Mr. Brown & Mr. Darling, please stop pissing away our money
A couple days ago I was travelling and so had time to read the FT in some detail, including the extended reporting on the ongoing Northern Rock saga and in particular the government guaranteed refinancing scheme floated by GS/the Chancellor. Basically, the idea is to refinance a big chunk of Northern Rock’s assets via a bond issue secured on these assets, enhanced with an explicit government guarantee. Many commentators have questioned this solution as a (bad-for-the-taxpayer) compromise between nationalization (politically embarrassing to Brown) and an entirely private solution (highly risky, with failure a real possibility and so equally politically embarrassing.) The quick-and-dirty analysis is that in this scenario, the government keeps all the (financial) downside, but gives up the upside if the rescue/restructuring is successful. The fact that the plan seems to include warrants (or some similar provision) for the government tacitly endorses this view (while hardly mitigating the potential outcome.)
Rather than dwell on the overall pros & cons of the proposed plan (which has been amply and eloquently done in many other places,) I just wanted to take a moment to take issue with the likely details of how such a structure would be executed. As it stands, it would seem a bond (or series of bonds) maturing in 3 or 4 years would be issued with a government guarantee. I’m not in the market anymore, but read that such securities would likely be sold at around Libor flat, which sounds reasonable and that the issuer would pay the government for it’s guarantee (ie the government is acting like a monoline insurer in this instance.) When the UK Treasury issues bonds directly - ie Gilts - at these maturies, they would be priced at around Libor -70 bps.) S0 for the Treasury to be equally well off, the issuer would need to pay an insurance premium of 70 bps on the amount guaranteed to the Treasury, or in this case c. £600mn. Of course this does not take into consideration whether or not the assets (Northern Rock mortgages, etc.) being financed are ‘good’ risks nor what it would cost to finance them without the government guarantee. Even if you accept the premise that the market is temporarily irrational and that the whole point of this government sponsored refinancing is to bridge this market dislocation, the ‘historical’ market cost of refinancing these assets would be signficantly above Libor flat. This difference should also be factored in to the insurance premium paid to the Treasury.
I hope I am wrong and that the winning package chosen by the Treasury includes a premium that is commensurate with the risks and the extra costs of using the Government’s balance sheet in this way, but my fear is that politics trumps economics and that UK taxpayers will end up taking on a substantial liability without being fairly compensated. Exactly the kind of thing that happens when you start confusing other people’s money (entrusted to you to manage) as being your own.
I hope I am wrong and the bid the Treasury ultimately accepts includes a commercially adequate insurance premium
