You might have expected Northern Rock to sound apologetic as queues formed outside its branches and its website was overwhelmed. Here is a bank that lent aggressively and tried to grab a big share of the mortgage market. Now its business model has been exposed as fragile and its brand damaged, perhaps beyond repair.
But there was barely a word of apology. “I didn’t see it [the credit freeze] coming. I have yet to meet somebody who did,” said Adam Applegarth, the chief executive.
Put like that, Northern Rock sounds like an unlucky and innocent victim of global market forces — a view that Alistair Darling, the chancellor, encouraged by talking about the influence of events in the United States mortgage market.
It is not the whole story. Northern Rock chose to expand its mortgage book way beyond its deposit base. Many mortgage lenders try to do this, but none has done so on Northern Rock’s scale: 10 years ago Northern Rock’s share of the market was 2%; now the bank accounts for 9% of the national mortgage book. Between January and June this year it was writing one in five mortgages. In another industry you would call it overtrading.
The risk was always that Northern Rock’s lopsided business model which relied on the money markets rather than individual savers to provide capital — would prove incapable of withstanding colder winds.
Yes, winter in financial markets has arrived at an alarming speed. To that degree Northern Rock is indeed unlucky. But there were warning signs in the first half of this year, when the US sub-prime crisis flared. At that moment Northern Rock was lending as if nothing had changed.
Of course Applegarth was encouraged at every turn by the City, London’s financial district. Northern Rock was hailed as a model of how to transform a provincial tiddler into a top-five player. The quality most admired by the City — Northern Rock’s low cost-to-income ratio — turns out to be the biggest weakness. Costs were so low because Northern Rock has relatively few branches. Fewer branches mean it is harder to attract deposits.
So, if Northern Rock will be remembered as a strategic experiment that hasn’t worked, why has it been bailed out? Didn’t Mervyn King, the governor of the Bank of England, pledge that there would be no bail-outs? Didn’t he say rescuing lenders from their mistakes would be to penalise the prudent?
Yes, he did. But it seems we have reached the point where central banking theory meets hard politics, a point appreciated by email jokers who circulated pictures of Newcastle United players with the name “Bank of England” on their shirts in place of Northern Rock’s logo.
The Bank finds itself derided as “a paper tiger” by Wilhelm Buiter, a former member of its monetary policy committee, but we shouldn’t be surprised that political expediency has won. Affordable housing is a central part of Prime Minister Gordon Brown’s agenda.
In fact, the provision of emergency funds to Northern Rock might only be stage one. Applegarth admitted the business model “is not appropriate going forward” and that the funding base has to be different. That sounds like a takeover by a better capitalised bank. HSBC and Lloyds TSB are the names in the frame.
The future of the housing market is the deeper worry to take from this tale. The credit freeze proved intolerable to Northern Rock, but others will not be immune from its effects. Will house prices fall? They are not doing so yet, but the trend over the summer is not encouraging.
Expect the spotlight to turn quickly from Applegarth to King and the Bank, which has steered a different path from the US Federal Reserve and the European central bank. The Bank of England has not shovelled cheap money into the markets and has stuck rigidly to its “don’t panic” line.
King might be relaxed, but others are not. Calls for him to do something, such as cut interest rates, will intensify. Can the Bank really stand pat for long now that the Fed has opted for a 0,5% cut in interest rates? Those arguing that the Bank of England has failed to appreciate the seriousness of the credit crunch suddenly have the exhibit called Northern Rock to wave. We’re now talking politics — and maybe even the first real test of the Bank of England’s independence. — Â