The Northern Rock blame game
Posted on February 20, 2008 by Richard Beddard
Filed Under Investing |
The authorities are pointing the finger of blame at each other for the implosion of Northern Rock, but who’s really to blame?
You’ve got to watch last Monday’s Dispatches programme (How the banks bet your money *1) presented by Jon Moulton, the financier.
His voice lends authority to the programme might otherwise lack, and also some spice as he ravages reputations.
Mr Moulton is a whistleblower. The industry insider who spares no-one in explaining how loans that shouldn’t have been made to people who couldn’t afford them in the United States brought down Northern Rock, threaten the profitability of UK banks, and, he believes, will trigger a recession as credit dries up. He spreads the blame around liberally but sums it up in one phrase:
Bankers’ greed and regulatory failure
There’s a calculated moment of utter disrespect where Mr Moulton says:
To its investors and to the public the problems seemed to come out of nowhere but to those of us who understood the situation a little it was a situation the regulators should have seen coming. They didn’t. There’s one simple reason why, and here he is…
While brandishing a picture of the Prime Minister.
He blames Gordon Brown for carving up the job of regulating banks between the Treasury, the FSA and the Bank of England, leaving the system leaderless and impotent. There’s a cast of sub-villains too:
- The mortgage salesmen who profiteered in the USA,
- The investment bankers who packaged the mortgages into Collaterised Loan Obligations (CLOs) and earned huge bonuses trading them.
- The credit rating agencies that sanitised the CLOs with benign ratings, motivated in part by payments from the issuers.
- Bonus chasing bankers who believed the ratings and invested in CLOs regardless of the risks.
- Northern Rock’s ambitious and/or greedy directors who built a business reliant on an endless supply of borrowed money without considering what would happen should nobody want to lend them it.
- The Bank of England. Mr Moulton says he had to explain CLO’s on the back of a dinner menu to senior officials.
- The Financial Services Authority, which, though responsible for supervising Northern Rock, failed to spot its risky business model.
By last summer banks knew CLOs were worth much less than they’d paid for them but they didn’t know how much less, and they didn’t know which banks had made the biggest losses. So they hoarded cash and stopped lending to each other. Northern Rock couldn’t refinance its loans triggering a bail-out from the Bank of England and a run on the bank. Now banks are reporting heavy losses because of the dodgy CLOs they bought, and the Government has nationalised Northern Rock.
We’ll all have our own favourite villains*2. But I think there’s at least one category Jon Moulton forgot. The owners of Northern Rock. What were they doing while their bank borrowed short and lent long? It’s easy to be wise in hindsight, but shareholders broke a basic investment rule, perhaps the basic investment rule, which is ‘buy what you know’. Northern Rock was unusual among British banks for its growth rate and the way it financed that growth, so investors knew where to start looking, if they wanted to understand the risks.
Small shareholders only have themselves to answer to, and will probably pay a high price. Buried at the bottom of The Treasury press release on Monday were the terms were the principles for assessing compensation. They:
…reflect that Government should not be required to compensate shareholders for value which is dependent on taxpayers’ support.
It looks like the independent assessor will value the bank at nothing much to nothing at all, as without the Bank’s of England’s support, it isn’t viable.
But the fund managers who invest our life savings, voted for the board at AGMs, and championed Northern Rock can join the other villains in the dock. They have a responsibility to their customers to understand the companies they own, yet in August, when rumours about Northern Rock swirled around the City, Baillie Gifford owned 6.9%, Lloyds TSB owned 5.8%, Legal & General owned 3.5%, and Bank of America owned 3.1% of Northern Rock. Of 16 brokers covering Northern Rock, five rated it a buy and seven rated it a hold.
This cast of villains could staff a fourth Lord of The Rings film (although it’s the hobbits that will probably pay; Northern Rock employees in particular). The real villain isn’t a who. It’s a what. It’s human nature and our base instinct to follow the money and ignore the risks. As Mr Moulton says of the banking chiefs who didn’t understand the CLO’s their own traders were buying:
The risks were a mystery to them, the profits weren’t. Ignorance was bliss and now the profits have turned to losses.
The same could be said about the agencies who rated the CLOs, the investors who bought shares in Northern Rock, and most of all the company’s directors. It’s all reminiscent of the technology bubble, when investors didn’t understand the companies they owned, and didn’t care because prices were rising.
The way to guard against such excess is to do your own research, something everybody, the bankers, the FSA, credit rating agencies, and investors seem to have forgotten. Mr Moulton says more losses at banks will come from Credit Default Swaps. If you’re attracted by low share prices and chunky yields at banks now, I’d get to know them.
Footnotes, and some Northern Rock links:
- You can watch it free on Channel 4’s 4oD (on demand) service until a month after the broadcast. Just search for ‘Dispatches’.
- And heroes. Robert Peston, the BBC journalist who first reported the Bank of England bailout was vilified on his blog for causing the run on the bank. Actually, he’s enlightened us all, repeatedly. The press as a whole doesn’t come out of it too well though, myself included. On the 3rd of September, I published this blog downplaying the threat of a bank going under. Ten days later Robert broke his story.
- How sub-prime really works - an alternative explanation.
- Monday’s press release from the Treasury.
- For more links, please look at the sidebar on the right.
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12 Responses to “The Northern Rock blame game”
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It seems to me that Mervyn King has a lot to answer for in revealing that Northern Rock had approached the BoE for assistance, thereby triggering the run on the bank. His excuse was that to have kept information secret would have run counter to EU rules - an assertion later denied by EU sources.
Can you imagine any other National Bank revealing that a major bank had approched it for assistance?
Switzerland? France? Germany?
Not on your life. Regardless of the rights or wrongs of the Northern Rock management philosophy, they were entitled to have their approach to the BoE regarded as Confidential. Moreover, King should have realised the impications of revealing the problem to an unsophisticated lay audience.
I’m with Doc Martin on this. There are many levels of risk involved in the Northern Rock model, but who’d ‘a thought that the money market would dry up? When it did, the Bank of England (potentially as the lender of last resort guarding the interests of its bailiwick) could surely have negotiated a money market loan to the Rock in exactly the same way that the Rock would have expected to do through the money market. No big deal, no need for special secrecy, just treat it as normal day-to-day transaction and no big song and dance either. We’d never have noticed the difference, would we?
What I don’t buy in this is the implication that the majority of banks don’t understand the relationship between risk and reward. No banker sees 26% return and thinks risk free. And all banks know risk = potential for loss.
I couldn’t agree more. Lead by Gordon Brown this country seems determined to flush away all its previously hard won advantages.
And now we have “Granite” which appears to be like a bicycle - only functions so long as it keeps moving, i.e is topped up with fresh mortgages. Just why this is alleged to be true, I don’t get. Surely its assets (mortgages) can somehow be securitised
Banking must be the easiest business in the world - borrow money at one rate, lend it at a higher rate. What all these farces have shown is the depth of incompetence in the sector. Given that management is so frequently useless, and they seem to be regarded as immune to the normal penalties of failed businesses, financial institutions will have to be regulated to much tougher standards. I would have let NR go to the wall pour encourager les autres - although whether they’re smart enough to take the lesson I doubt.
So Mervyn should have kept “stum”. What happened to transparency? Or was that yesterday.
The only good thing to come out of this is that some hedge funds will loose a packet.
Its greed on greed on greed its killing the world.
Lenin said ” Wih capitalism we will weave the rope with which we will hang it. Its looking that way to me.[or was it Mao]
I see Granite gets a mention here. Granite Financial Holdings, plus a gaggle of subsidiaries is an offshore compay whose shares are held by another called The Law Debenture Corporation. This last describes itself as a trustee in respect of the profits of Granite to the benefit of a small down’s syndrome charity in the North East. This charity however apparently is unaware of this fact. So th question arises - If this is so, what will now be the view of HMRC and will a large chunk of our £100 billion invested in this mess be called upon to settle a tx charge and penalties for the above? http://www.figurewizard.com/article.php/Granite_and_Northern_Rock__Who_Owns_the_Mortgages
This seems to be a carbon copy that cost me over half my life savings with EQUITABLE LIFE, even has the very same culprits ie the FSA, Directors, and profits that were unsustainable in the medium term. We have the same results too - when it all goes wrong no one is to blame, the directors come out with full pensions and bonus’s and the worst scenario I heard about was that when I rang the FSA I happened to say ” well we should be OK, at least all the MPs have their pensions in Equitable’. I was told they had all got out “collectively” before the public were aware of the true position. My contempt for MPs began then and has got worse as i realize what scum they really are. I have been asking the question “was this insider trading” for almost ten years now but no one will even answer the question. I have asked the treasury, MPs, Inland Revenue customs and excise, the list is endless. Simply not one reply
Can you trust anyone in finance? Darling would be out of his depth in a car park puddle
If he was in that puddle you could bet your shirt that he had put there by Gordon Brown.
[…] One of the City types he quizzed was Jon Moulton. He asked the financier, who wrote and presented this brilliant documentary, why he didn’t see the crunch coming. Mr Moulton replied: Well I did but nobody was […]