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Policy
Northern Rock
Northern Rock bank relied on wholesale markets to fund its mortgage lending, but had to seek emergency funding from the Bank of England when these markets became afflicted by uncertainty stemming from losses on loans in the United States. The bank was subsequently nationalised. Because building societies are run differently from Northern Rock bank, it would be very unlikely that they could get into the same predicament in which Northern Rock found itself in 2007. This page summarises the events that led to Northern Rock being nationalised and outlines building societies' concerns about the distortions the nationalised bank might make to the savings market. The summary is split into the following sections: Background For several years, Northern Rock bank grew its mortgage business rapidly. In the first half of 2007, the bank grew its mortgage lending by 31% compared to the same period a year earlier. In comparison, lending at building societies grew by 13% on the first half of 2006. In the first six months of 2007, Northern Rock was writing approximately one in every five new mortgages in the UK, a much greater proportion than it's historical market share. Northern Rock did not lend to sub-prime borrowers, and all reports suggest that the quality of Northern Rock's mortgage book was extremely good. Its level of mortgage arrears was around half of the average of all UK lenders. Northern Rock primarily used wholesale money markets to fund its lending, as opposed to lending out of money deposited by retail savers. More than 75% of Northern Rock's funding came from wholesale markets, a greater proportion than any other UK lender. It relied on securitising its mortgages. This means that the mortgage loans were bundled together and sold collectively in the money markets. In its report on the problems at Northern Rock, the Treasury Select Committee placed a major part of the blame on the bank's Directors pursuing this "reckless business model which was excessively reliant on wholesale funding". The spread of US sub-prime problems Sub-prime mortgages are mortgage loans made to people with poor credit histories and a record of defaulting on previous credit agreements. In the USA, many of these sub-prime mortgages were bundled together and securitised, then sold on in international capital markets. These bonds came to be owned by banks and financial institutions all over the world. In the first half of 2007, many sub-prime borrowers in the US started having difficulties meeting their mortgage repayments. With house prices in parts of the US falling, some lenders were unable to recover the total amount of the outstanding mortgage by repossessing the property. By August 2007, investors became alarmed at the emerging losses, and the market for these securities froze. This uncertainty spread so that investors were not even willing to purchase securities backed by higher quality loans than sub-prime. Commercial banks across the world began to hoard cash, cutting back on the credit they had usually made available to other banks. Banks could only secure funding from other banks for very short periods, and at more expensive rates of interest. Given Northern Rock's reliance on wholesale funding, it suddenly had problems making good on commitments to lend that it had already made. Within a few weeks, it was forced to approach the Bank of England for support. News breaks of Northern Rock's problems On the evening of Thursday 13 September 2007, news broke that Northern Rock had received emergency financial support from the Bank of England. The terms of the deal were formally announced on the morning of Friday 14 September. As a result of this announcement, queues of people desperate to withdraw their savings began to form outside Northern Rock branches. The bank's internet site crashed and its phone lines were jammed. News images showing the queues fuelled a sense of panic. Queues formed again on Saturday 15 September, despite assurances from the regulator, the FSA, that Northern Rock was solvent and had a sound long term loan book, but had short term liquidity difficulties. However, these assurances did not placate the fears of Northern Rock's savers, who flocked to withdraw their money from the bank. As a result of the ongoing run on the bank's savings, the Chancellor of the Exchequer, Alistair Darling, was forced to announce on the morning of Monday 17 September that the Government would guarantee all deposits held with Northern Rock. This guarantee appeared to address savers' concerns, and the queues abated. The guarantee was later extended from just covering retail depositors to cover all other creditors. Could it happen to a building society? Building societies are run differently from Northern Rock bank, making it extremely unlikely that they could have got into the same situation in which Northern Rock found itself. Northern Rock funded more than 75% of its lending in the wholesale markets. It is against the law for building societies to fund more than 50% of their lending with wholesale funding, and on average societies use around 30% wholesale funding. The majority of building society lending is funded by retail savings. Northern Rock used to be a building society, but demutualised and converted into a bank in 1997. Northern Rock’s mortgage business grew very rapidly and it relied to a greater extent than any other UK lender on the wholesale money markets to fund its lending. As the Government guarantee and emergency loans from the Bank of England remained in place, it became increasingly clear that Northern Rock would not be able to operate as a standalone entity again. Over subsequent months, the Government sought out potential buyers for the stricken bank. By the deadline for bids, there were just two offers left on the table: one from Virgin, and one from the Northern Rock board. However, none of the offers satisfactorily reconciled the competing claims from shareholders, Northern Rock customers and the need to protect taxpayers' money. As a result, the Government announced the temporary nationalisation of Northern Rock on 17 February 2008, with the aim of returning the business to the private sector "when financial markets stabilise". Northern Rock would be managed on arms' length terms, as a commercial entity, by a newly appointed management team. Recent developments, current concerns Northern Rock's new management team published a summary business plan in March 2008. This showed that Northern Rock plans to reduce the number of outstanding mortgages it holds and curtail new lending, but will try to attract substantial savings inflows to pay off the Bank of England loans. This strategy may result in a number of job losses at Northern Rock. The Building Societies Association is concerned that Northern Rock might be run in a way that provides unfair competition to other firms. The commitments made in the restructuring plan are a step in the right direction, but it is crucial that no unfar competition takes place in practice. We welcome the announcement from the European Commission that it will launch an investigation into the aid given to Northern Rock, because this provides another bulwark against this threat.
References:Treasury announcement of Bank of England support for Northern RockChancellor announces guarantee for Northern Rock deposits Announcement of extension of guarantee to wholesale deposits Announcement of extension of guarantee to new deposits Announcement of further extension of guarantee to all deposits BSA response to the Treasury Select Committee enquiry Treasury Select Committee report: The run on the Rock Treasury announcement of Northern Rock nationalisation BSA reaction to the Chancellor's outline of Northern Rock's business plan Northern Rock's summary business plan |
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