Nov 2007 19

Junk bonds at least give you a nice certificate to hang on the wall
So following Darling’s statement on Northern Rock this afternoon, are we any the wiser?

Not really- "it would be quite wrong to dismiss any option now without proper consideration as some suggest," doesn’t really tell us anything.

More to the point, are we all up to speed on subordinated debt?

Because as taxpayers, it looks like we need to be.

In the event Northern Rock goes into liquidation, we will be waiting in line with all the other creditors. Hoping the liquidators can raise enough from selling NR’s assets to pay us all out. Our problem is that not all creditors are equal. Some have claims that rank a long way ahead of ours.

At the top of NR’s claims tree are the secured creditors. They are people who’ve lent money specifically secured against a chunk of those high quality mortgage loans we’ve heard so much about.

Now, Darling tried hard this afternoon to leave us with the impression that all of our exposure is of this kind- debt secured against "quality assets". But that’s not true.

First, we need to note that because of the way NR funded itself in the wholesale money markets, a large chunk of its mortgage loans have already been pledged as security against market borrowing. Those mortgages have been ringfenced, most via NR’s complex offshore financing vehicle Granite, for the benefit of investors in its Medium Term Notes. Others have been assigned to a presciently constructed "bankruptcy remote special purpose vehicle" as security for NR’s Covered Bond programme.

How much of NR’s mortgages are so pledged? In its mid-year report, NR said it had £54bn of such secured borrowing, implying that over 60% of its £87bn mortgage loan book was pledged.

Of course, we don’t know what’s happened since then because we taxpayers have been kept in the dark. But those who’ve seen the leaked sales memorandum (see this blog) tell us that £74bn of the mortgage loan book is now "encumbered"- ie pledged as security. A chunk is (presumably) pledged to the Bank of England against our £25bn loan , but it sounds like at least £50bn is still pledged to wholesale creditors.

After the secured creditors, next in line come the so called senior unsecured creditors. They get first dibs on any fire sale proceeds left over after the pledged assets have been stripped away. In NR’s case, this ought to encompass all the other creditors with the exception of subordinated debtors. That includes the depositors, and the holders of senior debt issues.

Taxpayers have exposure to this unsecured senior debt via our guarantee to depositors, including all wholesale deposits (see HMT statement here). As at mid-year, such deposits were somewhere between £33bn and £48bn (depending on what exactly comprised "deposits" as opposed to other forms of borrowing.

Subordinated creditors come last, ranking just above the equity investors, who of course get nothing in a liquidation.

And for obvious reasons, NR subordinated (or sub) debt is getting riskier by the day. Moodys just cut its credit rating today, while S&P already assigned it a junk rating two months ago.

Now in theory, we taxpayers shouldn’t have any subordinated debt exposure at all. But according to the BBC’s Robert Peston, the penal element of the interest charged by the Bank of England on our loans to NR is being rolled up as subordinated debt, apparently not to be repaid for five years. Worse, the penal element has been defined as not merely the c 0.5% excess over the normal market interbank rate, but as the c 1% excess over Bank Rate.

According to Peston, it is being held by the Treasury rather than the Bank. More important, it could amount to £500m.

This afternoon, Darling denied it was as much that, but he did not deny its existence. So that’s a tranche of unsecured sub debt we knew nothing about until today.

What else don’t we know? As Mr Rumsfeld pointed out, we don’t know what we don’t know.

But it’s increasingly obvious that taxpayers are exposed to all layers of Northern Rock’s stressed out financial structure. We can take no comfort at all in all those official assurances that our lending is all fully secured. We are at risk all the way down to junk rated subordinated debt.
Nov 2007 19

Liam Byrne, Minister for the West Midlands, has revealed plans for a major new Birmingham acting school according to a report in the Birmingham Post today.

Negotiations are underway regarding the ‘Brit School’, a school with an ‘arts led curriculum’ for 950 students aged 14 to 19, and designed to be a flagship project in the Eastside area which is the focal point of new development plans. The public are to learn more next month, but what we do know is that Birmingham City Council, Birmingham City University and Advantage West Midlands will all be major players in the scheme.Facesad

But why, when the country is so short of skilled young workers, are our public bodies encouraging young people into careers in theatre, television and the media?

Acting is not a profession that should be ventured into without considerable thought, and it is certainly not a career option that should be foisted upon impressionable young people who only see the glamorous successes of film and television. On average an actor will work only 11 weeks of the year, but many will never work at all. Big breaks are few and far between and life is tough temping between auditions, or signing on to the dole between jobs as is often the case.

Knowing the trials of a handful of young actors, all trained on intensive three year degree courses at the big drama schools in London, it is difficult to see why any young person would be encouraged into a life of heartbreak and rejection (not to mention poverty) unless they were quite clearly talented, driven and truly committed to the arts as a vocation. The trouble with arts jobs is simple – there aren’t very many of them, particularly when set against the scores of budding entertainers who want to perform and get paid for it. Nice work if you can get it, as they say.

It seems strange that taxpayers should be called upon to fund training more young people for a saturated profession when there are so many vacancies in numerous practical areas. And as Claire Short pointed out, the city already has the Birmingham School of Acting and Birmingham City University has developed a reputation for the arts. The school itself even appears to be a surplus.

Without intending to insult the artistic professions, it is still the case that the UK doesn’t need more performers. So why should we all pay for them?

Nov 2007 19

BBC correspondent doubts
We currently spend some £26bn pa on incapacity, disability and injury benefits. We have 2.7m people of working age drawing IB.

Everybody agrees* that many recipients are claiming for pretty dubious reasons (eg see this blog), and this morning we get some more detail:

"Almost two thousand people who are too fat to work have been paid a total of £4.4 million in benefit. Other payments went to fifty sufferers of acne.

More than £2 billion was paid in 2006-07 for mental health complaints, including £518 million to those with what are described as “unknown and unspecified” diseases.

Overall more than £1.1 billion was paid to people suffering from a depressive episode plus a further £276 million to the estimated 116,000 claimants with “other anxiety disorders” and £122 million to the estimated 50,000 suffering from a “reaction to severe stress”.

A total of 15,600 people received benefits for “malaise and fatigue” and a further 8,100 for “dizziness and giddiness”. The figures disclose that 4,000 claimants had headaches, 2,700 migraines and 1,890 suffered from eating disorders. About £100,000 in benefits went to those with acne and a similar amount to 60 people with “nail disorder”. Nausea and vomiting cost £2 million in benefits for 900 people."

The reboubtable Frank Field comments:

“It is a racket, which governments have allowed to exist for far too long. I do not blame people for working the system, it is the job of politicians to stop them doing it.

The big change over the last decade has been into illnesses which largely defy a clear medical classification: depression, dizziness and such. It is a move from the tangible illness to the intangible.”

The proportion claiming for difficult to diagnose mental ailments has doubled over the last decade, to an eye-watering 40%.

Of course, if you were unemployed in the North East, you might claim it too. Because incapacity benefits contine to be higher than the alternative Jobseekers Allowance. Yet another of Whitehall’s perverse incentives.

*Footnote- When we say everybody agrees about dubious IB claims, we should exclude Kim Catcheside, the BBC’s social affairs correspondent. This morning Humphrys asked her about the one million people claiming IB who are capable of work, and she reckoned she was not familiar with the figure. We think it probably comes from the Department for Work and Pensions 2005 report A new deal for welfare: Empowering people to work. "We should aspire to reduce the number of incapacity benefits claimants by 1 million over the course of a decade" (para 15). True, that doesn’t mean DWP reckons it can get existing claimants off IB. It’s more a case of reducing the number of new younger claimants coming onto IB to replace those dropping off through hitting pension age (the cohort effect).
Update- Kim Catcheside has been in touch with us following this post. She feels we misinterpreted what she said, and on reflection, we agree. She is of course fully aware of the DWP paper, and its aspirational target of reducing IB recipients by 1m. But that’s not the same as DWP saying 1m existing recipients are false claims. And we can see that. Yet at the same time, the way ministers present this figure, they make it sound like they’re mounting a massive crack-down to get 1m workshy scroungers off benefits and back to work. Sure, the DWP smallprint explains what’s really happening, but that’s not the headline ministers apparently want to see in the Sun and Mail.
Nov 2007 18
£25 grand brekkie

In the news this week:

Fry up costs us £25,000- "When Denis Breading went for a fried breakfast at his work canteen it was meant to be a short break before getting on with his job. Instead he has been suspended for the past six weeks during an investigation into claims that he tried to avoid paying the £1.60 he owed for the meal. During this time he says his employers, the Legal Services Commission – which runs the legal aid scheme – has spent £10,000 of taxpayers’ money attempting to prove he "misused public funds"… In all, the great fry-up fiasco could land the public with a £25,000 bill. Mr Breading insists he has done nothing wrong. He claims no staff were present to take his money and he was still eating in the canteen when he was accused of "thieving". (Mail 14.11.07)

£2.4bn pa on new quangos- "Gordon Brown is creating NINE new busybody quangos costing £2.4 BILLION. That pushes the number of bureaucratic organisations interfering in our lives to 528 with a combined bill of £175billion. The move comes despite Mr Brown vowing in 1995 that a Labour government would ABOLISH most quangos. They land each taxpayer with a bill of £2,000 a year – even more if NHS trusts and the BBC are included… Meanwhile quangos like the Sugar Beet Research and Education Committee and the Home Grown Cereals Authority will continue." (People 18.11.07)

£6m pa to run hollow department- "TWENTY staff are employed at the £6 million-a-year Scotland Office to cope with just three letters a day. The Scotland Office occupies plush Dover House in Whitehall… but its role has shrunk dramatically since devolution in 1999… 20 staff employed to deal with mail replied to 1252 letters in 2006-2007 – just over one per member of staff every week. The letter scandal follows a series of damning reports on money-wasting at the department. Its 50 staff, who work between Edinburgh and Dover House, claimed £75,000 hotel expenses last year and another £8000 on hiring plants." (Sunday Mail 18.11.07)

Another £1.68bn for Euro-satellites- "Serious concerns have been raised about the merits of the Galileo global navigation satellite system… MPs on the transport committee say the European Commission is requesting a further €2.4 billion (£1.68 billion) for the project to continue, effectively asking UK taxpayers to contribute to a spiralling bill for the project… Committee chair Gwyneth Dunwoody said… "The government must stop this folly, and endeavour to bring the European Commission to its senses. The commission is poised to spend billions of taxpayers’ money on a satellite system without any realistic assessment of its costs and benefits." (In the News 12.11.07)

Total for week- £4,086,025,000

Nov 2007 16

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