Northern Rock's fate - who decides?

Directors have to act in the best interests of the shareholders.

Bank of England should act in the interests of financial stability.

Chancellor of the exchequer is blowing in the wind and will act however he/GB feels is politically expedient.

The shares are worthless. This company has loaned billions of pounds on long-term arrangements and no-one trusts it enough to lend it short-term money to cover its responsibilities.

The Bank of England needs to grasp the nettle, call in its loan, force the company into liquidation and then offer a pound for the whole jingbang.

Insteade we have the rather unedifying sight of hedge funds playing games and making millions on volatility in the share price and businessmen falling over each other to try and get the best guarantee (subsidy) from the Bank of England while every tax payer in the UK has lent it about 900.

Neb

I think the problem is, whilst the BoE loan is secured on the Mortgages, the motgages are not fully secured on the properties, because NR gave 125% loans. If the BoE rattle the cage too much, all of a sudden their loan is not fully guarenteeed.

I agree the shares are wothless and any posturing by their holders is pointless.

tim

Shareholders should be bottom of the list of those deserving any sympathy. That is the nature of being a shareholder. Apparently the biggest shareholder bought into NR for a quick killing - which I guess is what he got. He says the current offers are significantly below market value. No. The offers on the table *are* market value..

The BoE probably did the right thing; although clearly some free- marketeers think what they did was akin to paying a ransom to terrorists.

See what you mean but and while shareholders are at the bottom of the pile may it not be doing the stockmarket much good to see how easily shareholders investments can be vapurised so easily? They are for the most part after all, not the scum of the earth.

They are the ones that get all the extra money when things go well, and they ought to know that they risk losing money when things go badly.

Well personally I'd like the government to get the hell out of the banking business and leave 'em to free markets. To that end I'd like the government to sell the AAA Northern Rock mortgage assets it holds. When that proves to be short of the money it was held in collateral, I'd like them to demand more from NR. Then I'd like to see them demand the 2 billion interest. After all that's done,. I'd like them to shove Northern Rock down the stairs and wish them good luck in the future.

The hell with socialism for bankers.

FoFP

The BofE gave 95p in the Pound for AAA mortgage-back collateral. I've seen calculations this weekend, based on ABX indices, that such collateral is now worth around 66p in the Pound. Those calculations were based on "subprime" by the uS definition. An argument could be made that it doesn't apply to NR, but as you point out, they've been gaily handing out what one analyst called "stealth subprime" where it's instant negative equity for folks who don't even have to prove their income.

This has farce written all over it. Perhaps the real question is whether it will be only Darling who walks the plank, or whether the entire government will ultimately go down.

It's a Mexican standoff. The shareholders can threaten to kibosh any deal, and the governmennt can threaten to pull down the temple by withdrawing funding. I suspect this will get highly amusing in its denoument.

FoFP

I would be interested to see these calculations. What does 95p in the pound refer to the mortgage-backed collateral's calculated fair value, its redemption value or something else?

How can AAA stock be valued at 66p in the pound?

I'd like to point you to a reference, but I read about 500 finance articles this weekend (catching up after a holiday, I don't spend all my weekends doing this, honest). What I can remember is that it was probably a Bloomberg article, referred to the ABX indices, and had some discussion of European bond markets. It stated that in August, when the NR mortgages were put up for collateral, indices indicated that the AAA tranches of mortgage-backs were then worth 80% to 95% but were now down to 66% of value.

Good question. I'd assumed that this was referring to "mark to model" price, but given the ructions over pricing, it would be interesting to discover how the BofE valued NR's mortgages.

I think that means it fell by 34% in value from some reference value or date. If you're asking me how something that's AAA rated could do that. i'd have to say that I've been doubful about the value of mortgage-backs and the financial engineering based on them for some time. They're AAA because the ratings agencies clearly didn't share these doubts.

FoFP

I think it is the nominal value.

Redemption yields is one reason. Northern Rock's loans have a yield of 6%. Banks are currently using rates of around 6.5% as their starting point, so that in itself would cause values to fall.

Also, there is the concern that it isn't really AAA rated, or that the rating is likely to fall in the future.

We've yet to see any evidence that NR mortgage book is really dodgy. We heard they were into self-cert mortgages bigger than other lenders.

With US sub-prime mortgages it seems the baby has gone out with the bath water... there is a legitimate place for 'sub-prime' credit, just as there is for interest only and 'self cert' mortgages. Of course if either are dished out without proper controls and checks then they can undermine financial stability.

There have been plenty of bigger fiascos. Savings and Loans... Long Term Capital Management...Farepak (OK.. the last one was me being facetious..).

What is the nominal value of a mortgage, the outstanding balance?

I don't understand what you mean by redemption yields? Are you saying NR mortgages offer less return than other banks' mortgages or are you referring to the cost of (short term) funding.

A spread in the region of 400 bips is some down grading.

The trouble is that without being very specific in our language it is very hard to judge what these comments mean.

As for financial engineering I think that the public and senior management tend to underestimate the optional nature of gambling with other peoples money. If you get a cut of the winnings as a bonus the optimal strategy for increasing your expected return is to raise the stakes as high as possible because you don't have to pay a percentage of the losses.

I think that explains a great deal of what's been going on. Someone who plays with billions in CDOs for a fraction of a percent profit each turn will quit the game a multi-millionaire if they can keep it going for a couple of years. That's an incentive both to up the stakes, and to use fancy accounting to put off losses for as long as possible. Up until June, many at the centre of world finance had been pursuing both tactics.

The game I think we're in now is to squeeze tens of trillions in credit into a few trillion in cash. Thus not everyone who thought that credit was money is going to see the gains they thought they'd made.

FoFP

I assume the present value of the outstanding balance plus the stream of interest payments due over the period of the loan.

We've been seeing some AAA senior tranches of CDOs go to junk. It's almost as if someone somewhere thinks that housing isn't worth what it's currently priced at and that a large number of people aren't going to pay their mortgages once they figure that out.

It's called "debt deflation" but up to now it's been a kind of financial fairy that only I believe in.

FoFP

Is that realistic as many people remortgage during the period of the loan and thus the stream of interest payments stop and the lender just receives the outstanding balance plus any 'termination' fee.

When calculating a fair value (mark to model) for the contract you definitely do need to model mortgagee early redemption clauses. The way this is done is specific to the different types of mortgage.

As of 6 years ago I know at least one major player in this field was using extremely approximate methods to do this for Mortgage Backed Securities.

For a variable rate mortgage I think some one said the average lifetime was 7 years. For a fixed rate you can use some type of Black-Scholes.

Yes, but once the mortgage balance has been repaid, the lender gets back the cash, and the value of that cash is its face value plus the interest it will earn in the future - either by lending it to a new borrower or by depositing it on the money markets.

The income stream doesn't stop altogether, though its rate may change.

Look at it this way. Suppose you lend a friend some money to help him buy a car. He pays you interest on this loan, but any capital he pays you back, you immediately put into a savings account. Your money doesn't stop earning interest, it's just that instead of your friend paying the interest, now your bank will.

True. I'm pretty sure I've read of these portfolios having an adjustment for "maturity risk".

FoFP