Thursday, May 08, 2008

SRM - "...You've Gotta Be Kidding...!!"

Denial, tantrum, appeal to higher authority and almost certain subsequent rejection. It rarely works on the tennis court. And it is unlikely to work for Monaco-based SRM and Jon Wood in regards to their formerly-large equity position in the now-busted Northern Rock. Like McEnroe, Jimmy Connors and Ille Nastase before him, it is a decidedly unappealing spectacle to witness, bordering on the embarrassing, for friends, family and spectators alike. For being a sore loser is, in the final analysis, simply unbecoming.

It appears undisputed that, at the time of implosion, there was no private-market alternative provider of new equity and associated debt on terms, and in quantities that would have prevented receivership and liquidation. Despite the increasing difficulties funding short-term in the capital markets while lending long for increasingly dubious activities, both SRM and RAB bet heavily that the markets would relent in their miserly-ness, affording an exit at a higher price. But they didn't. The Bank of England provided what might be termed as bridge finance in a large way, and wrote valuable puts to existing depositors and creditors, in a bid to stop other bank-runs and shore-up systemic integrity. This is the BoEs right, if not their obligation. One can certainly argue about the wisdom of this operation, its future impact upon systemic moral hazard, but their role as largest creditor is beyond dispute, as was Northern Rock's insolvency without the BoEs interventions. Out of the goodness of their hearts, a sense of fiduciary duty to the public coffers, and a desire to have NRK shareholder shut-the-f*ck-up, the Bank offered NRK shareholders five pence on the pound ostensibly as compensation for not liquidating the enterprise wholesale. It would seem that, as the largest creditor, this was their right, ignoring that they themselves are perhaps the equivalent of a "line judge" too on the intensity of "public interest" at stake with regards to systemic integrity.

So now we can quibble about the fairness of "price". It seems SRM is taking the position its worth up to 500p/shr or 1.6x book, versus their current award of 0.05x book, irrespective of the fact that prudent and solvent peers whose managements matched funding better, are all currently south of book. THAT point of departure makes SRM claims suspect from the outset, but we know all lawyers begin with inherently outrageous positions, for which they sit a special course in law school.

Receivership and subsequent liquidation are nasty, dirty and wildly inefficient undertakings. Bankruptcy lawyers and trustees milk the teat on which they feed for everything they can, and clearly do better than either creditors, employees or even former management, judging by the cars they drive, and neighborhoods they inhabit. Delays are rife. The market - with certainty - front-runs trades and predates all the flow, including the brokers themselves who are charged with handling sales in the market. Chinese walls, you see, are in fact Shoji screens of paper. And then, there is the size of the liquidation which itself would create large and meaningful market-price impact into a market already-soft and credit constrained particularly for an asset less-than-desired by investors, and a currency on the wane. I will admit that I have NEVER done a 200 billion-dollar trade before, but I do not think there is a market - any market - that would absorb that without meaningful price impact. Finally, and perhaps most importantly, NRK equity itself was already wafer-thin, and the percentage of new loans (originated at very elevated, indeed peak home collateral values, with lower initial equity) were large. Given the massive leverage of the enterprise, one can calculate with a pencil and the back of the envelope what degree of "liquidation discount" on the GBP98,834,000,000 of NRK Loan & Mortgage book would be required to annihilate the GBP1,600,000,000 of shareholders equity. And the result?? Not friggin' much!!! Perhaps, had the global credit crunch, associated delveraging, and emerging recession and house-price crashes in US, UK, Spain and Ireland passed as (painfully) though as quickly as a kidney stone, SRM's claims (and so too BSC's shareholders) might deserve more consideration. However, in the the scheme of things, and the course of global financial events that's followed, 5p on the pound is markedly generous.

It is of course SRMs right to sue. Maybe even their fiduciary obligation (though let's remember, they are domiciled in Monaco where obligation is spelled with small-fonts and a lower-case "o"!). But neither excuse does anything to change this observer's perception that they are simply being sore losers, and no one likes a sore loser...


Anonymous said...

If you really want to do a 200 billion dollar trade, the instrument of choice would be Zimbabwe dollars.
More on point, if a lawsuit like this succeeds,it increases systemic risk going forward, as the chestnuts roasting on the open fire will more likely be left to burn.

"Cassandra" said...

Rawdon Adams at Capital Chronicle pointed out Mssr Wood was successful in prior litigation exploiting an EU loophole, and that may be emboldening him.

It's amusing to contemlpate that in "borrowing short to lend long" NRK risk managers (if that is the correct term) were focusing on entirely the wrong risk (curve risk) vs. what manifested itself - the willingness of the market to fund the "position" itself...