Friday 14 September 2007
Bank Crisis in UK
I just heard on the radio this morning that the UK bank Northern Rock has been hit by the credit crunch in the financial markets. My instant reaction was, phew, thank fuck I moved my few pound to another bank. I used to have a small savings account with NR, but when an Irish bank offered a higher rate I immediately jumped ship.
I used to be one of those suckers who stayed with the same bank through thick and thin, just sighing at bad rates and service and procrastinating about changing. Then I went to get a mortgage and I discovered that if you take them at face value they will screw you. I was told by a certain high street bank that they lend me X at Y% at best. I had banked with them for years. They said before they'd approve the loan I'd need to answer if any of my relatives had accounts with them in the past. What the? So if my old man had defaulted on a loan I wouldn't get mine approved? Pile of shite. So I shopped around and found a far better deal. I was offered more money and at a lower rate and no questions about my family's credit history. Then I rang back the first bank. Oh, they humed and hawed, and I need to talk to Dublin and I'll ring you back immediately. They rang back - we'll match the other deal. Right, so can you better it? No but we'll match it. Ok thanks bye. And ever since I change banks like I change my socks.
Anyway, back to NR. I thanked God I had jumped. But then I heared that the B of England are bailing them out. And the trio of BoE's gov Mervyn King, the chancellor, Alistair Darling, and the Financial Services Authority, have appealed for NR customers to remain calm. The message to savers - your money is safe. It will be interesting to see if savers take their word. Of course the interesting psychology here is that if customers start to think their money isn't safe, then it won't be. They'll start withdrawing producing a run on the bank and basically everyone won't get their money cos a huge percentage of it is locked up in non-liquid assets. But we'll see.
Two other things struck me about this bizarre intervention. First, like the ECB and Fed interventions earlier, it is bound to produce the condition of moral hazard. In other words, commercial and merchant banks are supposed to be best placed to assess their own risks and should run their businesses safely with the right risks and reserve ratios so that they are not over-exposed to shocks. But if they know when the shit hits the fan the central bank will bail them out then, in the cut-throat competitive market that they operate, they will be more likely to step over the red line to pull in bigger revenues. The only way to teach them not to is to refuse to bail them out by letting them fail. Of course the trouble is that the central banks and governments fear that this could spark a chain reaction that would crush the so-called real economy - ie. where people buy money not to relend it, but to build factories or roads or whatever. But perhaps the moral hazard case is overstated. NR's share price fell 20% and commentators are saying they are likely to be taken over now. In other words, by having the wrong business model and giving too many 125% loans to house buyers, they will fail. So despite the bail out, the lesson is plain for other banks.
But the second issue here relates to the independence of the Bank of England. One of the first things Gordon brown did on becoming chancellor in 1997 was to grant the B of E full independence from government. The idea was that political interference just screws things up because he political leaders have their own agendas (such as survival) which may not be in the interests of the economy. But according to the Guardian the B of E's intervention was agreed with the chancellor Alistair Darling. Agreed with the Chancellor. So much for political independence.
All this illustrates a few things. First, despite all the rhetoric about free markets, when the shit hits the fan for banks, the market begs for help from government. And second, it usually gets it.