The Northern Rock saga explained
The Northern Rock debacle has rumbled on for almost six months now, but what are the implications for borrowers? Barney McCarthy explains
Presuming you haven’t been living on another planet since September last year, you can’t have failed to notice the strife of Northern Rock. The North East-based lender has barely been out of the newspapers since then, and the images of worried customers queuing round the block to retrieve their savings was one of the enduring images of 2007. But while you may have a basic grasp of what has been going on, you may not understand why the bank got into difficulty and what the latest developments mean. Here we will give you a potted version of events over the last few months.
The cracks appear
On 13 September 2007, Northern Rock asked the Bank of England for financial assistance due to problems in raising funds in the money market. These difficulties were a knock-on effect from the sub-prime crisis in the US which made institutional lenders – the organisations that mortgage lenders borrow money from themselves – nervous about lending money to UK mortgage lenders as they feared a repeat of what happened in the US, where they had their fingers badly burned.
Although Northern Rock’s assets were sufficient to cover its liabilities, it had a liquidity problem because of the way the business was structured. Relying heavily on short-term funding, and securitisation – a method of operating whereby lenders sell on their ‘books’ of mortgage or loan accounts to fund their business – meant that when demand for these dried up, the lender hit trouble.
As news of Northern Rock asking the Bank of England for help emerged, many customers feared that the bank would collapse and withdrew their savings. In hindsight, it would appear such panic was unfounded. Jonathan Cornell, managing director at broker Hamptons Mortgages, says: “Customers of Northern Rock needn’t have worried, as those with mortgages have not see any difference and savers should continue to make the most of attractive rates. It will only be those borrowers coming to the end of their fixed or tracker period deals who may find that they are unable to remortgage with the bank as Northern Rock looks to reduce its level of borrowing.”
Initial funding from the Bank of England in September was estimated at around a couple of billion pounds, but by the beginning of this year, the figure had risen to well over £20bn.
A national affair
Several financial institutions expressed an interest in buying Northern Rock, most notably Sir Richard Branson’s Virgin Group which was the last interested party left in talks with the Government. An early bid from Lloyds TSB in September was declined personally by Chancellor Alistair Darling, according to Bank of England governor Mervyn King. Quite why, is unknown.
The decision was made on 17 February to nationalise the bank as Darling claimed the external bids did not offer sufficient value to the taxpayer. Nationalisation means that Northern Rock is publicly owned and that the taxpayer will be effectively supporting it. Although the Government claims such a move is temporary, it is unclear how long it will be nationalised for. One famous previous example, Rolls Royce, was nationalised in 1971 and was only privatised in 1987.
Although the financial services industry has expressed relief at a decision being made after months of procrastination, the plans to nationalise Northern Rock have been met with anger from rival banks. The concern centres round public ownership giving the lender an unfair competitive advantage in that it might be able to borrow and lend more cheaply. Shareholders may also be entitled to little compensation for their shares as a result of nationalisation. Shares currently stand at 90p, down from just under £2 when the trouble started.
Adrian Coles, director general of the Building Societies Association, says: “We are very concerned that taxpayer-funded compensation for an institution that has failed would lead to pressure being put on organisations which have not failed.”
Other parts of the financial services chain have also expressed dismay. Rosenblatt Solicitors claims the move to nationalise Northern Rock breaches EU competition law and is inconsistent with subsidy regulations. Head of financial services Nigel Frudd says: “Nationalisation provides Northern Rock with a guarantee that other banks cannot match and could indirectly have the opposite affect of what the Government was trying to avoid – another run on the banking system. Why should anyone have deposits with any other bank than Northern Rock when it is guaranteed by HM Treasury?”
Although nationalisation has ended speculation for now, questions remain unanswered about what the future holds for the stricken lender.
Tags: Credit crunch, nationalisation, Northern Rock, securitisation
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