Northern Rock fallout

I followed the Northern Rock crisis with more than my usual interest in banking issues due to the fact that a portion of my income was nestling in one of its online accounts. So, although I could listen dispassionately to some of the more hysterical news reports from outside various branches of the former building society, I sympathised with the desire to make a dash for the cash.

I wasn't really concerned until Alistair Darling said not to panic, which possibly says more about my faith in politicians than bankers.

However, it was Darling who finally turned up trumps for the depositors since he clearly realised that the public at large took a personal rather than a macroeconomic view of the banking system as a whole.

Meanwhile, protecting the system from "moral hazard" was Bank of England governor Mervyn King. Unlike the Federal Reserve and the European Central Bank (ECB), the Bank of England hadn't pumped liquidity into the markets as a result of tightening credit conditions, due in large part to concerns banks had about each other's exposure to subprime lending.

King felt that making credit available to the banks would encourage the kind of risky lending that had precipitated the problem in the first place.

On Wednesday, September 12th, the week that the Northern Rock fiasco unfolded, King, in front of the Treasury Select Committee, said that bailing out banks would "sow the seeds of a future financial crisis". Unfortunately, the future was closer than he realised. And the seeds had already been sown.

The reality is that there were no conceivable circumstances in which the British government could allow millions of depositors to lose their money. That's why Alistair Darling took the decision to guarantee them. Shareholders are another matter entirely - owning a part of the company means you accept the risks and rewards of the management strategy, and many shareholders were handsomely rewarded during the years when the bank aggressively grew its lending portfolio.

But people putting their money on deposit in a high-street bank shouldn't feel as though they are engaging in a high-risk strategy themselves.

And although depositors were lectured about the futility of standing in line for their cash, it was a hard sell. After all, the crisis of confidence in the banking system had been started by the banks not wanting to lend in the interbank market. If they didn't trust each other, why should a retired pensioner step into the breach?

Ultimately the issue became one of pragmatism over principles. Although understandably wanting to protect the system from the moral hazard of bankers lending out unlimited cash to all and sundry, the authorities suddenly realised depositors weren't going to sit around and wait while they discussed the finer points of how much pain to inflict on Northern Rock.

Of course, the guardians of moral hazard may have had slightly different criteria to the rest of us. Even as people began waiting in line outside Northern Rock, the Financial Services Authority made the point that it was a well-run bank with significant assets. Adam J Applegarth, the chief executive, insisted that the issue of liquidity was a temporary one. Both were partly correct.

But in the same way as King worried about hazards in a mythical "future", Applegarth's idea of "temporary" was equally indistinct. There is no doubt that the global credit crunch was the catalyst in the UK banking crisis.

But there were problems on the home front, too. A former member of the Bank of England's monetary policy committee, Willem Buiter, didn't mince his words when it came to his feelings about rescues in the banking system by proclaiming: "Moral hazard has received a boost in the UK banking sector and in the UK financial system as a whole. We will all pay the price in the years to come, when the next wave of reckless lending washes over us."

Buiter hasn't yet suggested what particular sector the bankers will chose as a target for their reckless largesse.

None of the bankers have covered themselves in glory over the last few weeks. The Bank of England must surely be accused of being too academic in its approach while the unseemly scramble by banks over the last 10 years to lend money to Ninja borrowers or to tie up funds in collateralised debt obligations is a sad reflection on the industry as a whole. Reckless lending will take place again. It always does. But the spectre of a damaged brand name will linger in the minds of bankers for a long time.

In the end, it took people queuing overnight to get their money to remind the industry that it is built upon confidence. Unfortunately, many people no longer trust the bankers to know what they are doing.

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