WSJ: U.K.'s Northern Rock Move Highlights Risk to Taxpayers
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U.K.'s Northern Rock Move Highlights Risk to Taxpayers
Nationalization Is Credit Mess's First; U.S. Role Narrower
By ALISTAIR MACDONALD and CARRICK MOLLENKAMP
February 19, 2008; Page A1
LONDON -- In the United Kingdom, a new stage in the global financial crisis
has begun.
In choosing on Sunday to nationalize troubled mortgage lender Northern Rock
PLC, U.K. Prime Minister Gordon Brown is heading down a path rarely taken by
a developed-nation government. It's a path that is fraught with political
peril and could ultimately bring the crisis home to regular taxpayers.
Since Northern Rock last fall became the target of the U.K.'s first bank run
in over a century, it has racked up more than £25 billion ($48.7 billion) in
debts to the state. Mr. Brown's decision to reject two offers for the bank
and nationalize it amounts to a bet that the state can earn a decent return
for taxpayers at a time when the U.K.'s housing market is sagging and its
consumers -- among the most indebted -- have turned decidedly gloomy.
Table:
http://s.wsj.net/public/resources/images/P1-AK554B_NROCK_20080218201214.gif
Achieving that goal will require the bank to take actions that any
politician would prefer to avoid: forcing shareholders to accept a deal that
will likely leave them next to nothing; evicting some people from their
homes amid a forecast rise in loan defaults; competing with private mortgage
lenders; and potentially slashing nearly half of the 6,300 jobs at a company
long a source of pride and economic growth for the northeastern English city
of Newcastle.
The initial political repercussions were on view yesterday. Opposition
Conservative leader David Cameron called the move "a disaster for the
taxpayer, a disaster for this government and a disaster for our country."
U.K. taxpayers might not be alone. While Northern Rock is the first bank
nationalized in the credit crisis, others have turned to governments for
emergency aid. Some of the largest -- including UBS AG, Citigroup Inc. and
Merrill Lynch & Co. -- have tapped Asian and Mideast government funds for
capital infusions after suffering from mortgage investments. The German
government has pledged more than €1 billion ($1.47 billion) to prop
small-business lender IKB Deutsche Industriebank, which became the first
European victim of the U.S. subprime-mortgage crisis last summer.
"Financial institutions have been pretty good at taking governments
hostage," said Charles Wyplosz, an economics professor at the Graduate
Institute in Geneva. "The taxpayer is likely to face a huge bill."
In the U.S., the government's role has so far been limited to orchestrating
private-sector rescues, pressuring mortgage lenders to cut deals with
borrowers and cushioning the blows to the economy with fiscal stimulus and
interest-rate cutting. But proposals to use federal money to ease the pain
are getting serious scrutiny in Washington.
The U.K. government's decision could also mark the beginning of a new and
more acrimonious stage of the financial crisis, in which the moves of
governments and regulators inevitably impinge upon the interests of powerful
groups. A recent plan to calm the U.S. market for municipal bonds by
breaking up FGIC Corp., the holding company for the U.S.'s third-largest
bond insurer, has been met with anger by U.S. and European banks that didn't
know of the plan.
Takeover Attempt
A similar plan for Ambac Financial Group Inc. is closer to completion but
will require financial backing from banks that face billions of dollars in
added write-downs on complex securities insured by the companies. Northern
Rock shareholders have attacked the government takeover move, promising a
long period of legal battles.
Northern Rock ran into trouble in August when short-term lending markets on
which it depended for capital froze up amid turmoil in credit markets. An
attempt to engineer a takeover by U.K. bank Lloyd's TSB Group PLC failed
after the Bank of England refused to provide preferential-rate financing for
it. To calm a run on Northern Rock that broke out after the announcement
that the bank had required emergency funding from the Bank of England, the
government took the unusual step of guaranteeing all Northern Rock deposits.
The government then negotiated with various bidders. As the global financial
crisis deepened, the list of viable suitors dwindled to two: Northern Rock's
own board and a consortium led by Richard Branson's Virgin Group Ltd.
In January, the government, using a nationalization threat as leverage,
demanded the two bidders make offers that would protect U.K. taxpayers --
who'd become the bank's biggest creditors -- and give them a chance to
profit if Northern Rock recovered. More than once, the government told its
advisers at Goldman Sachs Group to return to try to find a way the state
could finance a private-sector solution.
Last-Minute Efforts
Both bidders made last-minute efforts to sweeten their offers late last
week, but they remained far from what the government wanted. Under Virgin's
bid, Northern Rock's total value would need to rise to at least £2.7
billion, or $5.26 billion -- several times its current level -- before
taxpayers reaped any benefit. The government felt the management proposal
wouldn't raise enough new cash to protect taxpayers from the risk of losses.
On Sunday, Chancellor of the Exchequer Alistair Darling met with Mr. Brown
at lunchtime. The decision to nationalize the bank then was made.
Mr. Brown sought to distance the state from the bank's management, saying
the government's team, led by former Lloyd's insurance market Chief
Executive Ron Sandler, will run the company "at arm's length."
The government says it aims to return the bank to private hands as soon as
possible, though Mr. Brown said a privatization might not occur until after
the next election, which is due sometime before May 2010. London Stock
Exchange trading in Northern Rock shares was suspended in anticipation of a
delisting.
As to how long the bank may remain indebted to taxpayers, Mr. Sandler said,
"We are clearly talking about a period of years." In a sign of how long
government involvement can linger, the Bank of England only in recent years
finished winding down the loan book of Slater Walker Securities, a bank it
bailed out in 1975. The central bank still is looking to recover millions of
pounds in loans from Johnson Matthey Bankers, which it bought for £1 in 1984
and began to wind down.
One of the state-owned bank's first tasks will be dealing with disgruntled
shareholders. Mr. Darling has said an independent arbiter will value shares
of Northern Rock as if the bank had never received state support, an
approach likely to leave shareholders with next to nothing.
"We intend to pursue all action open to us in every jurisdiction possible,"
said Jon Wood, fund manager at Monaco-based SRM Advisers LP, one of two
activist hedge funds that together control about a fifth of the shares. The
two had backed the management bid.
The government's success with Northern Rock will also depend heavily on the
U.K. housing economy. That market is tottering toward a slowdown, a trend
that has already put a damper on consumer spending, which makes up more than
two-thirds of the UK economy. With UK consumers among the world's most
indebted -- their total debts amount to 164% of their annual disposable
income, by far the highest level among developed nations -- economists
expect any slowdown to bring a sharp rise in defaults on mortgage loans.
Adding to the risk, some 1.4 million mortgage holders will see their monthly
payments reset to higher levels this year.
That housing outlook means Northern Rock's new state owners will likely be
in the position of kicking some people out of their homes. "It's
inevitable," says Howard Archer, chief U.K. and European economist at Global
Insight. "Though the government has put a management team in place, it will
still be difficult."
Some competitors fret that as a state-owned entity, Northern Rock will have
unfair advantages in attracting deposits and borrowing money to fund its
business. Rating firm Standard & Poor's upgraded its credit to A from
A-minus yesterday, a change likely to trim its cost of borrowing.
Northern Rock "does have a significant cost advantage and also a
deposit-guarantee advantage," said Alex Potter, a mortgage-lender analyst at
London investment firm Collins Stewart.
Chart:
http://s.wsj.net/public/resources/images/P1-AK555A_NROCk_20080218201225.gif
Ability to Compete
The bank's ability to compete and expand its business, though, will depend
on European Union officials, to whom the government must submit a state-aid
plan by March 17. The EU has strict rules on government aid to any company,
which seek to ensure a level playing field.
The European Commission, the EU's executive arm, will look at how much the
state aid is worth to Northern Rock, in terms of how much cheaper it makes
the bank's lending and how much more attractive it makes the bank to
depositors. The Commission will try to balance that out by asking the lender
to shed assets and limit the scope of its activities.
Many analysts expect that Northern Rock's new management will be forced to
trim the business, selling off some of its £100 billion ($195 billion) in
mortgage loans to pay down its debt to the government and meet the EU's
downsizing requests. One person familiar with the matter said the U.K.
government has been told to expect the size of the bank's mortgage book to
be reduced by around 50% to 60%, so that the ratio of the mortgage loans it
has made against the deposits it has taken in is more in line with its U.K.
peers.
Shrinking the business, though, would present the difficult task of firing
many of Northern Rock's 6,300 employees. Most live near the bank's
headquarters in Northeastern England, a once heavily industrialized region
that's an important constituency for Mr. Brown's ruling Labour party.
--Cassell Bryan-Low, Mark Whitehouse, Damian Paletta and Charles Forelle
contributed to this article.
Write to Alistair MacDonald at alistair....@wsj.com1 and Carrick
Mollenkamp at carrick.m...@wsj.com2
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