Northern Rock £3 Billion Bail-Out - Why Is The Government Supporting Northern Rock?

I sent a rather aggressive email this morning:

"Oi! Stop taking all our money!"

It was to a former colleague at Northern Rock. I signed it as ‘The Taxpayer’ — a stroke of satirical genius I’m sure you’ll agree...

Or maybe not. Point is, though, the government has ploughed another £3 billion into Britain’s most damaged bank. That’s a lot of money when you consider that, at its peak, the Rock was worth only £5 billion. It’s especially huge given that we will likely never see it again. The funding takes the form of a debt for equity swap. Basically, the government has agreed to waive £3 billion of debt in return for shares in the bank. There’s a strong likelihood that these shares will ultimately prove to be worthless.

So the question is, why is the government doing this? Why, at a time when the public finances are in such a state, is it putting £3 billion into a broken business that’s heavily exposed to a falling property market?

I worked in one of the Northern Rock’s mortgage centres in 2004 and 2005. A lot of our business involved the now infamous Together product — the one designed to help first-time buyers by lending them up to 125% of a property’s value.

As part of the job we naturally got to see applicants’ private financial details. Bank statements. Wage slips. Employers’ references. Loan repayments. How much it cost the applicant to drive to work. I suspect some of the applicants I saw will struggle in a recession.

I was not surprised, therefore, to read yesterday that up to 5% of Northern Rock’s mortgage book is thought to be in negative equity. The figure is expected to rise to 20% over the next year.

So why is our strapped-for-cash government putting more money into Northern Rock?

I’ll tell you why — fear. In terms of the banking industry Northern Rock was never in the ‘too big to fail’ club. But in terms of the north east economy, a precipitous collapse could have sent shockwaves. That, at least, is the fear in Westminster.

The government is resorting to old school, 1960s-style Keynesian economics. Propping up a lame duck with public money to avoid the spectre of job losses.

We shouldn’t be surprised. As I wrote here last Thursday, the government has got into the habit of giving the jobs figures a leg up.

Maybe the government is right to try and support the local economy in this way. I’m not convinced by this argument. But the politicians seem to be, so why can’t they just say so?

Instead, we have this silly pantomime of pretending that an overexposed and failed mortgage lender will return to profitability in a couple of years time.

Even though the economic downturn will sour its loan book. Even though falling house prices reduce the value of collateral. Even though its savings arm is prevented from competing aggressively for funds (European competition law bans this as the bank receives state aid).

Labour wants to avoid job losses in one of its heartlands. It wants to avoid negative headlines.

That’s the main reason it will continue to support Northern Rock. But it’s not the reason we’ll be given.

Will oil carry on falling?

Oil was at $119 this morning. That’s quite a drop from its high last month of $147.

Oil bears are starting to write the invitations to their picnic. But they should refrain from being hasty. There are two wild cards that could send the price back up whence it fell.

One is Iran. Israeli prime minister Ehud Olmert has stepped down. Mooted as a replacement is Tzipi Livni, a former Mossad agent whose mother robbed a train as part of a Zionist campaign against the British. If Israel takes a more hawkish line on Iran, might this spook the oil market, and send the price higher? The other wildcard is the hurricane season. If an ill-placed storm knocks out producing capacity, that too could cause the price to jump.

If we do see such an event, it could cause a mini chain reaction, as colleague Frank Hemsley explains:

"A lot of blame was levelled at speculators for the dramatic rise in oil prices. Everyone, it seemed, was jumping on the most exciting bandwagon in town.

"Now speculators are driving the price back down. The FT reports today that over the last week, for every buyer of insurance against a rise in prices in 2009 there were almost 10 buyers of protection against a fall.

"In other words, ten times as many traders are betting on a fall by buying put options. The Wall Street banks, who are the originators of these options, have to sell oil futures to hedge their position... which pushes the oil price down.

"All we need is a shock to reverse this trend, and send the oil price up. That would send the short sellers scrabbling to cover their positions, sending the oil price higher still."

A bullish sign for platinum?

FTSE giant Xstrata has bid £5 billion for Lonmin, a producer of platinum group metals (PMGs). Lonmin has rejected the hostile approach. It reckons it undervalues the company’s assets.

Xstrata’s bid could be interpreted as a bullish sign for platinum. Indeed, technical analysts are suggesting PMGs are oversold.

So should you be adding platinum to your portfolio right now?

Here’s our commodities expert Garry White with his view...

Until tomorrow

Ben Traynor

Editor

The Daily Reckoning - The corrections continue...

"Fed keeps short-term interest rate at 2%" says today’s big financial headline. Stock market investors loved it. They bid up the Dow 331 points. "The correction is over," they seemed to say.

The Bernanke team knew it would be damned for sending the US into recession if it raised rates. It knew too that it would be damned for allowing inflation out of its cage if it cut them. So it decided to do nothing.

"Although downside risks to growth remain," said a Fed spokesman, "the upside risks to inflation are also of significant concern to the committee."

Here at the Daily Reckoning headquarters we are fans of doing nothing — at least in financial matters. Not spending money, for example, keeps us from going broke. Not investing money often has the same effect. When it comes to money, politics or romance...the sins of omission may cause you to miss opportunities, but the sins of commission get you sent to Hell.

You can read the Daily Reckoning in full here. P.S. If you enjoyed this article then we encourage you to sign up for the free Fleet Street Daily eletter. Learn what you can expect from today's markets -- and how to prosper in the face of uncertainty. You won't find more thought provoking writing anywhere on the Internet.

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Northern Rock £3 Billion Bail-Out - Why Is The Government Supporting Northern Rock?

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Why Is The Government Supporting Northern Rock?