The Northern Rock crisis has undermined this governmentâ€™s economic reputation, and deservedly so. They have made mistake after mistake in responding the Credit Crunch and the run on the bank. I have put the main blog entries on Northern Rock from this site together so people can remind themselves of the way the crisis unfolded from last summer. The main errors (highlighted at the time on this site) were:
July 2007 It was clear that credit was too tight and interest rates were too high for comfort. â€œIf the central banks donâ€™t back off soon it could be quite a collapseâ€. The UK authorities failed to supply enough liquidity to markets or to lower rates.
August 2007 The Credit squeeze became clearer in the markets, and some more City commentators came to appreciate the dangers. The UK authorities still did nothing.
September 1-13 The Fed and the ECB were taking action to relieve the squeeze, but the UK authorities still did nothing.
September 13th The Chancellor makes a stupid speech blaming the banks for poor lending and stating firmly there will be no bail outs of banks in trouble. This was an open invitation to anyone banking with a weaker institution to remove their money whilst they still could.
September 14th onwards Government and Bank of England become lender of last resort to Northern Rock and allow this to become public knowledge, encouraging a run on the bank.
Government fails to arrange a take-over for Northern Rock before the run develops, claiming the legal framework it has put in place does not allow it to.
Government allows the run on Northern Rock to develop, and only when it is very serious does it announce the biggest guarantee and bail out ever attempted in the UK.
Government lends around £25 billion to Northern Rock without being able to assure us it has taken sufficient high quality collateral to ensure taxpayers can get all their money back.
Government fails to set out terms for the loan, including the all important question of when it expects repayment. Government fails to tell us that it has carried out usual banking due diligence and leaves doubt about what power it has exerted to ensure proper monitoring of the loan, strong covenants, and a professional approach to repayment.
Government becomes involved in shareholder discussions and decisions about finding a new management team/new shareholders for the bank and raising new equity for it. These discussions fail to produce an answer acceptable to all concerned, but drag on from September 2007 until February 2008.
Government nationalises the bank, more than doubling the taxpayersâ€™ risk at a stroke and leaving itself open to endless legal disputes and rows about compensation and the way it will run the bank under its ownership.
What should the government have done differently? As this blog shows it should have
1. Made more liquidity available to markets and cut interest rates last summer, to prevent banks like Northern Rock being denied all access to market finance so it did not develop into the crisis we saw.
2. Not lecture the banks on their imperfections when the system was so distressed, as the Chancellor must have known when he spoke
3. Avoid any lender of last resort lending being made public, or cover the lending to one bank by requiring all banks to borrow something so the markets were not spooked about one individual bank â€“ this could have been part of a general liquidity increase and sold sensibly to markets
4. When lending to Northern Rock understand the need to be a strong and firm lender. This meant limiting the sums, and limiting the time of the loan. It meant telling the Board of the bank that they only had so long to find alternative private sector money, and if they could not they had to start selling mortgages and running off their business book to meet the repayments required.
5. Staying out of discussion about new shareholders and new management to increase the chances of something happening, but keeping up the pressure on them to reach a quick solution by demanding early repayment tranches.
At every stage the government made the wrong call. They have now ended up with the worst possible of worlds, and will doubtless run this bank as badly as they have been running Network Rail and the Post Office. In the first case they doubled the costs of running the track quite quickly after nationalising it, and in the second case they have embarked on a large programme of closures having undermined its counters business by their own decisions.
<strong>Click <a href=”http://www.johnredwoodsdiary.com/category/northern-rock/”>here </a>to see the archive of John Redwood’s previous postings on Northern Rock.</strong>