By James West

http://www.midasletter.com

Monday, February 18, 2008

And so it begins.

The end-of-the-line, bottom line buck-stops-here bailout of a bank so big, the alternative would be unacceptable.

After five months of seeking a buyer for Northern Rock and its inventory of toxic debt derivatives, the absence of takers forced the government of the United Kingdom to “nationalize” the bank. Offers from the bank’s management team and Richard Branson’s Virgin Group were not acceptable.

According to Britain’s finance minister, Alistair Darling, “"In the current market conditions, we do not believe the two proposals deliver sufficient value for money for the taxpayer," Mr. Darling said.

It is more likely that Richard Brasnon’s offer was too opportunistic, while approval of a buyout by the management team that got the bank into trouble in the first place is unacceptable from the government’s P.R. point of view.

Northern Rock is already into the Bank of England for $25 billion, and the “nationalization” means the government will restructure the remaining 90 billion pounds in write-downs and official accounting smokescreens.

Classifying the move as temporary, Darling said, “it would be a mistake for us to abandon this asset and take a loss now.”

Asset? A 90 billion pound boat anchor chained around your throat could hardly be described as an “asset”.

If markets were truly free, the bank would be allowed to collapse and its shareholders and creditors would suffer the loss, which would have the effect of an education on those affected.

The measure by the government not only demonstrates that markets are, in fact, not free in the developed world,  are closely intertwined with government and industry, and that the best way to ensure your isolation from and government protection against bankruptcy is to lose billions as opposed to millions.

Darling said, “"We had to intervene here, because if we let this bank fail there was every chance ... the problems would have spread into the wider British banking system.”

If there was ever a more credible statement that the global financial system is on very shaky ground, I’ve never heard it.

Northern Rock, if allowed to fall into the hands of the private sector, would be forced to foreclose on a large portion of its mortgages, that were allocated according to the recent American school of loose credit policy.  The public outcry in the U.K that would surely result might be enough to topple a government, and that’s just one of the many pitfalls Gordon Brown is keenly aware of.

“The world's biggest banks may have to book as much as $203 billion of write-downs, in addition to the $152 billion reported so far, if bond insurers the lenders rely on become insolvent,” according to UBS AG.

New York Insurance Department Superintendent Eric Dinallo said regulators are trying to help the two biggest bond insurers raise $15 billion to avert rating downgrades that may endanger the $1.2 trillion of debt they guarantee worldwide. One option is to split the insurers' municipal bond business from their money-losing subprime-mortgage units, Dinallo said in a Bloomberg Television interview yesterday.

It is now more or less a question of which banks are next. If the insurers of debt are unable to cover the claims triggered by these write-downs backing the debt, chances are a lot of banks are going to become insolvent in short order, and will be forced to seek buyers or government bailouts.

In Germany, IKB Deutsche Industrie Bank – a state-controlled bank – was the beneficiary of an additional $2.2 billion cash infusion last week designed to prevent the collapse of that institution, on top of the $8.7 billion it has received since last July.

Authorities there say the bank may yet require additional funding before it can be stabilized.

Finance minister Peer Steinbrueck said a failure of IKB would have "widespread" knock-on effects for the banking system and had to be prevented. "It could create difficulties for confidence and economic growth," he said.

Its just a matter of time until these writedowns start taking down banks that haven’t lost enough money to warrant the direct intervention of government.

-- Posted Tuesday, 19 February 2008 | Digg This Article