Britain - Northern Rock "nationalisation" - plugging the holes of a crisis-ridden system

Mar/Apr 2008

The uproar caused in certain circles by the so-called "nationalisation" of Northern Rock, on 17 February, was nothing short of hilarious.

Shadow chancellor George Osborne, declared with all due solemnity that this marked "the day Labour's reputation for economic competence died". As to his party leader, David Cameron, he went on record denouncing vehemently what he called "a disaster for the taxpayer, a disaster for the government and a disaster for our country." And predictably, the more or less Tory-aligned press, from the Daily Telegraph to the Daily Express and Daily Mail, among many others, followed like one man, with headlines denouncing Labour for returning to the "bad old days" of the 1970s nationalisations.

Significantly, it obviously would not have come to Cameron's mind to make such an outraged stand when this government decided that the "taxpayer" could fork out £25bn of loans to the failing bank, knowing that there was hardly any chance of this money ever being returned to the Treasury - but then, of course, Northern Rock was still a private bank, so that was alright, wasn't it?

Nor did the Tories find it necessary to make a peep when Alistair Darling added to this already considerable amount of cash, another £30bn in debt guarantees - meaning that the government was undertaking to pay back that much of the Northern Rock's unpaid debt if and when this was needed, to prevent it from having to file for bankruptcy. Again, the odds were that the £30bn in guarantees, if they were used before Northern Rock went bankrupt, would never be recovered by the state. And for all we know, given the secrecy rules that govern the operations of the Bank of England, part of these guarantees may well have been paid out already, anyway. Again, the Tories found nothing to object to, in the fact that by the beginning of this year, Northern Rock was already busy sponging, one way or another, a total of £55bn worth of funds paid up by the "taxpayer".

Even then, this £55bn was not the end of the story, as BBC finance correspondent Robert Peston revealed on 7 February this year. On the basis of an obscure technical article published by the Office of National Statistics, Peston found out that this figure is actually the lower limit of the state's agreed exposure to Northern Rock's indebtedness. But the upper limit of its agreed exposure is actually £75bn. However, added Peston, this is only Northern Rock's own share of the bail-out. In addition to this, Peston calculated that the government had lent an additional £30bn to some of Northern Rock's lenders, to prevent them from reclaiming their funds from the bank. So this brings the potential total price tag for the Northern Rock bail-out to somewhere close to £105bn. But this supposed maximum is only valid for the time being and it remains to be seen whether this sum will stay there or whether it will be inflated by all sorts of unexpected "overheads", as has so often been the case for major state bills over recent years.

Such a sum - £105 bn - is too astronomical to be easily apprehended. After all, it is more than the equivalent of the whole annual NHS budget, or the sum total of the annual budgets for education and housing put together - both of which are supposed to cater for the needs of 60 million inhabitants.

Not so, for the government aid package to Northern Rock. Indeed, who stands to really benefit from this colossal bounty? Primarily it is Northern Rock's lenders, in other words banks, mutual and hedge funds and all kinds of financial businesses, which buy debt bonds from borrowers like Northern Rock for purely speculative purposes. In fact, the beneficiaries of this bounty stand to be, overwhelmingly, the "investors" who entrust lenders with the management of their capital and the shareholders of these lenders, in other words a tiny layer of wealthy capitalists.

This is precisely where one of the cynical ironies of this whole affair lies: once this £105bn in state bail-out will have found its way into the deep pockets of these wealthy capitalists, the capitalist class as a whole will have been refunded twice over for the corporation tax it is due to pay this year. Indeed, the corporation tax, which is supposed to be the share of their profits that companies pay into the common pot of society, brought in just £50bn to the Treasury last year and it is projected to increase by only 2% this year. In other words, just with the Northern Rock operation alone, British capital will not only manage to keep the whole of its profits, but, on top of that, it will get paid up to £50bn by the state for its keep! Of course, this is only a (small?) part of the parasites' gravy train, given the many other ways used by the capitalist class to get subsidies from the state under all sorts of spurious pretexts.

No wonder the Tories never objected to Labour's bailing out of Northern Rock before Darling's announcement of the bank's "nationalisation". They had no objection to the "taxpayer" footing the bill, as long as the money went into the coffers of their capitalist masters for whose favours they are competing with Labour. Being seen opposing Labour over the oxygen injection that the government was providing to the capitalists' crippled financial system would not have gone down very well in the City!

Brown yields to big business

Not all politicians or commentators went along with the crass prejudices peddled by the Tories and their press, of course. And not all of them were pro-Labour, by far.

One commentator wrote, for instance, on the days following the "nationalisation" of Northern Rock: "Anybody who suggests that the Labour government has gone back to 1970s socialism deserves ridicule". These words sound as if they were written by some of Labour's Oxford-educated upstarts. Wrong! This was the punch line of an editorial published on that day by the very pro-business Financial Times. This editorial added, for good measure, that the government "has made a sensible, hard-headed, non-ideological choice."

To those media barons and Tory politicians who were already clamouring against what they described as "daylight robbery" at the expense of the bank's shareholders (without knowing yet what compensation they would get if any), the same Financial Times editorial replied: "Whether nationalisation is a good deal for taxpayers will depend on what they have to pay shareholders in compensation. That amount should be nominal. Northern Rock's theoretical book value may still be substantial, but the equity only has any value because of government loans (..) The independent valuer who determines the compensation should not force taxpayers to pay for the value of their own support to the bank."

The next day, the bosses' weekly The Economist, exclaimed: "At last a decision to nationalise", adding, like the FT, "critics who accuse the government of having reverted to its old socialist leanings of the 1970s are plainly wrong." The same issue of this journal pointed out, somewhat maliciously, that, since this "nationalisation" had been recommended by none other than US mega-banker Goldman Sachs, which advised the government in its bail-out of Northern Rock (and is said to have earned a miserly £100m for its pains), this "decision can hardly be part of a socialist plot (though it may be part of a capitalist plot, if Goldman figures money can be made from reversing all those privatisation that it profited by advising on, back in the 1980s and 1990s)."

In other words, this puts the two most prestigious mouthpieces of British big business firmly on the side of Brown, even if, as The Economist puts it, this decision "is the least worst of some poor options. Nationalisation provides legal recognition that the government has, in effect, owned the bank since bailing it out. Northern Rock has been kept afloat by public subsidy since September."

In fact both the FT's and The Economist's only real criticism against Brown was that he waited so long before taking the bank into public ownership! The Economist even went so far as to accuse the bank's shareholders' of greed, particularly the two largest among them, two hedge funds which own nearly 20% of the banks capital. In this journal's view, since it was known that these two hedge funds would have blocked any attempt by a private financial consortium to buy the bank, because they were gambling on generous state-funded compensation, waiting for so long was merely playing into their hands. Something which is probably true and illustrates how much this government was terrified at the idea of upsetting capitalist speculators.

The most lucid among the capitalist commentators highlighted what Darling had himself stressed at great pains. The bank was taken over "into temporary public ownership". It would not be run by ministry officials, but as an "arms-length company". In fact, its new head was to be Ron Sandler, a well-established private sector banker, formerly chief executive of Lloyd's Insurance market and known for his ruthlessness in "restructuring" - which is ominous news for Northern Rock's 6,000 workers, since one of the "options" now publicly discussed is to halve their numbers. This, in and of itself, is a gesture designed to reassure the City that its interests will come first, whatever happens.

Besides, Sandler also happens to belong to that tiny elite of so-called "non-doms", who are allowed by British legislation to keep their (usually large) assets in tax havens in order to reduce their taxable income in Britain to the nominal salaries they earn there. At a time when there is a big argument raging between Treasury officials, on the one hand, and the City, Tory politicians and even some Labour right-wingers, on the other, over whether some form of minimum tax contribution should be required from "non-doms", the simple fact of choosing one of them to head the "nationalised" Northern Rock can only appear as yet another gesture of subservience towards the City.

On the tracks of Railtrack

In fact this is not the first time that this Labour administration has resorted to "nationalisation". It also did it in 2001, when the greed of the shareholders and managers of Railtrack, the privatised company which owned (and was supposed to maintain and modernise) the country's railway infrastructure, resulted in the most appalling catalogue of train accidents and time-table disruption. Having increased without success the subsidies to Railtrack to a much higher level than they were before privatisation, Blair's government decided to "renationalise" it - in fact, at the time, they did not even dare to use this word, instead they talked about taking Railtrack "under public stewardship" temporarily.

In 2002, a "not-for-dividend", "private" limited company called "Network Rail" was created, with the various privatised train operating companies as associate members - which means they had a say in the decision-making, but no liability, if they provided no funds, which was the case. Then Network Rail bought the ill-famed Railtrack for a symbolic sum from the government.

This was always meant to be a temporary measure (at one point Blair even hoped that a consortium around the German Deutsche Bank would be willing to take over Network Rail). However, the state of the railways is so appalling and the need for investment so huge that it will take a long time before a buyer is found, assuming that ever happens. In the meantime, Network Rail is run entirely as a private company, under a board of directors made up of people straight out of private business, in which the government has no representative, not even as an observer - in any case, not publicly. It is through the government-appointed Office of Rail Regulation that the activity of Network Rail is overseen, from a long distance and through the intermediary of piles of reports on which action, if any is taken, happens in a matter of months, at the very best.

Yet, Network Rail operates entirely thanks to government subsidies. On paper, these subsidies go to the various rail operators, but part of them are earmarked for the operators to pay Network Rail for their use of the tracks and other infrastructure it owns and this is, by very far, the main source of income for Network Rail. Besides, whereas state subsidies to private companies, even in the railways, are always a delicate question for any government, state subsidies which can be described to the public as going to a "not-for-profit" railway company, are far more acceptable. So this structure makes it easier for the state to increase its funding of the railways, despite privatisation (which it did immediately after Network Rail was formed).

To all intents and purposes, Network Rail operates as a private company - but without any of its income being wasted in dividends. It is funded by the state, but its accountability to the state is reduced to a bare minimum, whereas it remains relatively accountable to the private railway operators. Due to its privileged relationship with the state and the banks' knowledge that Network Rail will never be allowed to go bust by any government, it has almost unlimited facilities to borrow on the money markets at the same relatively low interest rate that the state itself borrows. And this is how, in combination with state subsidies, it finances its long-term renovation investment of the rail network.

From the point of view of the capitalist class, the benefits of this structure are obvious. No capitalist group or shareholder would be willing to have their money frozen in long-term investment like large-scale railway renovation, which, almost by definition, can only bring in low profits, if any at all - and this was what led to the Railtrack disaster. Thanks to this kind of "privatisation", however, and without having anything to pay towards it, the capitalist class gets an improved railway network without which its goods and trade would be paralysed.

This is purely and simply a way for the state to substitute itself for the capitalist class in making vital investment that the capitalists themselves are unwilling to make.

Labour and Tory "bad old days"

A column published in the Financial Times on 19 February, reminded the reader that the first nationalisation carried out in Britain was not done by Labour, but actually by Winston Churchill, back in 1913, when he nationalised what was to become British Petroleum. This is usually explained by the fact that, as a "great military strategist", Churchill saw the importance of the oil in the war that was coming. Maybe so, but the point is that he knew the capitalist class well enough to be certain that they would not make the investment required, unless they could get something out of it quickly - or to put it differently, that the patriotism of big business does not stretch beyond its wallet!

It is seldom remembered that in the immediate pre-WWII period, most of British industry was de facto nationalised, by a Tory government, once again, for exactly the same reasons that Churchill had mistrusted the capitalist class - because it would not make the investment required for the war. A large part of the engineering industry that dominated the Midlands later, until the 1990s, was actually built in the run-up to WWII, with state funds.

Likewise, when the Labour government of the post WWII period nationalised whole sectors of the economy - which was done all over Europe, including in a country like France despite the fact that its government was led by a reactionary general - it was on the basis of a cross-party consensus. Tories and Labour spoke the same language - it was now necessary to "win the peace" and what this meant was to rebuild the profits of British capital. As far as the working class was concerned, this meant working hard in order to rebuild and modernise an industry which had already been decrepit before the war. But since British capitalists were far more keen to sell raw materials from the colonies to the destroyed countries of continental Europe and to lend them money out of imperial sterling balances, the state had to substitute itself for capitalist investment. Hence the nationalisations carried out at the time, mostly in the heavy industries, utilities and transport.

The reference made by the Tory press to Labour's "bad old days" of the 1970s, is either somewhat hypocritical or just plain ignorant. In fact, the first nationalisation of the 1970s was carried out by Edward Heath, in 1971. When Rolls-Royce Ltd went bust, Heath nationalised its aero-engine division under the same brand name. Again, it was a case of a bail-out which had ended up in a dead end, when no buyers or refinancing materialised. Rolls Royce's shareholders had chosen to allow their company to go bust, rather than putting in the required long-term investment needed for the costly development of new jet propellers, so Heath had no option other than to "nationalise" it, in order for the government to fund this development, which was considered vital at the time for the future of the whole aircraft industry.

As to Labour, one could argue that it carried out surprisingly few nationalisations after it came back into office, in 1974, given that this was a period of worldwide economic crisis, involving serious monetary disorders and a sudden drop in trade. Many companies were threatened with going bankrupt and, actually, the Labour government went out of its way to find ways of channelling state funds towards them, precisely in order to avoid having to nationalise them and so, to keep British capital happy. Predictably the Tories of the time were quick to denounce this as intolerable socialist interference with private business! Needless to say, they denounced nationalisations in much harsher terms.

When it comes to defending the interests of capital, either in terms of protecting these against economic difficulties by making investments that would be considered unprofitable by the capitalist class, the Tory and Labour governments have always, more or less depending on the degree of urgency, had the same policies. They have always done what was needed in order to supply the necessary investment or bail-out money out of public coffers. There are, of course, a number of ways of doing this and this is where the two parties may differ superficially. But when the pressure of urgency becomes high, nationalisation, that is the state substituting itself for capital in whichever shape or form, is about the only option. What happened at Northern Rock is no more than this. As one of the Financial Times commentators already quoted pointed out, this nationalisation only formalises the state of affairs which actually existed since the beginning of last September, when the Bank of England extended its first £10bn lifeline to Northern Rock. Already, in and of itself, this meant that the state had far more funds in the bank than all its shareholders put together.

Cheap credit dries up

From this point of view, the nationalisation of Northern Rock must be placed in the more general context of the financial crisis which was triggered around the middle of last year, by the impact on the money markets of rising defaults on mortgages in the US. As a result of these defaults, lenders began to distrust the credit-worthiness of borrowers seeking credit on the money markets, including when these borrowers offered guarantees in return for the loans.

This distrust, however, was to a large extent the consequence of a mechanism introduced in order to increase the availability of credit, by attracting the largest possible number of investors to the money markets. This mechanism involved, among other tricks, slicing up big debt into smaller debts and packaging many small debts into bonds which were then traded on the money markets - a process known as "securitisation" in the jargon of the trade. But the consequence of that was that no-one could tell what these anonymous debt bonds were really worth. They could have included "bad debts" which had already defaulted or were close to do it, there was no way to know, except by opening the books of the issuing institutions - something that was not an option due to commercial secrecy.

The first visible consequence of this distrust was an increase in interest rates for borrowers - either because lenders were factoring in what they considered as an increased risk, or because they jumped on the opportunity offered by the bad financial news to increase their rates and make a higher return, or a combination of both. But after a relatively long period of time when interest rates had been relatively low, especially for short-term credit, many finance companies had developed very profitable operations which relied on the existence of virtually unlimited amounts of money being available at such low interest. When interest rates went up, these finance companies were soon confronted with a choice between either winding up these operations - at a loss - or else waiting in case interest rates went down again, but thereby taking the risk of increasing their potential losses considerably. And many, if not most, chose the second option - mainly because the money markets are fundamentally gambling places, so there is nothing abnormal in taking such a gamble.

Northern Rock was just one among these borrowers (it lent money to house-buyers which it borrowed on the money markets). But it was much more exposed than the other big players in the mortgage market, because the sums it borrowed represented many times the assets it actually held in deposits. So it did not take long before the bank got into trouble and called on the Bank of England to help out - which then triggered the short-lived but spectacular rush on its branches by depositors.

But while the case of Northern Rock became public knowledge, all the other banks suffered as well. In total, to date, the main British banks have written-off £13bn of assets from their balance sheets - which means, in practice, that they consider that amount to be unrecoverable. We are told all these bad debts are linked to defaulted US mortgages. Maybe, maybe not. Firstly, because the very nature of these debt bonds is that no-one knows exactly the nature of the debt they represent. Secondly, because neither the banks nor this government and its regulatory authorities can be trusted: the veil of secrecy which surrounds banking operations means that there is no way of knowing even the real level of mortgage default in Britain (except that it has increased) nor what consequences it has. Moreover, and this may be even more important, there is absolutely no certainty that these banks have written-off all their bad debt. After all, they do not want their shares to crash nor their depositors to run to their branches, so it is not beyond these irresponsible people to conceal the truth.

Obviously the bail-out of Northern Rock is designed to ensure that the debt bonds issued by Northern Rock, in so far as they are known as such, remain trusted on money markets. Had Northern Rock gone under, at least part of those bonds which are owned by British banks (and they represent dozens of billions of pounds) would have had to be written off, thereby adding to the impact of the credit crisis on their balance sheet.

Bailing out a sick system

Maybe the large banks would have resisted to such an impact, although Barclays itself had a bad time when it was forced to acknowledge that it had been forced to go to the Bank of England in order to get an exceptional loan (and a very large one at that). But the middle-sized bank and finance companies might not have.

At the beginning of March this is just what happened to a London-based speculative fund called Peloton, which had £1.8bn under management. It was set up by one of the wealthiest whizz-kids in the City and made an 86% return for its investors last year. Yet it did not resist the disappearance of cheap money and the increased difficulties in finding credit. It had to unwind its operation at an unknown loss, big enough in any case, to be forced to sell its plush 7,000 sq ft Soho offices as a matter of emergency - meaning that it will lose out in this sale, so it must be bad! Likewise, a speculative fund owned by the large US financial group Carlyle, has found itself in the same situation at the same time, losing some £2.5bn. Yet, in neither case, were the problems faced by these groups directly linked to mortgages or real estate. But all speculators need credit and they need it cheap in order to make sufficient returns for greedy investors.

In fact what made both these speculative funds particularly fragile was that the sector of the stock market on which they operate has been confronted with a series of shocks. It all started at the end of January, when simultaneously, most of the world's stock markets went through a big drop. In London the City dropped by 5.5% and then recovered the next day. But other stock markets saw larger falls repeated for 2 or 3 days, before share prices went up again. This "nervousness" of stock markets, as commentators call it - in other words, the nervousness of stock market speculators - seems to have calmed down, for now, especially after the US central bank, the Fed, intervened by cutting its interest rates twice in a row.

However, another sector was hit by the ripples of the financial crisis - which was what caused the problems of Peloton, in particular. This was the so-called derivatives market, where contracts are bought and sold as an insurance against changes in the value of shares, debt bonds, corporate bonds, raw material, etc.., or as a means of gambling on these changes. These derivatives markets rely very heavily on credit and operators must have a good credit rating if they want to play there. Moreover the volumes traded are very high and the losses that can be incurred are very high too. Twice this year so far, a storm has struck these markets - at the end of February and the second time two weeks later. The problem is that in the meantime the cost of ensuring credit against default had increased by 20% due to the difficulties faced, in turn, by the credit insurance companies. As a result, derivative traders have been hit by the combination of these market storms and the sudden increase of credit insurances. How many have been hit and how badly? It will take time to know, especially among the big players.

Other areas are affected by problems with credit. Corporate bonds, which represent a large part of the long-term borrowing of big companies, are going down rapidly. No casualties have been announced so far, but this means, if it carries on, that it will be far more difficult for companies, including in manufacturing, to borrow for investment. This could become a pretext, genuine or not, for cutting jobs and closing factories. Meanwhile, US local authorities are facing a run on the bonds they issue to borrow money. Again, if this goes on, it may mean drastic cuts in local services, since central government is more likely to bail out its banks than its municipalities!

There is indeed no shortage of bailing out being done. Several times since last Summer, both the US Fed and the European Central Bank (ECB) have been "pouring money" (in other words lending state bonds on the basis of their current interest rate) in very large quantities in their respective money markets to provide operators with something that can be traded on the markets and that will be accepted by anyone as security for a loan. This has not been the case in Britain, where the policy of the Bank of England has been to let operators make their requests, rather than making an open offer. Subsequently lending conditions were eased and just about anything was accepted as collateral - although since "commercial confidentiality" must be maintained, no-one knows how much has been lent nor to whom. But there was no "pouring of money" in the City. However, Brown's bailing-out or nationalisation, whatever one calls it, of Northern Rock, amounts to exactly the same thing - it means "pouring" £100bn into the banking system as a whole, because the British lenders of Northern Rock will the ones to get the cash. And proportionally to the size of the respective economies, this is more or less equivalent to what the ECB "poured" in Europe.

But all that money which is poured into this crisis-ridden financial system is merely a bonus for the capitalists whose speculation is the cause of its crises. It cannot resolve anything, not any more than the "kitemark" that Darling has announced to label what regulators consider as "good" debt. There is no such thing as "good" debt in an economic system which is driven by profit and, therefore, speculation. The worst about all this is that, at the end of day, while none of these bailouts or regulation can or will resolve anything, the working class will be expected to pay for them. And it will be expected to pay twice: once by paying for the crisis itself, through job cuts as will happen at Northern Rock and probably quite a few banks and finance companies, but maybe also, if the financial crisis continues to ripple to other parts of the economy, in every other industry. And the working class will be expected to pay a second time, because someone will have to pay through the tax system and through cuts in government budgets, particularly social ones, for the money spent on repairing the damage caused by the capitalists.

Whether the working class agrees to pay, remains to be seen. It has a weapon at hand that it can use - the class struggle. And when this government turns round to workers with the bill in its hands, it should get the response it deserves: workers joining ranks across industries, whether they are directly affected or not, to say that since someone must pay, it must be those who are responsible for this mess - the capitalist class itself.