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Rocking capitalism
EARLY IN September, the impending insolvency of
Northern Rock provoked a classic bank run, with thousands of depositors
queuing to withdraw their money. The scenes recalled events in Argentina
in 2001, or the last bank run in Britain which occurred in 1886. The
problems of this relatively minor bank threatened to detonate a major
financial crisis, as well as a political crisis for the Brown
government. Moreover, the event highlights the current fragility of
globalised financial markets.
The Northern Rock directors informed the authorities
in mid-August that they were facing serious problems. Unable to find a
big bank willing to buy them out, Northern Rock went to the Bank of
England for emergency assistance. The governor, Mervyn King, ruled out
any assistance, though he was later overruled by the Chancellor of the
Exchequer who authorised emergency funds for the bank. When news of this
broke on 14 September, however, thousands of savers began to queue at
local branches to withdraw their money. Far from reassuring them, news
of emergency funding sounded serious alarm bells.
Directors of Northern Rock, as well as the Financial
Services Authority, the regulatory body, reassured savers that the bank
was solvent and that they could continue to deposit and withdraw funds.
In practice, however, this was problematic. The internet site for online
banking was jammed, while personal withdrawals required hours of
queuing. In one branch, in Cheltenham, two account holders barricaded
the bank manager into her office after she refused to let them withdraw
£1 million from their account.
King appeared inflexible, rejecting an effective
rescue package, while Alistair Darling, Chancellor of the Exchequer,
offered only vague assurances that savers’ deposits would be safe. The
run on Northern Rock was denounced as an irrational panic, unjustified
hysteria.
Yet the facts emerging about Northern Rock’s
‘business model’ more than justified savers’ anxieties. The board and
their apologists claimed that they had been hit by the unexpected and
unpredictable sub-prime mortgage crisis in the US, which had led to a
seizing up of short-term credit markets. But it was Northern Rock’s own
business methods that made it vulnerable to the sub-prime crisis, a
crisis that had been developing over the previous months.
Compared to other mortgage lenders, Northern Rock
has only a handful of branches. Instead of investing in high street
branches and building a wide base of savers, the board preferred to
raise money on the wholesale money market, relying on this for 75% of
their funding. They had increased their mortgage lending over 50% during
the last year.
This was a high-risk strategy, short-term borrowing
to finance long-term lending. When the banks reacted to the sub-prime
mortgage crisis by withholding short-term credit during the summer,
Northern Rock faced not merely a short-term liquidity crisis, but the
prospect of insolvency. The directors tried to negotiate a takeover by
bigger banks, but potential buyers were not prepared to shoulder the
likely losses.
Northern Rock’s share price plummeted, forcing the
directors to go to the Bank of England. This unsuccessful move led
savers to withdraw around £2 billion in three days, directly threatening
the viability of Northern Rock.
The government and the Bank of England were forced
to make a humiliating u-turn. The possible collapse of Northern Rock
potentially threatened the whole financial system. It has become clear,
moreover, that other banks deliberately withheld funding in an effort to
force action by the Bank of England and the government. At the same
time, continuing queues outside Northern Rock’s branches intensified the
political pressure on Brown and Darling, who had so far failed to take
decisive action.
Then, on 17 September, Darling announced that the
government and the Bank of England would guarantee all Northern Rock
deposits. Only this announcement brought the run to an end, though
confidence in Northern Rock is far from being restored. It seems
unlikely that Northern Rock will survive as an independent bank, and its
mortgage business may well be taken over by other banks.
Darling’s guarantee for Northern Rock depositors,
however, has wider implications. How can the government guarantee one
bank, without implicitly offering the same guarantee to all savers?
Previously, Mervyn King opposed rescuing Northern Rock (or any other
bank) on the grounds that it created ‘moral hazard’. In other words, the
security of an ultimate government guarantee could encourage banks to
undertake risky if not reckless speculative activities, secure in the
knowledge that they would not face bankruptcy. But the prospect of an
implosion of the whole banking system forced King, as well as Darling
and Brown, to change their tune. Forget moral hazard, the system is
under threat.
Writing in the Financial Times (19 September),
Martin Wolf comments: "The decision to guarantee deposits raises large
questions. Deposit liabilities are nationalised, while the financial
system’s assets, albeit regulated, remain in private hands. If you do
not understand the implications of that, you have not paid attention to
what has been happening in the financial sector".
Up until 21 September, Northern Rock had borrowed £3
billion from the Bank of England, in reality public funds to repair the
damage created by its reckless ‘business model’. But there is widespread
anger that the board still intends to make interim dividend payments to
shareholders, including a number of directors. Adam Applegarth, chief
executive, is due to receive £13,952 while others will receive between
£6-8,000. There is pressure on them to waive these payments, but they
have made no announcement about this so far.
Darling is now proposing to introduce a new deposit
guarantee scheme, insuring deposits of up to £100,000. This would
undoubtedly be an improvement over the current scheme, which only
insures deposits up to £31,000 (100% up to £2,000, 90% for the rest).
However, it would still be a question of the state picking up the tab
for bank losses, while allowing their owners to carry on as usual.
The real answer would be to nationalise Northern
Rock, together with all other major banks and building societies, to be
run on a planned basis. That would secure savers’ deposits, and at the
same time provide affordable mortgages for house buyers. Compensation
would be on the basis of need, not to the big financial institutions or
wealthy speculators, but to small investors who rely on the income to
live on. Such a policy, of course, implies a break from the anarchy of
the capitalist market, especially the current feverish financial
speculation, and a decisive switch to a planned economy on a socialist
basis.
The government, the Bank of England, and the
Financial Services Authority are now trying to offload the blame for the
Northern Rock crisis on to one another. The truth is, they all turned a
blind eye to the speculative policies of the Northern Rock directors.
History shows, however, that it is futile for capitalist governments to
attempt to regulate the finance system, especially in periods of intense
speculative activity and instability. For instance, in the 1990s in the
US the government was forced to step in to bail out (effectively
nationalising) the savings and loans institutions (the equivalent of
building societies). They were forced to pay out between $150-200
billion to clear up the mess that resulted from speculation and
fraudulent activity.
Earlier, in Britain in 1974-76, the Labour
government of that time was forced to bail out around 60 so-called
secondary banks, speculative outfits that sought to profit from the
property and commodities boom of that time.
"Is this the end of the story of crisis and
contagion?" asks Martin Wolf. "Far from it, is my guess. If we can have
such trouble with the financial system when the real economy is healthy,
I tremble at what may happen when conditions start to become worse. The
financial system looks more insecure than I feared. The unwinding of
past excesses may well bring more unpleasant surprises".
Undoubtedly, there will be further, even more
serious crises within the British and global financial system.
Globalisation ensures that almost any serious problem has worldwide
ramifications. But can ‘the real economy’ be described as ‘healthy’ when
it is so tied up with debt and speculative activity?
Lynn Walsh
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