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Rock nationalisation 'back on'

  • Robert Peston
  • 12 Feb 08, 09:30 PM

A consortium led by Virgin has tonight been told by the Treasury that it is out in front in the contest to take control of Northern Rock - but that at present nationalisation of the troubled bank would be a better outcome for the taxpayer.

The group led by Sir Richard Branson has been told to improve the terms of its rescue plan.

The Treasury wants the Virgin consortium to offer more for the billions in financial support being provided by the Government.

And it also wants a bigger potential stake in Northern Rock for the taxpayer, via a so-called warrant over the bank's shares.

A rescue plan put together by Northern Rock's management has not been killed off.

But the Treasury this evening told the management team that its current proposal is significantly inferior to that put forward by Virgin.

The disclosure will be a bitter blow to the Rock's shareholders - many of whom are very hostile to the Virgin proposal.

They believe the management's plan offers the best prospects of rebuilding the value of the bank's battered shares.

But what may alarm shareholders even more is that if the decision on what to do about the Rock were taken today, the Treasury would opt for full public ownership.

According to a banker close to negotiations, the Prime Minister is calling the shots on what to do about the Rock and is steeling himself to go for nationalisation.

Gordon Brown still hopes that a partial nationalisation deal with Virgin or the Rock management team can be negotiated.

But he is said to be no longer seeking to avoid nationalisation at any price.

"Nationalisation is looking much more likely than it did" said the banker.

AIG: the horror

  • Robert Peston
  • 12 Feb 08, 08:54 AM

If you want to understand why the world鈥檚 investors and financial institutions are so jittery about the outlook for financial markets, you should click on .

It鈥檚 yesterday鈥檚 announcement by , the vast US insurer, that it has been over-valuing insurance it has provided to bonds linked to US sub-prime lending.

AIG disclosed that it has increased its estimate of losses by just under $5bn for the October and November accounting months for its exposure to sub-prime related investments.

To be honest, you probably would not gather that from a casual reading of AIG鈥檚 statement 鈥 which is written in the most technical of language, explaining how it uses a 鈥渕odified Binomial Expansion Technique鈥 to value its portfolio of 鈥渟uper senior credit default swaps鈥, but seems to have taken too little account of the fall in 鈥渃ash bond prices for securities in the underlying collateral pools鈥.

Here is my translation: in valuing the claims that may be made on the insurance it has provided to , it relied too heavily on its own internally generated valuations and loss estimates, and seems to have taken too little account of the market price of asset-backed securities.

In the jargon, it was 鈥渕arking to model鈥 rather than 鈥渕arking to market鈥 鈥 and in the process, it was understating losses.

Anyone can grasp the significance of this killer clause in AIG鈥檚 statement: 鈥淎IG has been advised by its independent auditors, , that they have concluded that at December 31 2007 AIG had a material weakness in its internal control over financial reporting and oversight relating to the fair value valuation鈥 of all that CDO insurance.

What are the implications? Well, here are a few:

1) It suggests that the latitude given to insurers and banks by financial regulators over methods for valuing CDOs and other complex investments may have been misguided and misplaced.

2) It raises questions about whether other banks and insurers have been over-valuing their exposure to sub-prime. There will be particular concerns about those financial institutions which have tended to mark to model rather than to market (you know who you are).

3) It highlights the frightening potential size of the capital deficit at the so-called monoline insurers like and which specialised in insuring CDOs and other bonds.

But, for me, what is most important is the declaration of independence by PWC, the auditor. PWC has made it clear that it will not participate in any fudging of the scale of the sub-prime disaster 鈥 even where full and painful disclosure has the potential to undermine market confidence.

So in the coming few weeks the very worst of the losses from banks and insurers should be on display for all of us to see in their gory detail 鈥 and there may yet be further unanticipated horrors.

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