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Northern Rock - How a Problem became a Disaster ?

6 March 2008

Northern Rock has been a cloud over the UK financial sector since it ran out of cash in August 2007. This was due to the fact that most of its funds were being raised in the wholesale market, that is from other financial institutions rather than deposits from retail customers. The problems of the US subprime mortgage crisis, to which most UK banks remain exposed, dried up Northern Rock's funding.

This business model of financing rapid growth on the basis of short term borrowing from the wholesale market assisted Northern Rock to develop from a regional lender to a major player in the UK mortgage market. They had achieved a 22% share of new mortgages taken out in the first 6 months of 2007.


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Unlike the US subprime market, the mortgage book of Northern Rock was healthy. Defaults and repossessions were not significantly higher than the UK industry average.

The management of Northern Rock did approach the Financial Services Authority (FSA) and advise them of the situation, There were talks between Northern Rock and Lloyds TSB, but a take over bid did not materialise. This was partially due to the fact that the Bank of England was unwilling to underpin the takeover with significant public lending.

The initial response of the Governor of the Bank of England was to lecture the City and the nation on the ‘moral hazard' of baling out financial institutions who are in difficulty. Perhaps the Bank had considered opening a lapdancing club in Threadneedle Street.

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By mid November, the crisis had grown and the Bank of England had been forced to improve liquidity in financial markets, that is, print money and make it available for other banks.

The Governor also announced a series of auctions whereby the Bank would lend £40 billion to financial institutions at an interest rate of 6.75%. There were no takers for this last initiative. This was due to the high interest rates, but also to the fact that no bank wished to have the inevitable adverse publicity of being forced to approach the Bank of England for assistance. It should be recalled that the run on Northern Rock was triggered by a leak to the media.

The announcement of a government guarantee to depositors provided a breathing space during which interested parties could prepare bids for Northern Rock. There were 3 bidders, the favourite being the Virgin proposal, promoted by Sir Richard Branson.

It was generally felt that the Virgin bid was too advantageous to Sir Richard at the expense of the UK taxpayer. The prospect of ‘obscene' profits for Virgin prompted the Prime Minister, Gordon Brown, to announce nationalisation in mid February 2008.

The handling of the Northern Rock saga reflects badly on all the parties involved. While the management must take responsibility for the risky business model, they were helpless in the face of the global credit crunch. Once they had disclosed their problems to the FSA, then the public agencies took control of the situation.

However, the suggestion that any public body ‘took control' is a sad joke. The drama moved from the boardroom of Northern Rock in Newcastle to the tripartite regime established by Gordon Brown while he was Chancellor of the Exchequer during the Blair years. The parties in the tripartite regime are the Bank of England, the Financial Services Authority, and the UK Treasury. The Bank of England lectured on moral hazard, the FSA claimed to be powerless, and the Treasury dithered.

Gordon Brown repeatedly claimed during the successive Blair governments that the relative prosperity of the UK, and the success of London as an international financial centre, was due to his vision of a tripartite regulatory regime, with an independent Bank of England at the centre.

It is true that London overtook New York as the leading global financial centre, but this is due to the efforts of those employed in the City and the negative impact of restrictions imposed on the financial sector in New York. The bankruptcy of Enron in 2001 and subsequent criminal prosecutions further weakened New York as a financial centre.

Northern Rock was the first real test that the UK regulatory bodies had faced since the secondary banking crisis of 1973. By any yardstick, the tripartite regime was a dismal failure.

The run on Northern Rock was triggered by a media leak, allegedly from the tripartite regime, and the reaction of the regime was lamentable. The media seized the story with glee, and the tripartite regime looked on in horror while the queues of depositors formed outside Northern Rock branches.

Harry - a news blackout for 10 weeks

This can be compared with the news blackout on the deployment of Prince Harry in Afghanistan, which lasted for 10 weeks. The fact that the Prince had been posted to Afghanistan during December 2007 and that the UK media had unanimously agreed to suppress the story is breathtaking.

The UK media are well known for taking perverse pleasure in broadcasting embarrassing moments of 'celebrities'. They consider this justified, based on the cherished concept of freedom of the press. However, it is an ominous sign in an open society when the media colludes en masse with the government in suppressing a news story, unless there are powerful and compelling reasons to do so.

In fact, Prince Harry's deployment was reported in the Australian publication 'New Idea' on January 7 and in the German paper Bild on February 27. It is well known that some members of the Taliban are voracious readers, albeit of the Koran, but they may well have picked up the story from these publications.

To suggest that Prince Harry's presence in Afghanistan should be suppressed on the basis of the 'public interest' or 'national security' is farcical. If publicity of his presence were deemed to put other soldiers at heightened risk, then this raises the suggestion that he should not have been sent there.

One would suggest that a similar period of confidentiality surrounding the problems of Northern Rock would have led to a resolution of their difficulties.

The fact that the UK media conspired to suppress the Prince Harry story but exposed the problems at Northern Rock with glee is a sad reflection of contemporary UK culture. The financial standing of the UK banking industry is infinitely more important than a young man's desire to experience active service as a soldier. More to the point, the British Establishment was more concerned with the security of a member of the royal family than with the integrity and international reputation of the UK banking industry and the City of London. This episode clearly demonstrates how the Establishment prioritises and promotes the Royal Family and devalues the economic capability of the UK.

Another unfavourable comparison is that with the French banking crisis at Societe Generale. This crisis was occasioned by a rogue trader who caused losses of US$ 7.26 billion, rather than the global credit crunch.

Daniel Bouton waives 6 month's salary

Jerome Kerviel was the rogue trader, in the Nick Leeson mould, who resorted to illegal means in order to conceal his huge trading losses incurred in financial futures. Mr Kerviel apparently turned a profit during 2007, but in January 2008 he bet that the German DAX and the Dow Jones Euro Stock indices would rise. Unfortunately, they fell. The bank liquidated his positions in mid January 2008 and he is currently remanded in custody by the French authorities.

However, as soon as news broke in January, the French authorities stepped in. As well as providing funds, they also warned off foreign predators. This makes a mockery of EU rules, but the French always have a healthy disregard for EU regulations when their own national interest is threatened.

The bank has been rescued by a rights issue of US$ 8.4 billion. The one-for-four rights issue has been completely taken up by shareholders and the company share price has started recovering.

The Chairman of Societe Generale, Daniel Bouton, has personally invested US$2.2 million in the rights issue. He has also waived his bonus and six month's salary.

This episode further discredits the UK government's handing of Northern Rock. The French authorities reacted quickly and decisively to prevent a foreign takeover of the bank, and the funding shortfall was resolved within weeks by a fully subscribed rights issue.

Ron Sandler earns £90,000 per month

The commitment of Messr Bouton should also be congratulated. This contrasts markedly with the UK, where the government has appointed Ron Sandler on a salary of £1.1 million per annum to run Northern Rock. He was born in South Africa, but was educated at Cambridge and started his rise to fame as a management consultant.

He is credited with having masterminded the turnaround at Lloyds of London when they were facing bankruptcy by large exposure to asbestos claims in the USA.and Nat West. He has resigned as non executive chairman of Computacentre in order to focus on Northern Rock

He was commissioned by Gordon Brown to write a report on the long term UK savings industry in 2001, but very few recommendations have been implemented.

Mr Sandler is allegedly non domiciled in the UK for tax purposes.

Based on their failure to monitor and regulate the banking sector, the UK government has nationalised Northern Rock. For some inexplicable reason, they believe that while they were unable to regulate the bank, they will now be successful in managing the bank, attracting lenders, and returning it to the private sector.

Copyright - Leslie Hardy, 6 March 2008


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