That Northern Rock £100 Billion

Here\’s an interesting little opportunity for some economic research.

I\’ll probably get some of the wording wrong here as, as you know, I\’m not an economist, simply an enthusiastic amateur.

There\’s a fairly strong claim out there that markets process all of the available information and thus price things correctly. I\’m not sure I quite believe it (damn near all information and price things as well as can be done I would definitely support) but that is one of the claims.

This leads to interesting toughts: like, it doesn\’t matter whether, say, the PFI debts are on the Treasury\’s books or not, the long term pensions numbers: for the participants in the markets for public debt most certainly know that they are there and are thus already encapsulated in current prices. Whether the Treasury actually owns up to them or not is irrelevant.

We\’ve actually got a method of testing that idea:

Gordon Brown\’s reputation for economic competence has been dealt a severe blow as £100 billion of taxpayers\’ money used to shore up Northern Rock was added to the national debt.

Before the Northern Rock debts were added, the national debt stood at £537 billion, or 37.7 per cent of gross domestic product.

Taking the figure to around 45 per cent catapults Britain up the league table of indebted nations, above the United States and just below Germany, traditionally regarded as one of the highest spending countries in Europe.

Nothing of any significance has happened: everyone knew that this was indeed part of the national debt. Or did they? Is this new information that has just hit the market?

Has adding to the national debt to the sum of 7% of the economy changed the prices of such debt? Or not?

If it were a transaction of importance, or new information, we would expect the price of long term Gilts to slump, interest rates on them to rise. If prices are entirely unchanged then we would probably have to say that he market had already digested this information….that it was not new.

7 comments on “That Northern Rock £100 Billion

  1. The Treasury’s potential loss from all of this is nowhere near £100 bn, is it? If NR were wound up in a sensible fashion, the total loss wouldn’t be more than £20 bn or so, which is a drop in the ocean compared to other semi-quantifiable liabilities like future pension liabilities (public sector and state pensions), all the PFI stuff, £10 bn and counting for the Olympics etc etc.

  2. This is a much discussed issue in relation to the governments (particularly the US government) putting future pension and social security liabilities on its balance sheet, or even issuing bonds to make the debts explicit.

  3. “The Treasury’s potential loss from all of this is nowhere near £100 bn, is it?”

    No, it’s zero. NR’s assets exceed, and will continue to exceed, its liabilities – the *only* issue is liquidity. Indeed, it’s a shame that there isn’t (or at least, that I haven’t found) a spread-betting market on the taxpayer’s net loss from NR – betting against the idiots who think this is going to cost real money would be a highly profitable endeavour.

  4. Whether the Treasury actually owns up to them or not is irrelevant.

    I’m not so sure. I agree that in the long run markets (left unmolested by government) generally get things right, but in the short term the usual factors of greed, laziness, stupidity and conflict of interest means that even experienced market participants can get suckered, e.g. with Enron, Worldcom etc. Accurate accounting is essential, so that failure is broadcast loudly to the world. In this case, if adding the NR billions, PFI, pensions etc to the official national debt helps dispel the myth of Gordon Brown’s reputation for economic competence for more people, then it is a good idea to do it.

    Similarly, I don’t like the idea that a bank in trouble, like NR, could be bailed out in secret by the Bank of England, as some have suggested should have happened. Deposit holders in NR and more importantly taxpayers have a right to know what is happening, else how can they make rational decisions? And how would a system of secret bail-outs prevent the next bank deciding to adopt a dumb business model so as to boost short term profits for the benefit of the managers?

    even issuing bonds to make the debts explicit

    Sounds like a good idea to me.

    No, it’s zero. NR’s assets exceed, and will continue to exceed, its liabilities

    That’s good to know, though how can you be sure they will continue to? What if house prices collapse? (I’m hoping they do for other reasons).

  5. “how can you be sure they will continue to?”

    Average NR loan is c.80% of property value – and while house prices may fall in the short term, a 20% fall is incredibly unlikely.

  6. Can anybody tell me how much of the public lone money to NR went out of the country and what percentage NR loans are business property related.

    Gordon Hunter

  7. john_b
    It’s not the average of the loans which determines any losses, it is the worst loans. Some of the risk in the NR mortgage portfolio will be crystallised into losses, the only question is how much. If we are heading into a recession so that more people lose their jobs, houses take longer to sell, and go for lower prices, there could be a significant scale of losses.

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