Select Committee on Treasury Minutes of Evidence


Examination of Witnesses (Questions 1700 - 1719)

TUESDAY 18 DECEMBER 2007

MR MERVYN KING AND SIR JOHN GIEVE

  Q1700  Ms Keeble: How about the independence factor?

  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 again.

  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 England.

  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 as well.

  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 itself.

  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 billion?

  Mr King: As John said, if you take out the basic capital of the bank—subordinated debt, equity and so on—and 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 assets?

  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 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, 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 not?

  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 likely.

  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 the table.

  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 is circular?

  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.


 
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