxpayer subsidised competitor be it in private or nationalised hands? This is a monumental scandal and thank goodness that Robert Preston is keeping us updated on a regular basis. If taxpayers end up purchasing a bank which they do not want let them be under no illusion that Mother B is in the frame.
I really don't think this concerted effort is going to work. £50 billion is a huge amount of money, but not to the institutions that are now being dealt with. It will only take further erosion of conditions to quickly swallow that-up and then...more loans.
It seems highly irresponsible that the Bank of England is prepared to use credit card debt as collateral. Most credit card debt is, to my mind, sub-prime already, unless it has a faultless record of payment. The Bank of England is getting itself into a dangerous situation. People are complaining about supporting Northern Rock; how about when the Bank of England is propping up part of the banking system? Will a loan of £20 billion really do? I can quite easily imagine banks drying-up further and even more money having to be used? And at what point will the B of E say to a borrower 'you've had enough!' and the bank either collapses or a run begins. The sums involved are just too big and the B of E should get back to being a lender of last resort again so that if confidence collapses there's something to fall back on...unless, of course, it is still acting as the lender of last resort.
The critical thing, confidence, has evaporated. Even in my neck of the woods, the anecdotes are starting to go their rounds: properties that have dropped 25%; properties that aren't selling; people being told about cuts. The same way startling house price stories circulated.
As the SS Northern Rock continues on its last voyage it is becoming increasingly clear that the ship has been holed below the water line. Mother B seems to have been reduced to waiting for something to turn up and the crew have the feeling they are drifting to oblivion. No serious private sector offers are on the table and the nightmare of public control grows ever closer. This is a scandal of epic proportions so more credit to you Robert for keeping this horror story on the front burner. Is it fair to let Northern Rock sail on with public finances behind it to compete against other banks or building societies which have been more prudent? Level playing field forget it. Mother B got us into this absurd situation and is now looking for a way to re-write history. When we needed decisive action we got fudge and buck passing. When we needed leadership we got the real Mother B. We have still not been given any convincing explanation as to why Lloyds TSB were not given the green light to "rescue' the Rock. It is often said that we get the government we deserve. Let us hope that we can raise our sights above the current shower.
#30 * Gordon Bennett wrote:
"It did/does NOT have any US sub-prime investments. It is not an investment bank! Lots of other [commercial] banks have been burnt this way and have since refrained from lending on to other banks, hence cutting off NR's money supply."
The extent of NR's exposure to the US sub-prime market is unknown to the public. Given its behaviour it may well be that it has a huge deficit on assets to liabilities. It is constantly repeated that NR is basically solvent, but there is never any evidence given to support this.
If NR is solvent it will find a buyer. If it is not, there is no way it should be nationalised, as the taxpayer would then be liable for all its debts.
The announcement that a group of central banks will work in concert is simply the next stage in the artificial and illusory world of finance.
It is interesting to see on the ̳ Business pages that Citigroup is now moving debt onto it's balance sheet. I must confess that I am not sure what this actually means. How can such vast sums of money be hidden off the balance sheet in the first place! To paraphrase the expression "I don't know art but I know what I like" to "I'm no economist but I can COUNT" seems appropriate.
If I might make a recommendation there is a book called "MONEY, Whence it came, Where it went" by John Kenneth Galbraith. Printed in 1975, provides an excellent insight to many of the issues we now face yet again...
Comment 56 : Bill Ward
Bill, one of the ways the authorities try to control the amount of spending power, money, in circulation is to insist that commercial banks operate within what they call a required reserve ratio. In practice, what this means is that banks are not allowed to take deposits to a greater level than a certain multiple of their own worth. So if a bank is worth £5 billion and the multiple is 20, they may only take deposits up to £100 billion.
All well and good until someone has the bright idea of using the letter of the law to enable banks to manage, control and, most importantly, make profits from deposits over and above the £100 billion. What they do is to take advantage of the modern creed that deviousness is a human attribute that is superior to honesty. They create institutions, generally offshore and outside the control of competent authority, to take deposits and lend them out again, just like a normal bank, but without any reserve ratio requirements. The onshore banks control every aspect of the activities of these offshore institutions, and take their profits from them.
So they're all part of the business of the onshore banks, right? Wrong! They're set up legally so that they don't have to be accounted for as part of the onshore bank, so, despite the fact that this is in reality what they are, this is not how things are shown.
Clever, eh?
The Bank of England has widened the type of assets it will take as collateral for loans. It will now consider triple A rated assets of types it would not accept in the past. My question or comment is how can we continue to trust the rating. The rating agencies clearly got it wrong on CDO's so why does the Bank continue to rely on their ratings? Is it because there is no alternative?
It appears to me that the rating agencies are hugely culpable in the entire credit squeeze and are to some extent responsible for the lack of liquidity in the market. However, I beleive that they are immune from suit in the US for giving negligent ratings and seem to be avoiding all the bad press that is hitting the banks. Is it not the rating agencies we should be concerned about?
I wonder if the facade that constitutes the British Banking Code (a voluntary code with no teeth) would better serve consumers if it was to fall under FSA control ?