A surprisingly large number of commentators seem to believe that Northern Rock’s shareholders should be eligible for some kind of compensation, following the bank’s nationalisation. To me, this seems utterly bizarre.
According to the Merril/Citi/Blackstone plan to sell Northern Rock in October 2007 (which was leaked by Bad People, and which certainly can’t be found anywhere on the Internet these days), the bank had mortgage assets in October 2007 of just over £100bn, and liabilities to retail depositors, commercial lenders and the UK government of just under £100bn, giving the company shareholders’ equity of somewhere well south of £5bn (based on its balance sheet, not on share prices).
…but answer came there none
It’s clear from the events of the last few months that there is no private investor out there who is willing to purchase Northern Rock as a going concern, or to purchase its mortgage assets at book price: if there were, then said investor would be doing precisely that right now. Why not? Well, there are two possibilities:
1) people with access to £100bn cash-money are a bit thin on the ground at the moment;
2) spending £100bn on UK residential mortgages is a terrible idea even if you do have that kind of money lying around.
If 2, then that’s a bit of a bummer for UK taxpayers; if 1, then it’s possible that in the style of Continental Illinois, we could end up making a net profit on the deal once markets recover.
Either way, it’s clear that Northern Rock is not capable of running as a going concern without taxpayer aid, and that Northern Rock’s assets are not capable of being realised at their book value [or, given the professed impossibility of valuing residential property assets accurately at present, anywhere close] – the only debate is whether, with the bank’s bust status a given, the government have just done something clever or something disastrous.
Now let’s turn to Dave, who runs a widget factory. According to the books, Dave’s widget machine is worth £103 [*]; unfortunately, he owes the bank £98, he only has a fiver of cash, the bank has just revoked his overdraft, and none of the other banks are willing to lend him any more money. Oh, and while I’d very much like to buy Dave’s widget machine, I’m only willing to pay £90 for it (nobody else can afford it at all). In short, his company is not capable of running as a going concern, and its assets aren’t capable of being realised at book value.
What happens to Dave? Well, his company goes into administration. The administrators will try and sell the company itself to start with – but if their only offers are insultingly low, then they’ll try and realise the value of his machine instead. So they’ll sell me the widget machine for £90, pay back the bank at 91p in the pound, and Dave will lose his fiver.
However, the government thinks Dave’s company is dead important and shouldn’t be allowed to fail – so instead of allowing the administrators to break it up and sell the machinery, they nationalise the company and allow it to borrow money directly from the government. Under this scenario, the bank gets paid back at full wack and the widget machine goes onto the government’s books at £103.
a) get his fiver back from the government, because that’s the value of his original stake based on the company’s balance sheet;
b) get roundly told to sod off, because his company’s already bust and he’d not have seen a penny if the government hadn’t intervened?
In the case of Dave, it’s pretty hard to opt for anything other than b. So I’m slightly confused on why some people seem to believe that Northern Rock shareholders should get a different treatment…
[*] this is its fair value based on estimated future revenues, as signed off by Dave’s accountant