The Northern Rock Debacle and
More to Come?
Lifeboats, Nationalisation, Moral Hazard and Free Market
London, UK - 18th February 2008, 08:36 GMT
Dear Open ATCA & Philanthropia Friends
[Please note that the views presented by individual contributors
are not necessarily representative of the views of ATCA, which is neutral.
ATCA conducts collective Socratic dialogue on global opportunities and threats.]
The UK finance minister, Chancellor Alistair Darling, is due
to put forward emergency legislation in Parliament to nationalise Northern
Rock, the infamous "non-bank" bank, which became the picture poster
victim of the global credit crunch in September 2007. Northern Rock suffered
the first run on a British bank in 140 years.
Sunday's surprise announcement means the bank's estimated GBP 55+ billion
(USD 108+ bn) in liabilities will be placed in the public's lap. The British
taxpayer's relationship with Northern Rock has evolved in the last six months
from creditor to guarantor to owner! This will be the first lifeboat-nationalisation
solution of its kind in nearly 35 years. The Opposition led by the Conservative
Party has said the move to public ownership marks the death of the government's
reputation for economic competence. However, the Liberal Democrats said
the government had made the right decision, "belatedly". Mr Darling
has insisted that it was the best way to safeguard people's money. The decision
has infuriated Northern Rock shareholders and shocked the remaining two
private bidders vying for the stricken mortgage lender.
In parallel, the UK current account deficit reached 5.7% of GDP in the third
quarter of last year, the worst of any major country in the world, bar Spain.
Further, the household sector is borrowing at an unprecedented 4% of GDP.
Basing economic growth on unsustainable asset price bubbles may yet prove
to be a recipe for protracted trouble. With a budget deficit of 3% of GDP
at the top of the cycle, the UK enters the slump without a fiscal shield.
For those who remember Euro-land rules, this deficit is beyond the legal
limit of the Maastricht Treaty. The government share of GDP has risen from
37% to 45% in eight years based on OECD figures and now exceeds that of
Germany for the first time since the 1970s.
The emergency lifeboat public loans designed to keep Northern Rock afloat
until a private-sector solution could be found totalled at least GBP 25
billion (USD 49 bn), yet no credible offers for the bank emerged. Interest
among private-sector bidders waned since the gigantic loans were first revealed
in September. That is in part because of market conditions more generally
and in part because the loans, and the government's insistence that they
be repaid post-haste, became an anchor that no private lifeboat could, would
or should bear. The Northern Rock debacle may tarnish the UK's reputation
for excellence in banking and may be perceived to be a symbol of massive
regulatory failure. Britain claims to be the world's pre-eminent financial
centre and yet has been forced to nationalise a mortgage bank. This is a
The government may have made the right basic decision, but it is several
months too late and unrealistic in its plan to run the bank as a normal
commercial operation. Northern Rock may not just have to be nationalised
but its doors to future business may have to be eventually shut otherwise
its continued existence may fundamentally distort the UK mortgage market
as a whole. Sir Richard Branson, whose Virgin Group was a bidder, said he
was disappointed by the decision, "We believe nationalisation is not
the right answer and that a commercial solution would have been the best
The vast pools of easy short-term credit on which Northern Rock's non-bank
business model was built are not likely to return anytime soon, if ever.
Using the public purse to put the Rock in a position of strength versus
other banks that have been battered by the subprime crisis but did not ask
taxpayers to bail them out may be a travesty and completely against the
principles of free market economics. Not to talk about the attendant moral
hazard and the strong interventionist signal which it sends out to the global
financial markets. The second disturbing message that nationalisation sends
out is that any financial institution which mismanages itself will be saved
by the government. This is the "moral hazard" that Prof Mervyn
King, the Governor of the Bank of England, has warned about repeatedly since
the crisis started. It may encourage some banks to be more reckless but
that is unfair on their prudent counterparts and sets a negative precedent.
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