Examination of Witnesses (Questions 1700
TUESDAY 18 DECEMBER 2007
Q1700 Ms Keeble: How about the independence
Sir John Gieve: I think the independence.
I think the fact that the rating agencies are paid by the issuer
is a problem and did encourage the rating agencies to expand their
business into structured credit as far as they could, and perhaps
beyond where their models could really support the rating. I would
welcome it if investors themselves could sponsor a rating agency
which was dependent on investors; in other words they were being
paid by the people they were supplying the service to; but that
has not proved possible as a business model. I would not be surprised
if some of the investment bodies consider that again.
Q1701 Ms Keeble: How are you going
to carry these proposals forward? I would just come back to you,
Governor. You said this was an international problem and needed
international solutions, but we are supposed to be world leaders
in financial services. Surely it is not adequate to say it is
an international problem and we are just little UK here doing
our own thing. Surely we should be having a major influence in
the international arena, in particular in dealing with the problem
of the ratings agencies.
Mr King: That is absolutely right,
and we are, and there is no doubt that a lot of material that
goes to the Financial Stability Forum comes from the work of the
Federal Reserve and ourselves. We are the two main financial centres
that people look to in wanting advice in these areas and we are
making a big input into it, but, as John says, trying to find
a purely domestic solution will not work. These are international
ratings of internationally traded instruments; so we have to take
our partners with us; but there will need to be, I think, reappraisal
of this. Not least is the fact that the Basle system of capital
regulation that is about to be introduced more widely across the
world does itself rely on ratings provided by ratings agencies,
and that is an issue that I am sure people will want to look at
Sir John Gieve: Just on what could
be done, the main rating agencies are approved by regulators,
by the FSA and the SEC, so that their ratings can be used in regulation.
One possibility which I know we are examining is whether we build
on that certain new requirements. There is a code at present,
but you could build on that, for example, in the areas that we
have suggested. So that would be a way in which public authorities
could influence what happens.
Q1702 Mr Dunne: Before coming on
to looking to the future, I would like to ask a couple of questions
about what has happened today. Can you confirm what the Bank of
England exposure is to Northern Rock today?
Mr King: 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,
and ten days ago it did reveal that the facility was from that
point £25 billion.
Q1703 Mr Dunne: From the Bank of
Mr King: Yes, but in two facilities.
It is very important to distinguish between two facilities. The
first facility was the original Bank of England lender of last
resort facility. That is securitised against collateral that is
in is our possession; we have that in our accounts. 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.
Q1704 Mr Dunne: Thank you for making
that clear. The Government today has announced that they have
increased their guarantee arrangements to cover, it appears, all
liabilities of Northern Rock. Could you comment on that, in particular
the scale of that underwriting and the security package, if there
is one, underlying it?
Mr King: Yes. John has been working
on this, so I will let him answer.
Sir John Gieve: Essentially, this
does widen the scope of the guarantee to pretty much the whole
balance sheet, excluding the capital instruments and the Granite
securitised instruments. Of course, all that guarantee is secured
against the assets of the company. So, if there is a net asset
value in the company, then there is security for all the assets
that have been guaranteed.
Q1705 Mr Dunne: So you can confirm
this is a Treasury facility, not a Bank of England facility, although
it is operated through the Bank of England; but the risk falls
on the Treasury rather than the Bank?
Sir John Gieve: It does, yes.
The guarantee is a Treasury guarantee, and it goes wider than
the 25 billion advance that we have actually made. It covers also
all the retail deposits and now nearly all the wholesale deposits
Q1706 Mr Dunne: Indeed. Does it also
cover the investments which Northern Rock has in other market
traded securities: so instruments issued by other issuers where
the trader will on trade it?
Sir John Gieve: It does not cover
the asset value of their assets, it covers their liabilities under
some swap and other transactions.
Q1707 Mr Dunne: I am looking at the
balance sheet of 31 December 2006, and obviously there are more
recent balance sheets available to you, I assume. There is some
six billion of debt securities in issue covered bonds. Those are
bonds which have been issued by others which have been acquired
by Northern Rock. Is that right?
Sir John Gieve: I am sorry, I
have not got that in front of me. Northern Rock itself has issued
covered bonds, and 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. Northern Rock
also has a treasury which holds some securities, interest bearing
securities, and it made a statement, I think last week, about
the nature of those securities.
Mr King: Of the total balance
sheet, approximately 40% is in Granite, about a third is now covered
by the extended guarantee, about a quarter is the contribution
of the Treasury and the Bank through their loans to Northern Rock,
leaving a very small residual for the basic capital of the bank
Q1708 Mr Dunne: What you are telling
us is that roughly half of the balance sheet at the moment is
guaranteed by the Government in one form or another, roughly £50
Mr King: As John said, if you
take out the basic capital of the banksubordinated debt,
equity and so onand take out Granite, put those two things
to one side, then most of the rest of it is effectively covered
by the guarantee.
Q1709 Mr Dunne: That would also cover
Northern Rock's sellers' share, as it is known, within Granite;
so approximately seven billion pounds of, effectively, Northern
Rock's equity in Granite is now also subject to the guarantee.
Mr King: That is an asset, not
a liability. This only covers liabilities.
Q1710 Mr Dunne: Indeed, but in relation
to the collateral package that the bank has, if that collateral
were to fail, the guarantee would be called in relation to those
Mr King: There are two kinds of
collateral here. 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 onthat is already legally
in our possessionthere is a margin over the extent of the
loan, so that we are a clear margin above the value of the loan,
and then 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.
Q1711 Mr Dunne: Indeed. So the Bank
of England has quite properly got the best security and the Government
has got the least.
Mr King: I do like to think that
we are seen together in the public sector as a consolidated balance
sheet, but it does mean that it is appropriate for the Treasury
to take the decisions about what is happening to Northern Rock,
because they are the ones bearing the risk.
Q1712 Mr Dunne: Indeed; and that
risk would appear to have increased significantly with this additional
undertaking given today.
Mr King: I think this was a natural
extension to help the company. What is important now is to try
to make sure we can stabilise the company and, as soon as possible,
find a new management team and organisation to take it forward.
I think that is the next step.
Q1713 Mr Dunne: Indeed, but if the
bank is only solvent as a result of the guaranteed facilities
which you have put in place, and if any of the underlying asset
values are not realisable at the level at which they are in the
bank's balance sheet, then the tax payer will lose, will they
Sir John Gieve: There is a margin
of capital, as Mervyn was saying. Yes, no lending is without risk,
and if the assets prove to be worth less than they are currently
valued at, yes, that is the risk.
Q1714 Mr Dunne: Indeed, and in a
falling housing market and in a market where it is difficult to
determine the underlying value of some of these securities which
are sitting on the banks balance sheet, that would look increasingly
Sir John Gieve: To be clear, Northern
Rock's assets are nearly all prime mortgages in the UK. Of course,
you can have defaults on prime mortgages, but Northern Rock was
not itself in the business of creating sophisticated products.
Q1715 Mr Dunne: Could I take you
back, Governor, to your answer to the first of Mr Mudie's questions
in relation to the history of Northern Rock, the way it unfolded.
You were very clear in saying that there was no firm proposal
on the table when you were asked whether the Bank would guarantee
a bidder's funding arrangement. Would you as the Bank of England
have seen the detail of negotiations that were taking place between
Northern Rock and any of the bidding vehicles?
Mr King: This is between Northern
Rock and the bidders in the recent
Q1716 Mr Dunne: In September before
the lender of last resort. I am specifically referring to the
Lloyd's TSB approach.
Mr King: No, at that stage any
discussions between Northern Rock and any other potential bidder
would come under the heading of private sector solutions and were
the responsibility of FSA.
Q1717 Mr Dunne: Indeed; so you would
not necessarily have known whether there was a firm proposal available.
You were being asked specifically whether you would provide a
facility and you would not necessarily have been privy to all
of the detailed negotiations that were going on between the private
bidder and Northern Rock?
Mr King: No, but I would have
thought that, if there had been a firm bid on the table, we would
have been informed of it, and we were not.
Q1718 Mr Dunne: You were informed,
were you not? You told us, I think today, you were invited to
provide a facility in the context of a bid.
Mr King: In the context of a possibility
of a bid, but it was not suggested that there was a firm bid on
Q1719 Mr Dunne: No, but the bid could
only have been firm had you provided a facility, and, therefore,
for you to say that that there was no firm bid on the proposal
Mr King: No, I do not think that
is right. We were quite explicitly told that it was not the case
that there was a clear bid which was there in every detail but
could proceed only if the money was made available. That was clearly
not the situation. The situation was other way around, that the
bidder did not want to come up with a firm bid or get into excessive
detail until it knew that such a facility would be available.
That was what we were told.