Rocky Road Ahead

Philip Booth on the Northern Rock Crisis in the Yorkshire Post

The problems at Northern Rock are still making the headlines several days after the Bank of England stepped in to lend to the troubled bank. Queues of people are forming outside the bank to withdraw their deposits. At the time of writing about £2bn had already been withdrawn, although to put this in context it only represents about 2% of the value of Northern Rock’s mortgage book. In an extraordinary attack by David Cameron, even the government is being blamed for the crisis.

Such party political interventions by politicians do nothing to alleviate one notable aspect of this crisis: the fact that nobody believes the politicians. The Chancellor of the Exchequer and others have told depositors that they have nothing to worry about. They are broadly correct. Even if Northern Rock were to have serious, structural solvency problems customers’ losses would be limited by the deposit insurance scheme to which all banks have to subscribe. Yet the more the politicians reassure depositors, the more depositors ignore the politicians! It is a warning to those who respond to crises by proposing more and more regulation in financial affairs by politicians that trust in politicians is probably rather lower than trust in banks.

How did this all happen? Northern Rock is well known for providing mortgages at high multiples of income and at a very high proportion of a property’s value. They funded such mortgages, many of which were tied to the Bank of England’s lending rate, by borrowing funds at an interest rate which can, and did, rise significantly above the Bank of England’s rate in times of financial turmoil.

In my view, with one or two caveats that I shall mention later, this problem has been dealt with correctly from the point of view of policymakers and regulators. But what about Northern Rock? It is not for me to comment on its business model. As long as appropriate, risk-adjusted rates of interest are charged, it is not unreasonable for a bank to lend high multiples of salary or high percentages of property values. Like many critics, I have a distaste for spending too much beyond my income. But, unlike other critics, I recognise that one cannot make judgements from an ivory tower about the borrowing needs of people who need to get onto the property ladder or who are trying to sort out their financial affairs after a separation or divorce. The important thing is that those who make the decisions bear the cost when things go wrong. There should be no bail out of borrowers; there should be no bail out of shareholders; and any assistance given to savers must be strictly limited to the terms of the statutory deposit insurance scheme. Any assistance given by the Ban