Select Committee on Treasury Fifth Report

9  Northern Rock since September


332. In this chapter we explore developments relating to Northern Rock since the run on its retail deposits in September. We examine the extent of State sector support for the company and the public and parliamentary accountability for that support. We also summarise information relating to the options for Northern Rock. We only took evidence once during the inquiry from the (then) current leadership of Northern Rock. The situation facing Northern Rock and the options under consideration have changed in the course of our inquiry, and have continued to change since we concluded taking oral evidence. In these circumstances, we do not seek in this chapter to reach particular conclusions about Northern Rock's future, but seek to aid understanding of the company's continued development.

The Bank of England liquidity facility announced on 14 September

333. The first public sector support for Northern Rock was the liquidity support facility advanced by the Bank of England, authorised by the Chancellor of the Exchequer and announced on Friday 14 September. We have previously discussed the role that the announcement of this facility—together with the premature disclosure of that announcement—played in the run on the Rock.[583] Here we are concerned solely with financial aspects of the facility. As was noted before, Northern Rock had hoped to use the facility as a "backstop" and had hopes that the facility would not be drawn down. In fact, because of the loss of retail deposits, Northern Rock was forced to use the facility almost as soon as it became available. It is known that, by late October, Northern Rock had drawn down about £13 or £14 billion from the facility.[584] Subsequent figures relating to Northern Rock's borrowing from the State appear to include money available from other facilities that we discuss later.[585]

334. On 19 November, the Chancellor of the Exchequer said the following about the security of Bank of England lending, including the initial facility:

    I can tell the House that Bank of England lending is secured against assets held by Northern Rock, which include high-quality mortgages with a significant protection margin built in and high-quality securities with the highest quality of credit rating. The Bank is the senior secured creditor.[586]

The Governor of the Bank of England told us in December that the initial facility from the Bank of England was "securitised against collateral that is in is our possession; we have that in our accounts",[587] and then expanded upon this:

    On the original Bank of England facility there is name-specific collateral, which is already in our possession in our accounts in Euroclear and so on—that is already legally in our possession—there is a margin over the extent of the loan, so that we are a clear margin above the value of the loan.[588]

The deposit guarantees of September and October

335. The initial Government guarantee on Northern Rock deposits was announced on Monday 17 September in circumstances we considered earlier.[589] The announcement did not take place until late that day even though the decision in principle to provide it had been reached the previous day because, in the Chancellor of the Exchequer's words, "when I announced the guarantee, I wanted to be pretty clear what exactly I was announcing because people would want to know beyond doubt what the position was".[590] The initial guarantee announced on 17 September referred to "all the existing deposits in Northern Rock" and was set for the duration of "the current instability in the financial markets".[591] As the Chancellor of the Exchequer noted, the terms of the guarantee have gone through several changes since that initial announcement.[592]

336. On Thursday 20 September, the Treasury modified and clarified the coverage of the guarantee. The Treasury stated on that day that the guarantee "would cover all accounts existing at midnight on Wednesday 19 September". It was also made clear that the "guarantee covers future interest payments, movements of funds between existing accounts, and new deposits into existing accounts". In addition, to assist in re-building Northern Rock's depositor base following the run, the guarantee was extended to "cover accounts re-opened in the future by those who closed them between Thursday 13 September and Wednesday 19 September". In relation to wholesale deposits, it was stated that the guarantee covered "existing and renewed wholesale deposits; and existing and renewed wholesale borrowing which is not collateralised".[593] The guarantee did not cover other debt instruments such as "covered bonds", securities issued under the "Granite" securitisation programme and subordinated and other hybrid capital instruments.[594]

337. On 9 October, the guarantee was further extended to all retail deposits made with Northern Rock since 19 September. This additional guarantee was put in place at the request of Northern Rock and was intended to "allow the Company to continue to pursue the full range of its strategic options". The Treasury also announced that "Northern Rock plc will pay an appropriate fee for the extension of the arrangements, which is designed to ensure it does not receive a commercial advantage".[595] The fee was subsequently described as being one "from which the Treasury will benefit", which was "set at a higher rate than the interest premium on the additional facilities" that we consider later.[596]

338. On 11 October, the Treasury clarified that the Government guarantee was intended to "supplement, and not replace, any compensation provided by the Financial Services Compensation Scheme (FSCS), which the Financial Services Authority has recently extended to cover 100% of the first £35,000 of deposits".[597] In chapter 6 of this Report, we described some of the limitations of the deposit protection available under the Financial Services Compensation Scheme. Most of these limitations do not currently affect Northern Rock depositors, because those depositors have comprehensive cover under the Treasury guarantee. However, we noted in that chapter that there is a power under the FSCS for deposits to be off-set by liabilities such as mortgages.[598] If such a power existed in relation to the guarantee to Northern Rock depositors, the effect would be that such depositors who also held a mortgage with Northern Rock would not be guaranteed a return on the guarantee in the form of a liquid asset in the event that it were to be invoked. We recommend that the Government clarify as a matter of urgency whether, in the event of the retail deposit guarantee for Northern Rock being invoked, any payments due to depositors would be off-set against depositors' mortgages with Northern Rock.

339. The guarantee would only be engaged in a situation where Northern Rock was itself unable to meet its payments. The Chancellor of the Exchequer told us in October that he was not contemplating the bankruptcy of Northern Rock.[599] The Treasury liability in the event that Northern Rock entered into administration or was otherwise unable to meet its commitments to depositors relates to the value of deposits in excess of the limit of £35,000 under the FSCS, together with the complete value of any deposits that are not eligible. The Treasury declined our request to provide information on the scale of this liability. Assuming that the value of Northern Rock's assets exceeds its liabilities—an assumption that we consider later in this chapter[600]—the Treasury would expect to recoup the costs of payments under the guarantee in due course.

340. The guarantee on Northern Rock's retail deposits was necessary to stop the run on those deposits. The guarantees issued in September and October to categories of wholesale deposits with Northern Rock assisted with the stability of the company during that period and since. One effect of the various Government guarantees issued in September and October has been to reinforce the incentive for the Government to help to ensure that Northern Rock remains a going concern that honours its commitments to depositors.

The additional facilities announced on 9 October

341. On 9 October, the Bank of England announced that "additional facilities" would be available to Northern Rock "through the Bank of England".[601] On 11 October, the Government provided further information about these new lending facilities for Northern Rock, which would be additional to the support facility advanced by the Bank of England in September. The additional facilities were intended to enable Northern Rock to "pursue the full range of strategic options open to it"—options that we consider later in this chapter[602]—and were limited to the period needed to pursue such options, a process that was to be completed by February 2008.[603] Like the facility announced on 14 September, the new facilities would be provided through the Bank of England, but the ultimate risk of default was to be borne by the Treasury rather than the Bank of England:

    These facilities are uncommitted and are, therefore, not subject to any specific borrowing limit. They are repayable on demand and will incur a premium rate of interest. The interest premium will roll up and rank alongside the company's Tier II regulatory capital. The facilities are secured against all assets of the company but in view of the scale and nature of the new facilities, the Treasury has agreed to indemnify the Bank of England should the Bank of England face a deficit having previously made all reasonable endeavors [sic] to recover its claims on the company. The interest premium will therefore be passed to the Treasury.

    The Treasury has also indemnified the Bank of England against other liabilities that might arise from the Bank of England's role in the extended guarantee arrangements and additional facilities.

    The company has in turn indemnified the Bank of England and the Treasury in respect of the guarantee arrangements and certain costs and expenses, including our advisor costs. The company has also agreed to the usual range of lender protections typical for facilities of this nature.[604]

The Governor of the Bank of England, in December 2007, explained the difference between these additional facilities and the earlier facility announced on 14 September:

    The second facility, introduced in October, is the facility from the Government through the Bank of England to Northern Rock with an indemnity from the Government, and that is entirely at the risk of the Government and, therefore, they determine what happens to it.[605]

342. The Chancellor of the Exchequer emphasised that the Government facilities provided through the Bank of England were "secured against collateral",[606] although the Governor of the Bank of England subsequently noted that the collateral was not the same as the "name-specific" collateral relating to the Bank of England facility of 14 September:

    The second facility is basically covered by a floating charge of all the assets of Northern Rock, the whole lot, right down to the paper clips … [The Treasury] are the ones bearing the risk.[607]

Although these facilities have no "specific borrowing limit",[608] Mr Nicholas Macpherson, the Treasury's Permanent Secretary, indicated that the collateral available against borrowing would exceed the lending provided, as a result of an arrangement known as a "haircut",[609] a term defined by Mr Clive Maxwell, Director, Financial Services, in the Treasury:

    A haircut is the amount of discount you set against some collateral that somebody provides against a loan, so if you are making a loan to somebody and you take an asset which on the face of it is worth £100, you might apply a haircut to that so that you consider it as being worth £90 because you do not know how much it might be worth in the future. That is how a haircut works.[610]

343. Mr Macpherson subsequently explained that "the design of the arrangements and facilities, through … the premium rate of interest on the facility, the security of the facility against all the assets of the company and the indemnity to the Government for certain costs" reflected the principle of minimising the cost to the taxpayer. He also confirmed that "the interest premium to be paid ultimately to the Treasury … has been rolled-up and subordinated as tier two debt".[611] The effect of the treatment of this liability as tier two debt is to provide that the Treasury—in relation to the interest premium—does not have the same status of "senior secured creditor" as the Bank of England has in relation to the wider support.[612] In January, we asked the Treasury why it had accepted this lower status, and Mr John Kingman, Managing Director, Public Services and Growth, provided the following explanation: "We took that decision in the context of our wider aim which is to create a period in which there is stability for the bank … The premium over and above base rate is rolled up."[613] In November, the Chancellor of the Exchequer emphasised that the liability for the interest premium in relation to which the Treasury was bearing a higher risk related to "a small amount of money".[614] In January, Mr Kingman stated: "The amount involved is not gigantic in the context of the sums involved in Northern Rock, it is well under £100 million that we have given that agreement." [615]

The discussions on State aid rules up to early December

344. The three forms of support that we have described—the Bank of England liquidity facility announced on 14 September, the various retail and wholesale deposit guarantees of September and October, and the additional facilities announced on 9 October—were all intended to be of limited duration. The first of these was described on 14 September as being available "to help Northern Rock to fund its operations during the current period of turbulence in financial markets while Northern Rock works to secure an orderly resolution to its current liquidity problems".[616] The initial deposit guarantee was initially intended to last "during the current instability in the financial markets",[617] and the Chancellor of the Exchequer confirmed on 19 November that "the guarantee will not be removed without proper notice being given to depositors".[618] The duration of the additional facilities announced on 9 October was not stated explicitly, although it was designed in part to support Northern Rock's consideration of strategic options, a process which the Treasury stated on 11 October "will be completed by February 2008".[619]

345. When he gave evidence in late October, the Chancellor of the Exchequer was slightly more precise about the timetable and set out one reason why State support was viewed as time-limited:

    We have asked the Northern Rock bank to come back to us with its proposals by the beginning of February and obviously, I am willing to review the situation at that time. We do have a State aid issue in that, as you know, there comes a point where the [European] Commission will say this is going on for too long. I am not sure that is an immediate problem but I really want to get across to the bank that they have a breathing space, if you like; they need to consider their options; they have a new chairman now and they need to consider what the best course of action is for the bank. That is their decision, they are the directors, they own the company but we have given them that breathing space and we have said to them 'Look, you need to come back by the beginning of February'.[620]

346. According to the European Commission, "The objective of State aid control is, as laid down in the founding Treaties of the European Communities, to ensure that government interventions do not distort competition and intra-Community trade. In this respect, State aid is defined as an advantage in any form whatsoever conferred on a selective basis to undertakings by national public authorities".[621]

347. The Chancellor of the Exchequer subsequently added that the beginning of February was not "a drop dead date",[622] but also went on say:

    We have to get State aid clearance for this sort of support and the State aid rules are quite clear, you can do this sort of thing to provide support in times of difficulty like Northern Rock but you cannot do it in perpetuity.[623]

Mr Maxwell also stated that:

    There are different ways in which you can apply for State aid approval and some of those approvals have certain time limits on them … Rescue aid, for example, usually has initial limits around six months.[624]

The Chancellor of the Exchequer then drew attention to the importance of the word "usually" in that last sentence.[625]

348. On 26 November, following "intensive contacts" between the UK authorities and the European Commission, the Treasury provided the Commission with full details of measures taken to support Northern Rock.[626] On 5 December, the Commission announced the following decisions relating to that support:

  • The emergency liquidity assistance provided by the Bank of England and announced on 14 September, which was secured by sufficient collateral and was interest-bearing, did not constitute State aid;
  • The guarantee on deposits offered on 17 September, as well as the subsequent extension of that guarantee, did constitute State aid; and
  • The additional facilities announced on 9 October also constituted State aid.[627]

The Commission announcement went on to state:

    These aid measures can be authorised as rescue aid in line with the Community Guidelines on State aid for rescuing and restructuring firms in difficulty. Under these rules, rescue aid must be given in the form of loans or guarantees lasting no more than six months, although there are certain exceptions to these rules in the banking sector, in order to allow for prudential requirements, which have been applied in this case.[628]

Having concluded that the measures complied with EU rules on rescue aid, the Commission also stated:

    The approval of the rescue aid measures has no bearing on whether any future measures taken by the UK authorities to support a restructuring plan would be similarly approved. Any such measures would have to be assessed on their own merits according to the rules on restructuring aid to establish whether aid was involved, and if so whether there was sufficient restructuring to offset any distortion of the competition caused by the aid and to ensure the future viability of the company without further State aid.

    … The UK authorities have given a commitment to deliver to the Commission by 17 March 2008 a plan for Northern Rock going beyond the short-term rescue. If a restructuring plan were to involve State aid, it would have to be assessed on its own merits under the rules on restructuring aid.

349. According to the European Commission, restructuring aid must be based on "a feasible, coherent and far-reaching plan to restore a firm's long-term viability". The restructuring plan, the duration of which must be as short as possible, must restore the long-term viability of the firm within a reasonable timescale, although there is no specified time limit for completion of the restructuring plan. The general principle used by the Commission in assessing suitability of restructuring aid is that the Commission will allow the grant of such aid "only in circumstances in which it can be demonstrated that it does not run counter to the Community interest". Such agreement will only be granted if strict criteria are met, and if it is certain that any distortions of competition will be offset by the benefits flowing from the firm's survival and that, in principle, there are adequate compensatory measures in favour of competitors.[629] With regard to the duration of restructuring aid, the Commission has stated:

    Where restructuring operations cover several years and involve substantial amounts of aid, the Commission may require payment of the restructuring aid to be split into instalments and may make payment of each instalment subject to: (i) confirmation, prior to each payment, of the satisfactory implementation of each stage in the restructuring plan, in accordance with the planned timetable; or (ii) its approval, prior to each payment, after verification that the plan is being satisfactorily implemented.[630]

The further extension of the Government guarantee in December

350. On 18 December, the Government granted a further extension of the earlier guarantee arrangements, at the request of Northern Rock, "to the following unsubordinated wholesale obligations, whether now existing or arising in the future:

The Treasury stated that "Northern Rock plc will pay an appropriate fee for the extension of the guarantee arrangements".[632] The Treasury also gave further information about the duration of the guarantees, clarifying the commitment given in November to give "proper notice" of the removal of the guarantee:[633]

    As previously announced, the arrangements to protect retail and wholesale depositors of Northern Rock plc will remain in place during the current instability in the financial markets. Reasonable notice, which will not be less than 3 months, will be given by HM Treasury of any termination of these arrangements.[634]

351. On 18 December, in oral evidence, Sir John Gieve confirmed that the extension announced earlier that day "does widen the scope of the guarantee to pretty much the whole balance sheet, excluding the capital instruments and the Granite securitised instruments".[635] He said that it covered "nearly all the wholesale deposits" of Northern Rock.[636] With specific reference to "covered bonds"—a term we defined earlier in this Report[637]—Sir John said: "part of the announcement today was to cover the liability that may arise if the obligations exceed the proceeds of the realised collateral on those covered bonds".[638] The Governor of the Bank of England characterised the announcement of 18 December as "a natural extension to help the company".[639] In January, asked about the gradual extension of the Government commitment to Northern Rock, the Chancellor of the Exchequer said that the initial commitment in September had been made in view of "a wider systemic risk to the financial system" and, "having offered that support, we need to see that through".[640]

Security of the overall State commitment

352. On 25 October 2007, the Chancellor of the Exchequer told us, in relation to the State lending to Northern Rock up to that point, "we fully expect to be able to get that money back".[641] On 10 January 2008, when we asked whether he remained as confident about this point, he replied:

    Yes, one of my objectives is to make sure we do get our money back. When we reach a conclusion, whatever that conclusion is, one of the priorities, in addition to protecting depositors, is to make sure that we get our money back. [642]

353. The confidence in the security of State lending to Northern Rock and of State guarantees appears to be based on the view of the Tripartite authorities that the company has balance sheet solvency—in other words that Northern Rock's assets exceed in value the company's liabilities, including those to the State. On 14 September, the judgement of the FSA had been that "Northern Rock is solvent, exceeds its regulatory capital requirement and has a good quality loan book".[643] On 25 October, the Chancellor of the Exchequer reaffirmed that "Northern Rock is and was solvent",[644] and, on 19 November, he told the House that "the Financial Services Authority has said before, and continues to say, that Northern Rock's main asset base—its mortgage book—is strong and sound".[645]

354. On 11 December, Sir Callum McCarthy expanded upon the reasons for the FSA's continued judgement that Northern Rock was solvent:[646]

    We have looked at the assets it has and the demands on those assets and believe that those assets meet those demands. The amount that has come from the taxpayer is secured against the assets of Northern Rock … We would not deem it solvent unless we believed it could [meet all its obligations within the normal course of its business].[647]

Sir Callum also noted that, without the liquidity that Northern Rock was receiving through the Bank of England, the company "would have failed".[648]

Reporting and parliamentary accountability

355. The range and extent of State support for Northern Rock has created liabilities for the taxpayer in the form of conditional commitments to future public expenditure. In general, should such liabilities eventually give rise to the need for public expenditure, they would require the authority of an Appropriation Act and possibly also specific enabling legislation.[649] Many such liabilities are characterised as "contingent liabilities", in that the commitment only gives rise to expenditure in certain circumstances.[650] The State commitments to Northern Rock represent such contingent liabilities, in that it is the intention of the Government that the liabilities will not give rise to an actual charge upon the public purse. In this section, we consider how effectively the Treasury has accounted to the House of Commons for these contingent liabilities.

356. Under the relevant Treasury guidance published in 2007 and contained in a document entitled Managing Public Money, there is a general statement that "Parliament expects to be notified of the existence" of any contingent liability when it is entered into.[651] The same guidance also states that, where a liability is entered into with little notice, it should be reported to Parliament "at the earliest opportunity".[652] The standard procedure for such reporting is the laying of a minute before the House of Commons, which should, according to the Treasury guidance, "describe the amount and the expected duration of the proposed liability, giving an estimate if precision is impossible".[653] The guidance notes that "sometimes it is not possible to give details of a contingent liability with full transparency" and goes on to state that, "in such circumstances, the department should write to the chairs of both [the Committee of Public Accounts] and the [relevant] departmental committee" to provide on a confidential basis the details that otherwise would have been included in the minute.[654] The guidance also states that a minute should be laid "if an originally confidential liability … can be reported transparently".[655]

357. On 20 September, the Chancellor of the Exchequer wrote to the Chairman of this Committee noting that a contingent liability had been incurred and explaining the circumstances of special urgency which meant that advance notice could not be given of the liability. This letter was published at the time by the Treasury. On 11 October, the Chancellor of the Exchequer wrote again to the Chairman explaining the extension of the contingent liability arising from the announcements of 9 October relating both to the extended guarantee and the additional lending facility.[656] Neither of these letters contained confidential information. On 22 November, we asked the Treasury whether a minute had been laid before the House of Commons in accordance with its own guidance and whether the Treasury had considered providing further information to the relevant select committee chairmen on a confidential basis.

358. On 26 November, the Treasury for the first time laid a minute before the House of Commons relating to the contingent liability.[657] This minute provided no new information about the scale of these liabilities; most of it was devoted to an account of the announcement by the Board of Northern Rock that morning relating to a bidder for Northern Rock, an announcement which is discussed further below. In reply to our requests of 22 November, Mr Macpherson referred to the minute of 26 November and went on to say:

    At the time that the guarantees and indemnity were granted, a formal minute was not laid. While I accept that a formal minute would have been preferable, the Chancellor was explicit about the guarantee and resulting contingent liabilities in his oral statement and letters to the chairs of the [Treasury Committee] and [the Committee of Public Accounts], copies of which were placed in the Library of the House. I therefore consider that we have disclosed everything directly to the House—and the market—in a form that took into account the technical, commercial and policy issues.[658]

359. Although Mr Macpherson believes that the Treasury has "disclosed everything", it has not followed its own guidance, which refers specifically to the provision in the minute or on a confidential basis of the amount or the estimated amount of a contingent liability.[659] It is known that between £13 and £14 billion had been drawn down from the initial support facility by late October.[660] In early December, Northern Rock disclosed that it had borrowed £25 billion from the Bank of England.[661] The scale of the contingent liability relating to the guarantee on Northern Rock deposits has not been acknowledged. Sir John Gieve confirmed that it covered "nearly all of the wholesale deposits" of Northern Rock, but the last reported information on the scale of such deposits was that available from Northern Rock's balance sheet as at 31 December 2006. Similarly, the Treasury has not disclosed information about the scale of the contingent liability relating to all retail deposits that are not covered by the FSCS.

360. On 19 November, the Chancellor of the Exchequer told the House of Commons:

    I know that there has been interest in how much support the Bank of England is giving. The Bank publishes its balance sheet every week. However, in common with other central banks, it does not provide details of any operations because it believes that doing so would undermine its ability to provide such support. I understand the frustrations that that can sometimes cause, but to provide what would, in effect, be a running commentary on any operations would be likely to have adverse affects that none of us would want.[662]

The Bank of England weekly balance sheet to which the Chancellor of the Exchequer referred includes lending to Northern Rock within the category of "Other assets", and that category is not broken down further. On 16 January 2008, the total value of the Bank of England's "other assets" was £43,402,237,127, but this amount does not imply that lending to Northern Rock had risen to £43 billion.[663] The position of the Bank of England as described by the Chancellor was reaffirmed by the Governor in evidence in December:

    I am not going to give a number today, because I do not think the central bank in its role as lender of last resort should be giving a sort of public commentary, minute by minute, on the scale of any facilities. What we have said is that if it would help the company itself to reveal the scale of the borrowing, then it is free to do so.[664]

On 21 January 2008, the Chancellor assured the House of Commons that the Bank of England's lending to Northern Rock would be "repaid in full" but gave no indication of when the amount of that lending would be put in the public domain.

361. Under the Treasury's own guidance, Estimates and Supplementary Estimates must include a note giving details of any contingent liabilities in force.[665] The principle underpinning that requirement is that the House of Commons should be informed at the earliest possible opportunity of any commitment that might give rise to a subsequent request for formal authorisation of expenditure and that does not have a current statutory authority. In view of the fact that the contingent liability had first been acknowledged on 20 September, we asked the Treasury why there was no reference to the contingent liability of that date or any subsequent contingent liability in the Winter Supplementary estimates published on 15 November. In response, Mr Macpherson stated that "we will … make a note of the contingent liability in the Spring Supplementary Estimates",[666] which are usually published in mid-February.

362. State support for Northern Rock has involved the Government entering into contingent liabilities on a very large scale. It is important that the Treasury discharges its obligations to the House of Commons—and through the House of Commons to the taxpayer—promptly and fully to report on the extent of such liabilities. The actual level of Bank of England support underwritten by the taxpayer is not specified within the Bank of England return. The Government itself should not have relied upon either the Bank of England or the Northern Rock to be the sole sources on the scale of the State commitment. The House of Commons should be updated about the scale of the commitment on a quarterly basis.

Tripartite influence on Northern Rock's business until December

363. In mid-October, the then Chairman of Northern Rock told us that Northern Rock was being run by its Board.[667] In late October, the Chancellor of the Exchequer also said that "Northern Rock is and remains the property of its shareholders and it is run by its directors".[668] He told us that, while he had been consulted over the appointment of a new Chairman, the changes in Board membership were for the Board itself.[669]

364. Witnesses from Northern Rock told us that no particular governance conditions had been attached to State support,[670] but also stated that the Tripartite authorities, and the FSA in particular, were "involved in considerable detail in overseeing what we do".[671] Until mid-September, Northern Rock had intended to pay a dividend to shareholders that it had announced in July. The then Chairman of Northern Rock confirmed that the Board had listened to the views of the FSA and others before reaching its final decision not to pay the dividend.[672] On 19 November, the Chancellor of the Exchequer said:

    As with any lender on this scale, we have ensured that the Bank [of England]'s lending is subject to significant conditions and controls to ensure that our interests are protected, and, in return for that facility, Northern Rock has agreed a number of controls, including not declaring, making or paying any dividend without the prior written consent of the Bank of England, and not making any substantial change to the nature of its business.[673]

365. In January, Mr Kingman explained that the Treasury had used its leverage when lending money to Northern Rock to secure control over its business model, but he warned that that level of control could have a detrimental effect, stating that:

    We have, as you would expect, lent rather a large sum of money to this bank and taken very significant loan protections, as you would expect in this sort of situation, which means that a whole variety of commercial decisions they have to take require the authorities' agreement. That is obviously not a fantastically sustainable way to run the business and any solution will have to protect our interests in an ongoing way, but allow genuine commercial decision-making.[674]

In chapter 5 of this Report, we examined the extent to which a relevant authority might be given greater control of the affairs of a failing bank. The Chancellor of the Exchequer indicated that his experience in the case of Northern Rock had led him to favour future provision for "the availability of powers … to take greater control" in future cases comparable to that of Northern Rock.[675] We note that a very large commitment was made to Northern Rock without any clear public statement of the safeguards that were put in place to protect taxpayers' money. We share the sentiment of the Chancellor of the Exchequer that powers should be available in future cases, and it is for this reason that we have recommended that the relevant authority should have the powers of prompt corrective action and the powers for the administration of banks without jeopardising the availability of deposits.

Options for Northern Rock under consideration: September to November

366. In the period between September and November 2007, Northern Rock appears to have searched for a private sector take-over as a solution to its difficulties. On 25 September, Northern Rock announced that:

By 9 October, Northern Rock had announced that it had appointed Citi and Merrill Lynch to advise it on a "range of options for the future of the Company and these discussions [on potential buyers]".[677] On 11 October, the Tripartite authorities stated the conditions under which the Tripartite authorities would consider proposals for Northern Rock. These were that proposals protected taxpayers, promoted financial stability and protected consumers.[678] The Chancellor later confirmed that these conditions would have equal weight when considering proposals.[679]

367. On 12 October 2007, Virgin Group "submitted a non-binding indication of interest" to the Board of Northern Rock.[680] On 15 October, Northern Rock announced that the company was:

    working with a number of potentially interested parties regarding proposals for a variety of potential transactions as well as developing further options to explore with new parties as part of its review of all strategic options in the interests of shareholders, customers and other stakeholders.[681]

368. On 31 October, it was announced that the number of advisors to Northern Rock had grown, as The Blackstone Group LP joined Citi and Merrill Lynch. This also meant that Blackstone would not take part in the bidding process for Northern Rock.[682] On 12 November 2007, Olivant Advisers Limited indicated that it was preparing a bid for Northern Rock. In their statement, they provided an outline of that bid:

    Olivant, an independent investment group, today announces that it is preparing a proposal for the Board of Northern Rock. The proposal would involve the immediate introduction into Northern Rock of a core team of Olivant's experienced principals, led by its chairman, Luqman Arnold, to work intensively alongside its existing Board and management, together with a subscription of a minority stake in Northern Rock, intended to ensure Olivant's alignment with the Board and shareholders. Olivant is not proposing an offer for the shares of Northern Rock.[683]

369. On 14 November, the Chancellor of the Exchequer explained that:

    We have allowed the directors a breathing space to decide on the strategic options for Northern Rock. That is what they are doing, and it is best that they be allowed to do that, because it is in everyone's interest that we try and find a satisfactory solution.[684]

On 19 November, Northern Rock provided information about the offers that it had already received:

    The proposals received by the Company are of two types:

    (i) proposals to invest in the Company (including through an injection of assets as well as new capital); and

    (ii) proposals to acquire parts of the business or assets of the Company.[685]

This announcement also contained a warning to shareholders:

    While further analysis and discussion of the proposals is required, based on the information it has so far, the Board of Northern Rock believes that the range of values for the existing equity implied by the proposals is materially below the market price at the close of business on Friday 16 November 2007. The value to shareholders from any of the proposals (and indeed any of the other strategic options available to the Company) remains highly uncertain and will be dependent, among other things, on when and if there is an improvement in market conditions including access to liquidity and the value created, if any, from the run off of the assets and liabilities remaining in the Company following any disposal of all or part of its business.[686]

As well as this announcement by Northern Rock, the Treasury set out the principles that it would use to assess the proposals being put forward for Northern Rock. As well as reiterating the three conditions stated on 11 October 2007, the Treasury also noted that:

    Interested parties should not assume at this stage that the current Bank of England loan facilities will be available beyond either any sale or the expiry of the facilities in February. However, the Authorities are willing to discuss any proposals made; any proposal that envisages an ongoing role for the Authorities, beyond their usual statutory and regulatory functions, will be evaluated on its merits against the Authorities' stated objectives. The Authorities expect the costs and risks associated with Northern Rock to be borne to the greatest extent possible by the current and future private sector providers of capital..[687]

370. On 21 November 2007, Northern Rock stated that it had received further offers since 19 November 2007.[688] On 26 November 2007, Northern Rock declared that, having considered all the offers and conducted discussions with some of the interested parties:

    And following discussions with the Tripartite Authorities (the Bank of England, HM Treasury and the Financial Services Authority), the Board has concluded that it wishes to take forward discussions on an accelerated basis with a consortium comprising Virgin Group, WL Ross & Co, Toscafund Asset Management LLP and First Eastern Investment Group (the 'Virgin Consortium').[689]

Options for Northern Rock under consideration since December


371. Some of the public debate on the future of Northern Rock has concentrated on the issue of ownership. The real decision is whether to wind the business down or attempt to give it a future on a new basis.


372. The "accelerated basis" for the discussions with the Virgin Consortium seems to have led to a statement by Olivant on 7 December 2007, in which it disclosed that it had "submitted today further detailed materials in support of its indicative proposal to the Board of Northern Rock plc".[690] This intervention appears to have been successful in persuading Northern Rock to consider the Olivant proposal further, because on 13 December 2007, Northern Rock made the following declaration:

    Since its announcement on 26 November 2007, the Company has continued to pursue discussions with the Virgin Consortium on an accelerated basis. At the same time, the Company has engaged with other parties, including Olivant, to explore their expressions of interest as part of its review of its strategic options in the interests of shareholders, creditors, customers and other stakeholders of the Company.[691]


373. One of the potential routes for resolving the problems with Northern Rock has been nationalisation. However, this option has been regarded by the Tripartite authorities, according to Sir John Gieve, as a "Plan B" after a private sector sale.[692] However, in the event that Northern Rock were nationalised, Sir John Gieve told us that "it would be possible to pass many of its activities to other institutions in the private sector".[693] The Governor of the Bank of England told us that nationalisation ought to be regarded as a means of achieving change:

    If we were to get to nationalisation (and I stress 'if'), then I think it would be better if it could be used as a means of breaking the log-jam and going into an arrangement which would pass very quickly to a new management team and, ultimately, to a new ownership team.[694]

374. When we asked the Chancellor of the Exchequer about the compliance of possible nationalisation legislation with the European Convention on Human Rights, he pointed out that consideration of the Human Rights Act would be automatic, telling us that "as you know, legislation has to be compatible with human rights and indeed the Minister introducing the Bill has to sign a certificate to that effect and, if not, they have to say it explicitly".[695] The Chancellor also told us that:

    The Government is legally obliged to obey the law. There is no surprise there. When we introduced the Human Rights Act, I think at the end of the last decade, we were very aware of that and so we have to take that into account, but, …, equally I am quite sure that people who have been buying Northern Rock shares since September were fully aware of its present circumstances.[696]

375. One other aspect of nationalisation preparations we considered was the creation of a team to run Northern Rock after nationalisation. Sir Callum McCarthy, when asked where in the public sector there was expertise to run a nationalised bank, told us "If that eventuality occurred [nationalisation], it would be necessary to find a team to do so".[697] The Government appears to have begun to work on this, because by 12 January 2008, media reports suggested that Ron Sandler had been lined up as executive Chairman of Northern Rock should it be nationalised.[698]

Announcement on 21 January 2008

376. On 21 January 2008, the Treasury issued a statement detailing how it would proceed with offers for Northern Rock. This statement indicated that the current support for Northern Rock would continue until 17 March 2008.[699] To aid a sale of Northern Rock, the Treasury put forward a financing option that would be available to potential private sector parties. The Chancellor explained how this financing option would work:

    Northern Rock would raise the funds it needs from investors by selling assets. The Treasury would guarantee payment to these investors in the event that the assets were insufficient to meet its obligations, for which Northern Rock would pay the Treasury a fee. In this arrangement, shareholders and other providers of capital in Northern Rock accept the first risk; with the Government acting as a backstop.[700]

The Chancellor of the Exchequer also explained in his statement to the House why he thought that a purely private sector solution for Northern Rock was impossible:

    Whilst conditions [in financial markets[ are better now than they were before Christmas they remain difficult and the Government's financial advisers believe that there is no chance of achieving a private sector deal backed entirely with private finance in the near future.[701]

377. The plan set out on 21 November requires approval by the European Commission in line with the State aid rules relating to restructuring of a company that we referred to earlier.[702] The Treasury statement set out what would be required of bidders should they wish to follow this plan:

    implementation of the financing structure would require the submission by HM Treasury to the European Commission of an appropriate restructuring plan and the authorisation by the Commission of any state aid which it involves. The company and other relevant interested parties would be expected to assist HM Treasury with the preparation of such a plan. Implementation of the financing structure would follow receipt of the necessary state aid authorisation.[703]

378. The Treasury emphasised that the solution to the financing problem proposed in the statement of 21 January did not rule out the possibility of nationalisation. In his statement to the House, the Chancellor said that "I will only authorise support for the private sector if the public interest will be better served than through taking the company into temporary public ownership".[704] The market statement by the Treasury outlined what would happen to Northern Rock if it were nationalised because a private sector solution was not forthcoming. The Treasury sought to reassure savers and borrowers that Northern Rock would continue to operate as it did now in the event of nationalisation.[705] However, the management would change. The Treasury stated that, should Northern Rock be brought into temporary public ownership, the company "would be managed on arms' length terms, as a commercial entity, by a newly appointed experienced and professional management team".[706] The Treasury also stated what would happen to shareholders should Northern Rock have to be nationalised:

    It is envisaged that any such power would be used to transfer Northern Rock's share capital, including its preference shares, into public ownership. It is anticipated that the remaining Tier 1 and Tier 2 capital instruments would continue in their existing ownership as listed securities. Holders of these capital instruments would remain at risk of first loss ahead of the Bank of England and HM Treasury as providers of secured financial support to the company.[707]

To compensate shareholders for the loss of their shares, the Treasury envisaged an

    assessment by an independent valuer of compensation payable to any holder of securities transferred to HM Treasury. The principles for assessing compensation, which would be set out in the legislation brought forward, would reflect the principle that the Government should not be required to compensate shareholders for value which is dependent on taxpayers' support and the fact that public sector ownership would be an alternative to an administration of the company. Accordingly, the compensation would be assessed by the valuer on the basis, among other things, that all financial assistance to Northern Rock from the Bank of England or HM Treasury (including HM Treasury's existing guarantee arrangements) had been withdrawn and no other financial assistance (apart from Bank of England assistance on its usual terms through standing facilities or open market operations) were made available by them to Northern Rock.[708]

379. The Treasury noted that "The Tripartite Authorities do not consider that an administration of Northern Rock would meet [their stated] objectives". [709] The Chancellor in his statement to the House explained why he could not agree with administration:

    Administration would mean that control would immediately pass to an administrator who would look to realise the value of the company's assets which, under current market conditions, would amount to a fire sale. It could also exacerbate current market turbulence. And costs would be significant. I have therefore rejected such a proposal.[710]

380. In his statement of 21 January, the Chancellor of the Exchequer also referred to the possible implications for fiscal policy of his announcement on that day:

    It is for the independent Office of National Statistics to determine whether or not Northern Rock is classified to the public sector in the National Accounts. Any liabilities classified to the public sector would be temporary and backed by significant assets and do not represent any meaningful measure of fiscal sustainability. The Code for Fiscal Stability—underpinned in legislation passed by this House—provides for such situations.

Paragraph 11 of The Code for Fiscal Stability states:

    The Government may depart from its fiscal objectives and operating rules temporarily, provided that it specifies:

    a. the reasons for departing from the previous fiscal policy objectives and operating rules;

    b. the approach and period of time that the Government intends to take to return to the previous fiscal policy objectives and operating rules; and

    c. the fiscal policy objectives and operating rules that shall apply over this period.[711]

We expect to explore the implications for fiscal policy of the Government's decisions relating to Northern Rock in due course.

583   See paragraphs Error! Reference source not found.-Error! Reference source not found.. Back

584   Q 821 Back

585   See paragraphs Error! Reference source not found.-Error! Reference source not found.. Back

586   HC Deb, 19 November 2007, col 960 Back

587   Q 1703 Back

588   Q 1710 Back

589   See paragraphs Error! Reference source not found.-Error! Reference source not found.. Back

590   Q 1761 Back

591   HM Treasury press notice 95/07, 17 September 2007 Back

592   Q 1760 Back

593   HM Treasury press notice 96/07, 20 September 2007. On 21 September, the Treasury confirmed that "renewals with Northern Rock plc of existing uncollateralised deposits and wholesale borrowing and retail bonds (in each case up to the same maturity) are covered for the term of the renewal": HM Treasury press notice, 21 September 2007, "Northern Rock plc RNS". Back

594   HM Treasury press notice 96/07 Back

595   HM Treasury press notice 104/07, 9 October 2007 Back

596   HM Treasury press notice 107/07, 11 October 2007; see paragraph Error! Reference source not found.. Back

597   HM Treasury press notice 107/07, 11 October 2007 Back

598   See paragraphs Error! Reference source not found.-Error! Reference source not found.. Back

599   Q 848 Back

600   See paragraphs Error! Reference source not found.-Error! Reference source not found.. Back

601   Bank of England News Release, "Northern Rock plc deposits", 9 October 2007 Back

602   See paragraphs Error! Reference source not found.-Error! Reference source not found.. Back

603   HM Treasury press notice 107/07, 11 October 2007 Back

604   Ibid. Back

605   Q 1703 Back

606   Q 822 Back

607   Qq 1710-1711 Back

608   HM Treasury press notice 107/07, 11 October 2007 Back

609   Q 825 Back

610   Q 826 Back

611   HC (Session 2007-08) 57, Ev 80 Back

612   Tier 2 capital is debt that is subordinated to the majority of other calls on a bank. It is divided into Upper Tier 2 and Lower Tier 2. Upper Tier 2 debt is undated. It must be of a type unlikely to threaten the solvency of the bank. Lower Tier 2 capital is dated, normally with a maturity date of more than 5 years:; for the reference to "senior secured creditor", see HC Deb, 19 November 2007, col 960 Back

613   Q 1783 Back

614   HC Deb, 19 November 2007, col 964 Back

615   Q 1783 Back

616   HM Treasury press notice 94/07, 14 September 2007 Back

617   HM Treasury press notice 95/07, 17 September 2007 Back

618   HC Deb, 19 November 2007, col 960 Back

619   HM Treasury press notice 107/07, 11 October 2007 Back

620   Q 842 Back

621 Back

622   Q 843 Back

623   Q 844 Back

624   Qq 845-846 Back

625   Q 846 Back

626   European Commission press release, "State aid: Commission approves UK rescue aid package for Northern Rock", 5 December 2007 Back

627   Ibid. Back

628   Ibid. Back

629   European Commission, Vade Mecum Community Rules On State Aid, p 27 Back

630   European Commission, Community Guidelines On State Aid For Rescuing And Restructuring Firms In Difficulty, (2004/C 244/02) Back

631   HM Treasury press notice, 149/07, 18 December 2007 Back

632   Ibid. Back

633   HC Deb, 19 November 2007, col 959 Back

634   HM Treasury press notice, 149/07, 18 December 2007 Back

635   Q 1704 Back

636   Q 1705 Back

637   See paragraph Error! Reference source not found.. Back

638   Q 1707 Back

639   Q 1712 Back

640   Q 1782 Back

641   Q 822 Back

642   Q 1780 Back

643   HM Treasury press notice 94/07, 14 September 2007 Back

644   Q 759 Back

645   HC Deb, 19 November 2007, col 960 Back

646   Qq 1491, 1511 Back

647   Qq 1500, 1509 Back

648   Q 1509 Back

649   HM Treasury, Managing Public Money, July 2007, Annex 5.5, para 1 Back

650   Ibid., para 3 Back

651   Ibid., para 1 Back

652   Ibid., para 6 Back

653   Ibid., paras 23-24 Back

654   Ibid, para 28 Back

655   Ibid., para 33 Back

656   Ev 240-241 Back

657   HM Treasury, Departmental Minute: Northern Rock, 26 November 2007 Back

658   HC (2007-08) 57, Ev 80 Back

659   See paragraph Error! Reference source not found.. Back

660   Q 821 Back

661   Q 1702 Back

662   HC Deb, 19 November 2007, col 960 Back

663   Bank of England, "Banking Department Statement, 17 January 2008 Back

664   Q 1702 Back

665   HM Treasury, PES Paper (2004) 14, Annex D, paragraph 9 Back

666   HC (Session 2007-08) 57, Ev 80 Back

667   Q 493 Back

668   Q 756 Back

669   Qq 804-805 Back

670   Qq 496-497 Back

671   Q 499 Back

672   Qq 704-705 Back

673   HC Deb, 19 November 2007, col 960 Back

674   Q 1784 Back

675   Q 1784 Back

676   Northern Rock Plc, Stock exchange announcement, 25 September 2007 Back

677   Northern Rock Plc, Northern Rock Update: New guarantee arrangements agreed with Treasury, 9 October 2007 Back

678   HM Treasury, 107/07, Extended guarantee and additional facility for Northern Rock plc, 11 October 2007 Back

679   HC Deb, 19 November 2007, Col 969 Back

680   Virgin Group - Statement re Proposal, 12 October 2007 Back

681   Northern Rock Plc, Northern Rock Update, 15 October 2007 Back

682   Northern Rock Plc, Strategic Review Update, 31 October 2007 Back

683   Olivant, Statement regarding Northern Rock PLC, 12 November 2007 Back

684   HC Deb, 14 November 2007, Col 702 Back

685   Northern Rock PLC - Strategic Update, 19 November 2007 Back

686   Northern Rock PLC - Strategic Update, 19 November 2007 Back

687   HM Treasury statement Re Northern Rock, 19 November 2007 Back

688   Northern Rock PLC - Strategic Review Update, 21 November 2007 Back

689   Northern Rock PLC - Update on Strategic Review, 26 November 2007 Back

690   Olivant, Statement regarding Northern Rock Plc, 12 December 2007 Back

691   Northern Rock Update, 13 December 2007 Back

692   Q 1737 Back

693   Q 1738 Back

694   Q 1626 Back

695   Q 1756 Back

696   Q 1866 Back

697   Q 1499 Back

698   BBC News Online, Back

699   HM Treasury, Statement Re Northern Rock, 21 January 2008 Back

700   HC Deb, 21 January 2008, col 1208 Back

701   HC Deb, 21 January 2008, col 1208 Back

702   See paragraph Error! Reference source not found.. Back

703   HM Treasury, Statement Re Northern Rock, 21 January 2008 Back

704   HC Deb, 21 January 2008, Col 1208 Back

705   HM Treasury, Statement Re Northern Rock, 21 January 2008 Back

706   Ibid. Back

707   Ibid. Back

708   Ibid. Back

709   HM Treasury, Statement Re Northern Rock, 21 January 2008 Back

710   HC Deb, 21 January 2008, Col 1208 Back

711   HM Treasury, The Code for Fiscal Stability, November 1998, paragraph 11 Back

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