Over the weekend of 15-16 September, we witnessed the effective collapse of Britain’s seventh largest bank, Northern Rock plc. Jeff Randall in the Daily Telegraph of 21 September very aptly remarked: “The Northern Rock shambles has dented City confidence. Having superseded New York as the financial capital of the world, London cringed in shame over the weekend, as widows and orphans shuffled in queues to withdraw their savings …”
Starting on Friday 14 September, huge queues formed outside branches of the bank, spurred partly by the announcement that it had applied (successfully) to the Bank of England for temporary emergency funding and partly by the fact that its online system appears to have crashed so that online customers were unable to conduct their usual business. All this started a panic which had Northern Rock depositors queuing for hours outside branches to withdraw their often very substantial savings. Of the bank’s £23bn in customer deposits, approximately £1bn were withdrawn on 14 September and another £1bn on 15 September. This followed outflows of some £1.4bn in July and August.
Were the Northern Rock depositors panicking unnecessarily? It had minimal exposure to US subprime lending (less than 0.25 percent of its assets were tied up in that particular slough of despond). Its own mortgage lending had not run into trouble. Less than 0.5 percent of its mortgagors are over three months in arrears – half the industry average. Even if it was making very large loans in relation to salary, this was to people able to pay. Nothing had happened to suggest that Northern Rock mortgages were not rock solid.
Nevertheless, Northern Rock’s weakness was that most of the money it was lending out was not received from its depositors, but borrowed cheaply on the money markets. To generate a high level of profits for its shareholders, Northern Rock relied on bulk – lending as much as possible, which meant that it needed to keep borrowing large amounts of money.
It suited Northern Rock to ‘borrow short to lend long’ – ie, it preferred to take out short-term loans on the money markets. It was therefore peculiarly vulnerable to the present credit crunch connected to the subprime crisis. When Northern Rock’s short-term loans ran out in the middle of the credit crunch, it could only borrow at rates higher than it had already lent the money out at. A hole opened up through which the bank’s assets began to seep away at an alarming pace. Profits turned to losses as Northern Rock found itself subsidising its borrowers – thousands of them … On top of that, there were still wages, rents etc to pay.
Who pays these losses? The first to be wiped out are the company’s shareholders. Once their money is gone, the bank’s creditors compete against each other for what remains. Depositors are unsecured creditors of the bank, and may be badly at risk if, as is likely, the bank’s money-market debts were secured by a mortgage on the bank’s assets – its mortgages. If the bank was then forced out of business by reason of its inability to pay its debts, the mortgages would be sold. The net proceeds would go first to the secured creditors (ie, the money-market lenders) and then only what was left would go to the depositors.
There was a definite risk, then, that depositors would lose a good deal of their money! The panic of the depositors was by no means irrational. The Bank of England had been quite adamant that it was not going to come to the rescue by making cash available at low rates of interest, as had the Federal Reserve in the USA and the European Central Bank – for this was, forsooth, but to reward excessive risk taking. It was therefore very much on the cards that Northern Rock was going to collapse, dragging its depositors down with it.
In the event, on 17 September, the government did undertake to guarantee the depositors’ money – all of it – in order to stop the run on the bank, and to pre-empt possible runs on other banks (Alliance & Leicester, Paragon and Bradford & Bingley were possibly vulnerable). Financial services now contribute a very large percentage of British GDP, and the government obviously concluded that it could not afford to allow several of Britain’s banks to collapse.
The depositors at Northern Rock have been exceptionally lucky. When the currency crisis hit the Far East in 1997, millions of small savers lost all they had. Plenty of bourgeois economists are criticising the decision to underwrite the Northern Rock’s depositors on the basis that this will impede ‘recovery’ of the economy! As it is, it looks probable that we are in for a period of recession, falling house prices and job losses.
The Northern Rock fiasco illustrates for the umpteenth time the total absurdity of the capitalist system, as explained elsewhere in this issue. Millions of people with accounts in a fairly staid British bank came close to losing their life’s savings, not because they gambled recklessly, but because of the activities of speculators in subprime mortgages and derivatives. If, in the event, Northern Rock’s assets sell for less than all the money owed, then it is the British taxpayer who is going to pick up the tab for the shortfall.
In the old Soviet Union, you did not have to worry about saving for your old age. The state guaranteed you a pension, cheap accommodation, cheap food and even holidays. There was no freedom to gamble, there was only freedom from worry. Surely that’s how things need to be here!