Clarity over charity is far too hard for Callum

It was a killer punch from a Dumbartonshire hard man. Callum McCarthy and Hector Sants had been ducking and weaving well enough in front of the Treasury committee that is investigating Northern Rock, when the chairman caught the pair cold.

What, John McFall asked, did the Financial Services Authority think about Granite? Was not the use of a Channel Islands vehicle, a charity and a trustee company, to raise huge sums of money "a totally artificial construction?" Er, er, pass, was the gist of the reply from the pair. We'll find out and write you a letter.

This is a bizarre story indeed. One Richard Murphy, a forensic accountant, has dug into the technical details of the Rock's vast financing in the money markets and unearthed an operation of bewildering complexity which appears to rest on a tiny charity. The charity, it seems, is completely ignorant of its role in high finance, and the only contribution it can find is a whip-round from Northern Rock staff in 2001.

The bank's vehicle for its financing is called Granite Finance Holdings, and has issued paper worth close to £50 billion. Yet Granite is not owned by Rock, but by Law Debenture Corporation, a reputable trustee company which holds it "for the benefit of one or more charities". Any profits "will be paid for the benefit of the Down's Syndrome North East Association (UK) and for other charitable purposes".

Murphy has also constructed a diagram complicated enough to make grown men cry. It connects Northern Rock to the various classes of Notes (the paper that the buyers in the wholesale markets actually receive) which is as impressive a piece of slice-and-dice complexity as you'll ever see.

It's unlikely that more than a handful of employees at the Rock could draw it without help, and it's a racing certainty that none of the directors could say why it was needed. Adam Applegarth, the chief executive, would be well advised to have an explanation ready when he faces McFall's committee next week.

Suffice to say that the buyers were being sold paper which was four financial steps away from the borrowers who were paying their mortgage interest. It would be impossible for a buyer to judge their creditworthiness even in the unlikely event that he would choose to do so.

This may be common practice in the murky world of swaps and derivatives, but complexity always arouses suspicion that there's something to hide, and it might also help explain the curious tale told by the graph above. The red line shows the price of Northern Rock's five-year credit default swaps, effectively the market's view of the creditworthiness of the bank. Having been rock steady at less than 20 basis points, the price started to climb in July. In early August it took a leap of 50 basis points, or 0.5%. The share price (the yellow line) had been falling, but it was another four weeks before disaster struck and the bank collapsed.

Someone in the money markets knew something, or perhaps they decided that Granite wasn't as solid as a Rock after all, and was going to crumble under pressure. Sadly, it's unlikely that the letter the FSA has promised to the committee will answer such an awkward question.