Northern Fudge
The latest casualty of the global credit crisis is a middle-sized British mortgage bank, Northern Rock
- which until last week had almost 20% of the new mortgage market in
the UK. It financed its aggressive expansion by borrowing from the
money markets and securitising its loans. The credit windows of other
banks have suddenly shut in its face, though its loan book is sound
according to the regulators. Northern Rock has had to go to the Bank of
England as lender of last resort. The Bank's line of credit is at a
penal rate, so Northern Rock will have to quit the market for new
mortgages, its share price has collapsed and it's up for sale.
It's more or less irrelevant to the failure, but Northern Rock has
been the object of a classic run by retail depositors. Classic, but
very unusual in recent times. The last retail bank failures in Britain
were in 1973-74, and the secondary banks in question - such as Slater
Walker - were niche players that were obviously riskier than the High
Street ones. But Northern Rock is a High Street bank, and the run has meant highly visible queues of depositors trying to withdraw their money.
Any lessons of general application?
- The regulators - the Bank of England, the Financial Services
Authority, the Chancellor of the Exchequer - all reassured depositors
that their money was safe, but they were not believed. It's difficult
to imagine a more solid establishment lineup, so the scepticism may
reflect the wider decline of deference. Bank deposits aren't insured in
Britain, on the moral hazard argument, so depositors didn't have a legal guarantee.
Since the interest penalty for switching banks is insignificant, even
the tiny risk of default was too much. This is worth remembering in
discussions of reform of deposit insurance in the USA.
- Like most British banks today, Northern Rock had a large
number of online depositors. ( I do almost all my own banking on the
Internet.) When the run started, the website jammed, making customers
even more panicky. Online banking drops the transaction costs of
switching deposits to near-zero and therefore quite possibly makes runs
more likely; it will surely increase their speed and intensity.
Regulators should think about this. Perhaps online banks should be
required to be more conservative in lending. At least. they should be
required to build in huge safety margins of capacity on their websites,
like stock exchanges, and to set up transparent management of online
queues.