x Abu Dhabi, UAEThursday 21 September 2017

Northern Rock collapse: A canary in a coal mine

Northern Rock provided an early warning of deep-seated systemic problems that would lead to a full-blown global crisis

Northern Rock customers queue outside the branch in Surrey in 2007. Chris Ratcliffe / Bloomberg News
Northern Rock customers queue outside the branch in Surrey in 2007. Chris Ratcliffe / Bloomberg News

Even as the share price of British bank Northern Rock was tanking, Dennis Grainger told his wife not to worry. Their retirement nest egg might have been completely bound up in Northern Rock stock, but as a former loyal company man he knew the bank would ride out the crisis. The bank’s business model was sound, the former finance worker told her. The share price would bounce back.

It was a position that Mr Grainger maintained as Northern Rock endured the first run on a British bank for nearly 150 years. Even as the global credit crisis deepened, the share price kept falling and the embattled chief executive of the bank Adam Applegarth quit, he refused to cash out the stocks that he’d carefully built during a near decade of service. If it took five or ten years to recover their value, that wasn’t a problem. They were planning for the long-term.

His confidence evaporated only when the UK government nationalised the bank in February 2008. His savings, calculated at more than £112,000, were suddenly worth nothing. The financially comfortable retirement has failed to materialise. He’s moved to a smaller house.

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Read more: UK government's £37 billion bailout of Northern Rock in 2007 pays off

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“My wife hardly speaks to me,” admits Mr Grainger.

As significant as Mr Grainger’s personal losses were, they paled into insignificance compared with the collapse in confidence in the banking system and the multi-trillion-pound cost of the global banking crisis.

The crisis prompted the major rewriting of regulations to bolster reserves and better protect the banking sector, some of which is now threatened with being rolled back in the United States under Donald Trump.

Northern Rock was a canary in the mine, the run on the bank providing an early warning of deep-seated systemic problems that would lead to a full-blown global crisis with the collapse of the investment bank Lehman brothers exactly one year later.

For the UK, it allowed a government woefully ill-prepared for the first bank run in 150 years to prepare itself for greater challenges to come.

Dennis Grainger, leader of the North East campaign, with shareholders from Northern Rock as they protest outside the High Court in London.
Dennis Grainger, leader of the North East campaign, with shareholders from Northern Rock as they protest outside the High Court in London.

Northern Rock had been more vulnerable than most when the crisis came. It was headquartered in Newcastle upon Tyne, in the northeast of England, a region that had been hit hard by the decline of traditional manufacturing industries in mining and shipbuilding.

The City of London had seen the greatest benefits from the deregulation of financial markets in the previous two decades, but in Northern Rock the region had a successful banking business in which it could be proud.

Its charitable foundation – which was five per cent of bank profits – had ploughed nearly £250 million into good causes over the previous decade and was seen as a model of responsible corporate governance. It also sponsored Newcastle United, a top-flight football team.

Its swift growth had been based on providing mortgages to the young and moderately-paid trying to get a foothold on to the housing ladder. By the time of the crisis, it supplied credit to nearly one in five home buyers.

Unlike most other banks that funded operations through customer deposits, it secured capital from the international markets. It was susceptible to a catastrophic event that prevented the cross-border flow of capital. And so it proved.

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Read more: Ten years later, the credit crunch's effects are still felt

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Five years before, US lenders provided billions in credit to families on low incomes. The failure of many to repay mortgages when interest rates were hiked in 2004 put pressure on financial institutions, and led to a sharp downturn on interbank lending.

Northern Rock suffered a liquidity crisis and had to seek a bailout from the central bank. Mervyn King, the former governor of the Bank of England, said that he gave clear instructions that funding was to be given secretly to the bank. “My advice was very clear – we should not reveal publicly the fact that we were going to lend to Northern Rock,” he told the BBC this week.

The proposal for secret funding was contested by lawyers for the bank and the UK industry regulator, who claimed it would go against EU law to keep the funding quiet. No other central bankers in Europe “believed that for a minute,” said King in a documentary of the crisis.

 

The exposure of the bank’s parlous position following a leak to the BBC sparked the run on the bank, a situation worsened, according to critics, by the government’s failure to act decisively in the early hours of the crisis to allay consumer concerns. In addition, the Bank of England was unwilling to bail out a bank that had indulged in risky lending practices.

 

Virgin Money had tried to buy Northern Rock before it was nationalised in February 2008 and restructured into a smaller bank. AP Photo
Virgin Money had tried to buy Northern Rock before it was nationalised in February 2008 and restructured into a smaller bank. AP Photo

The run led to a plunging share price, the bank being put up for sale, and its nationalisation within five months. It was broken up and the most successful parts eventually sold to Virgin Money, run by the entrepreneur Richard Branson in 2012.

It has not escaped those who lost money from the Northern Rock crisis that the following year the Bank made secret loans of more than £61 billion to similarly troubled banks RBS and HBOS as the full impact of the global financial crisis struck the UK. That news was first revealed nearly a year after the money had been repaid in full.

“The Northern Rock experience meant that …. we were determined that we’d do whatever it took to stop another run like that,” Alistair Darling, the Finance Minister, who oversaw Britain’s response to the financial crisis during the premiership of Gordon Brown, told the BBC.

The fallout of the affair continues, though not for Mr Applegarth who runs a small property firm and turns out for the second team of a minor league cricket side, according to newspaper reports at the weekend.

The most senior official at the UK’s finance ministry Nicholas Macpherson admitted this week that the ministry, regulators and the central bank had been ill-prepared for the turn of events in 2007 after a near unbroken 15-year run of growth. Banks are now subjected to regular ‘stress-testing’ to ensure they had enough capital to cope with a similar crisis, though analysts have noted a return to some of the riskier lending practices of the past.

Mr Grainger continues to fight on behalf of the estimated 150,000 small shareholders. A legal campaign for compensation foundered when a decision by the European Court on Human Rights went against them.

Having downgraded the legal fight, Mr Grainger is due to deliver a 50-page dossier of evidence to Downing Street on Thursday seeking some form of recognition for those who lost money. He says he feels betrayed by the former Labour government, which has traditionally had strong support in the northeast.

Trust in the UK’s key banking sector was also damaged by the sight of customers queuing around corners to withdraw their money from Northern Rock deposit accounts on September 14, 2007. Despite an announcement by the Bank of England that it would support the bank and its depositors, trust in the institution withered. Commentators took it as another sign of the end of deference in UK society.

It was “one of those moments where everything that a generation had taken as true was suddenly questioned,” said Jayne-Anne Gadhia, the head of Virgin Money which eventually bought the distressed bank.