Investment Markets » Banking and Finance
Could The Panic Have Been Averted?
A combination of high-minded principle and communication cock-ups fuelled the crisis at Northern Rock.
It was the first run on a British bank since the collapse of Overend and Gurney in 1866, and the blame game for Northern Rock's descent from stock market darling to Alistair Darling is already under way. The crumbling of Northern Rock reminds us that conservative banking rarely survives the lure of easy money. But it also highlights the deep flaws in the regulatory system.
The extraordinary spectacle of the Chancellor resorting to a verbal guarantee of all UK bank deposits on national TV shows that the old tools don't work. But did it also demonstrate that the triumvirate of regulators – the Bank, the Treasury and the Financial Services Authority (FSA) – was hopelessly inadequate to its task?
The tripartite arrangement seems a recipe for weaknesses of bureaucracy: buck-passing, backside-covering and turf wars. And so it proved with Northern Rock.
The authorities might plead that the scale of the panic was unprecedented. But the risks of using short-term money loans to fund aggressive growth in mortgages are well known, and this squeeze was hardly a bolt from the blue. It now emerges that the FSA urged the Bank to intervene earlier by widening the types of collateral it would accept when lending to troubled institutions; the Bank refused on grounds of moral hazard.
Governor Mervyn King's instinct was to attempt a quiet sale of Northern Rock, with Lloyds Bank lined up as the saviour. Yet when that failed, there was no plan B – an error compounded by a grand communications cock-up, which meant news of the emergency bailout was leaked before the deal had been finalised, with catastrophic effects.
Part of the job of a central bank is to communicate a sense of calm and quiet authority, but this quality has been absent from the Bank of England throughout the current credit crises.
King's high-minded adherence to the principles of moral hazard was peculiarly unsuited to the seriousness of the situation. It isn't fair to apply these principles to ordinary savers, who put their money in a deposit account rather than the stock market because they believe it to be risk free. And a key factor behind the panic was the knowledge that if Northern Rock did go under, depositors stood to lose everything bar the £31,000 guaranteed by the FSA.
If there is one positive outcome to the crisis, it is the now widespread argument that a gold-plated system of deposit insurance protection is crucial.
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