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Fed bounced?

  • Robert Peston
  • 25 Jan 08, 11:45 AM

This is a transcript of a piece I did for the 6pm News on Radio 4 on Thursday.

At the world economic forum, the mob of bankers are agog at the Societe Generale debacle.

They simply don't understand how a trader earning around £70,000 a year was able to evade SocGen's risk controls - and bet the entire bank that stock markets in Europe would rise this year.

His ability to vaporise the bank's capital represents a massive dereliction of SocGen's responsibility to look after the savings of its millions of customers.

Regulators around the world will be seeking reassurance that the same flaw does not exist in their banks.

What also intrigues the Davos crowd is the extent to which SocGen's actions in reversing its rogue traders' bets on Monday and Tuesday were responsible for the sharp drop in European stock markets.

This matters - because that fall in share prices in part spurred the US Federal Reserve to announce its emergency cut in interest rates on Tuesday.

Sir Howard Davies, the director of the London School of Economics and a former central banker, explains.

Davies told me: "Did the Fed know this was going to happen? If it didn't know it was going to happen, then why on earth wasn't it told? And if it did know it was going to happen could it not then see that it was likely to have an unusual effect on the market - and then was it reacting to a false market in a sense because SocGen was dumping a lot of shares on to the market?"

The notion that this rogue trader could have bounced the most powerful central bank in the world into a savage interest rate cut is alarming, to put it mildly.

Rock bonds

  • Robert Peston
  • 25 Jan 08, 10:00 AM

I can't escape Northern Rock even in Davos. What I've discovered is that the term sheet for the massive bond issue has now been discussed with potential issuers.

Much is still up for negotiation. But as of this moment the Treasury is insisting that it will have a claim on the assets of a rescued Northern Rock, were the new special purpose vehicle that would hold billions of the Rock's assets and would issue the Government-backed bonds to suffer a calamitous fall in the value of its assets and be unable to pay bondholders their due.

Or to put it in more technical terms, the term sheet provides that the Treasury would have full secured recourse against all other assets of the Rock in the event that the Treasury guarantee is called.

What does that mean?

Well it provides extra comfort to the taxpayer. In the event that the value of assets in the special purpose vehicle - dubbed 'crapco' by one of the putative rescuers - were not sufficient to repay bondholders, the taxpayer guarantee would only kick in after the reconstructed and rescued Northern Rock distributed all its capital to said bondholders.

I'd better translate further. It means that if crapco suffered a capital shortfall, it could wipe out the new equity to be provided by any successful rescuer of the Rock, such as Virgin, Olivant and/or the existing shareholders, inter alia.

So the Bond issue - which could be as big as £35bn or £40bn - isn't quite the gift that the supposed rescuers may have believed.

Also rules provide that holders of more than 15% of the shares of a bank must normally provide a comfort letter backing the bank – for the full amount of its liabilities.

So presumably the would-be Rock rescuers will take great pains to construct their participation in the Rock to ensure that only their Rock capital could be called were crapco's assets to be vaporised. Sir Richard Branson won't want to hand over a few jumbo jets to bondholders, in the event of a crash in the housing market.

It all rather suggests to me that the partial nationalisation of the Rock favoured by Gordon Brown may yet stumble and fall - so it's not quite 100% certain that nationalisation will be avoided.

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