Solid as a Nothern Rock?

Who'd have thought it? The property market slide in value means that many of the assets on which the Northern Rock has its mortgages secured are worth less than the mortgages themselves. The Northern Rock was aggressively selling mortgages to people who were offered high multiples of income and/or high percentages of property value (up to 125%). Now with house prices falling there are a lot of Northern Rock mortgage customers in arrears and/or in negative equity.


Take a read of the Supplementary Estimates, 2007-08 - HM Treasury Northern Rock and Banking Reform debate in yesterday's Hansard. There are some interesting question and answer exchanges between MPs and John MCFall MP, the head of the Treasury Select Committee; here are a few:

"Mr. John Redwood (Wokingham) (Con): When the right hon. Gentleman’s Committee looked into the matter, did it come to any conclusion about what fair figures should go into the estimates for the actual costs incurred so far, for the contingent guarantees and for the cash costs of the advances, as it would help this debate very much if we had some figures?"

The key part of this question with regard to this article being the "contingent guarantees and for the cash costs of the advances".

"John McFall: That certainly would help the debate, but the Treasury Committee does not have inside information. All of us on the Committee have realised that if we overstretch ourselves, we can make fools of ourselves. We have not overstretched ourselves; therefore our report has been well received. I do not want to get into crystal ball gazing; what I am asking is for the Ministers on the Front Bench to fill in the blanks and to fill them in soon. Then we can have a decent debate on the issue."

The Treasury Committee do not know what the contingent guarantees or cash costs of advances are, nor have they investigated - well that's reassuring!


Please also have a read of Mr. Michael Fallon's points whcih are technical and well made - it's good to know that there are a few MPs who know what they are talking about regarding the City "Basel I drove the search for yield off balance sheets. The Sarbanes-Oxley Act drove the search for yield across the Atlantic, fired up the City and all our financial services sectors and perhaps made every British building society consider itself the next Morgan Stanley. Some aspects of Basel II may well be unhelpful in binding the extremely conflicted credit rating agencies into the regulatory structure. The answer may not necessarily be instant, knee-jerk regulation."

Frank Dobson made a strange point comparing CDOs to pre-packed salads that was entertaining if a little forced:

"Frank Dobson (Holborn and St. Pancras) (Lab): CDOs are rather like pre-prepared and pre-packaged supermarket salads, with different assets all chopped up and mingled together, but these packages contained very few genuine assets. The remaining elements were worthless, or rather worse than worthless: they were liabilities. A CDO was a bit like a pre-packaged Caesar salad in which there is one anchovy and all the rest is lettuce, apart from the fact that the package containing the salad is transparent. There was nothing transparent about the CDOs; however, they were sold on as top-quality and bought by idiots as top-quality, and the credit rating agencies invariably gave them triple-A ratings. They were risk-free. The banks bought them out of recklessness or stupidity, or perhaps they were deceived, but what is more likely is that they suffered from the worst form of deception—self-deception—and it is they who have got us into this mess."


Vincent Cable is another of the MPs who do understand the issues and he was on target about the valuation of the Northern Rock (my emphasis):

"However, the Committee largely seems to have taken at face value the assumption that the bank’s assets were basically sound. In paragraph 13 of “The run on the Rock”, the Committee approvingly cites a quotation from Mr. Sants, stating that Northern Rock had had

“high quality assets—there is no suggestion here that this is an organisation taking on poor quality assets”.

Northern Rock also got a glowing testimonial from the Governor of the Bank of England, who is quoted at some length. Among other things, he said:

“What I would say about Northern Rock...is that most of the staff that worked...on the lending side, all the evidence shows, did an excellent job in appraising the loans that they were making, and that they monitored very carefully and did not lend money to people who should not be borrowing from them. The lending side was handled extremely well.”

The issue is left there.

I wonder how that came to be accepted. I have worried about this from the outset of the Northern Rock affair. The worry centres on the so-called Together mortgages, which are one of the main products of the bank. We know that there are 200,000 of those out of 900,000, which is a big chunk. Those mortgages varied, but the basic principle was that they were well over 100 per cent. of the value of the property—they were usually something like 125 per cent. It seems that the bank was lending a fairly conventional 95 per cent. mortgage to its borrowers and adding on a 30 per cent. unsecured loan, which was typically £25,000. A lot of that happened when the housing market was at its peak last year.

I wonder how that could possibly have happened. The Governor of the Bank of England and the chief regulator concluded that this was straightforward and uncomplicated and that the assets were perfectly sound. That does not ring true. The Select Committee pointed out that managers were asked to undertake a stress test to see what would happen if house prices fell by 40 per cent. and concluded that the bank was safe and would have survived. I cannot understand how it could possibly have passed that test. Nothing we know about the bank leads us to believe that it would have survived that test, but it has become written into the orthodoxy that it was perfectly sound and secure."

Another MP added:
"Mr. Kevan Jones: Is it not correct that there are two separate items in the mortgage book? There are traditional long-term mortgages, and I know from once applying for a Northern Rock mortgage that they are very difficult to get. There was also the activity described by the hon. Gentleman. His point was backed up by my constituents who worked in the Sunderland processing centre; in the last 12 months, mortgages were being given without any reference to payslips or anything else simply to get the market share up, which was Mr. Applegarth’s key thing to boost the share price."


Vince Cable continued :"However, the point in answer to both the right hon. Member for Wokingham (Mr. Redwood) and the hon. Member for North Durham (Mr. Jones) is that we now know that over the past few months the Northern Rock management has refused to accept any individual voluntary arrangements. Northern Rock is the only bank that has refused to do that. It is clearly worried about the security of the people who have been lent to. There have been complaints from the Insolvency Service that that is bad practice and against policy. Northern Rock is the only bank that is taking that extremely aggressive approach towards the people who have borrowed from it, as it is worried about conditions such as those described by the right hon. Member for Wokingham.

We also know that whenever borrowers have got into any kind of difficulty—for example, when they have failed to make one month’s mortgage payment—the bank has immediately come in to get a first charge on the property. That behaviour is much more aggressive than that of any other bank around, so why is it doing that? There is clearly a lot of worry in the bank about the quality of its assets.

The question then arises of what happened to all those mortgages. The answer is that we do not know. They may have been dealt with entirely separately, as the hon. Member for North Durham said. One possibility is that they were bundled together and sold, through the Granite vehicle, on the market. A more likely possibility that follows on from what the hon. Gentleman said is that the mortgages were separated, with the good, traditional mortgages being sold off through Granite—sold through intermediation into markets—and all the unsecured loans being left behind in Northern Rock, which is now a nationalised bank. If that is what happened, the outcome is worrying. It has been worrying all along, both when Northern Rock was nationalised and when it was not, but that is what we are left with.

I have been trying to secure a proper, independent audit, as have hon. Members from different parties. Clearly, the FSA failed in that task. We need to get a proper understanding of how good the assets really are. The honest answer is that we do not know. I hope that the Select Committee goes further into the issue in future."


Vince Cable also discussed the benefits of counter-cyclical systems:

"The third set of questions that arise from the conclusions of the Select Committee are about how banks should be regulated in the broadest sense of liquidity. There was an interesting passage in “The run on the Rock” which I had not understood previously, about what happened when the Northern Rock bank managers discovered that they had excess capital—that they had over-complied with the capital adequacy requirements. As I understand it, they simply blew it on a big payout to their shareholders.

That raises the question what those capital adequacy ratios are for. Common sense suggests that in a boom period, as those bank managers were, with a massive expansion of lending and a booming housing market, the requirement should have been tightened rather than relaxed. Similarly, a period like the present, when the market is going down, should be the point at which it was relaxed. I ask, and I do not know the answer, whether it is possible to design a system that is counter-cyclical, and whether that is compatible with the rules of the European Union, under whose auspices these institutions now operate. That is the kind of mechanism we should consider."


Do read the whole debate, it is most interesting and so of course was completely ignored by the BBC who have dumbed down to an extraordinary degree.