James Max - James Max is a broadcaster, columnist and business expert

A good deal for Branson

The sale of Northern Rock by the Government to Richard Branson’s Virgin Money is probably the deal of the century. For Mr Branson, anyway.

When Northern Rock was nationalised, it was split in two. In essence, good bank and bad bank. We, the taxpayers, still have the bad bit. It owes the Treasury £21 billion. It’s unlikely we will ever see much of that money back again. It’s probably right for the government to offload anything it can right now, in order to reduce its exposure and liabilities. It’s also a manifestation that governments should avoid getting involved in business. They just aren’t very good at it.

It is worth looking at why Northern Rock got into trouble in the first place. The business model was rotten. It was in the lending business and relied upon the wholesale markets for the money it lent. Worse than that it had an asset-backed model, where the assets did not back up the loans. Even in a rising market, lending on 100% of an asset’s value is crazy. When you lend more than the asset is worth, it’s even crazier. The interest rates charged simply didn’t match the risks involved. When packaged up, for some reason the products were sold with the benefit of the rating of the company issuing the debt and not of the underlying assets.

The FSA and the government did not see the error of their ways at the time although the alarm bells should have been ringing. Why? Because it suited them politically. The asset bubble they were feeding provided grass roots support for their actions. It’s probably the worst form of gerrymandering we have seen in our country’s history. Those least able to afford to borrow were being offered money to buy property. The housing market was rising and so individuals were able to cash in on this phenomenon. It made them feel wealthy. For some, they made a lot of money and certainly lived a life they could never afford.

Talk about casino banking is nonsense. Taxing banks with the proposed Tobin tax is merely looking at the symptom. The cause was simple. A government was keen to hype up an asset bubble that helped them achieve their aims. The mortgages that ended up in the wholesale market were, of course, toxic. A minnow in comparison to what was going on in the US where the housing market is far less supply constrained, nevertheless, a toxic mix. Of course the wholesale markets were operating at a level that demanded the products. There was a wash of money coming from central banks keen to stave off recession by artificially lowering interest rates. However the fundamental problem was irresponsible lending at the retail bank level.

We are now in a position where some are calling for investment banks to have their wings clipped. Transaction taxes and other measures are in vogue with the ill informed. However the root cause of the problem is lending too much to people who cannot afford to repay their debts. Worse still, lending too much on assets that cannot support the loan should the mortgagee be unable to make their repayments. Indeed over the road at RBS and Lloyds the problems are far larger. Simply because these banks bought market share. Not with residential mortgages but commercial ones. However the problem was the same. Funding irresponsible lending from the wholesale markets whilst buying market share.

Until we learn the lessons of what happened in 2008, we are storing up for another massive financial crisis all over again.

The question as to whether George Osborne was right to sell now or sell later will hang in the balance. However it might have been shrewd to cut his losses. Some predicted RBS and Lloyds would return to health quickly. They haven’t. Some thought this financial crisis and economic malaise would be short and sharp. They were wrong. Remember that even if the bank were to recover over the next few years, you need to look not only at the opportunity cost of the capital involved but whether it could or would actually grow to such an extent that the returns to the taxpayer would be worthwhile.

On this particular deal, the taxpayer was always going to get stuffed.

Tags: , , , , , , ,