Monday, 24 September 2007

No Longer a Wonderful Life at Northern Rock

So the Bank of England has had to effectively nationalise the mortgage bank Northern Rock to save it. A “run on a bank” what an old fashioned phenomenon. We have seen the astonishing sight of thousands of customers queuing to get their money out of a bank something not seen for generations. This means that as a “brand” Northern Rock will almost certainly disappear and an institution that has served the North East well will vanish into some global conglomerate.

To me there are two sets of greedy people here who have destroyed a valuable North Eastern Institution firstly the “customers”. This institution was not so long ago a safe and boring building society doing dull things like providing mortgages for its members and dull but predictable returns on the savings of another (or sometimes the same) set of members.

Many of those panicking to get their life savings out of the Northern Rock today had earlier sold their membership in the Building Society to become shareholders in the new bank. Freed from the constraints of “building society-dom” the “management” of the new Bank has been, to say the least, innovative in generating profits for its shareholders.

Mervyn King at the Bank of England it seems to me tried to explain the rules of the private sector to the Rocks and its customers ie that this is a private business and private businesses from time to time go bust; that is a fact of life. Whatever form of regulation we employ some businesses will always go bust. Asking a private business to behave like a public institution is like asking a cat to be a dog.

Of course the sight of a private business going bust was too much for the political class and they bounced the bank into a bail out. Not the policy, of course, if the business had been going bust out of sight or happened to be in the “old economy”, of say manufacturing or mining or agriculture, you know the ones that actually produce things. Gordon Brown the architect of the current deregulated financial services infrastructure wants the current state of affairs to continue as long as possible or at least past the next election.

The second issue is the business model the management employed. This was to give mortgages to almost anyone who passed through their doors and to raise the cash to fund these mortgages from the wholesale money market. There is no doubt that the new Bank played the globalisation game very well. They sourced cash where it was cheap and resold it in the UK where it is, contrary to the protestations of our Chancellor of the Exchequer, expensive. UK interests rates being amongst the highest in the developed world.

Nothing wrong with this - unless you are trying to balance the nation’s books. This is what Tesco do with underpants or vegetables: exploiting the opening out of the global economy and the strong pound to buy cheap and sell expensive. For Northern Rock this was fine until August 9th. The surpluses in the Middle East and Russia from high oil prices and in China from its huge trade surplus could be happily recycled through complex financial instruments to buy houses in the USA or here in the UK.

This was always going to end in tears cheap “tic” from overseas was never going to last for ever. If an individual constantly borrows to fund their current expenditure their bank manager would not be too impressed. We, following the US, have been using cheap credit, not to invest in productive capacity or new products but to fund current expenditure.

The amount we save in Britain is pathetic, we have had fifteen years of continuous economic growth, but instead of using this to build up our industries and to create a product base of goods and services the world wants to buy, we have simply gone shopping. The only thing we have built is a £1.3 trillion mountain of personal debt. It is no good saying, as I heard the Director General of the CBI say on that the radio, that 80% of this is secured against housing.

Houses simply keep some of us dry and give us somewhere to sleep. They do not do anything else they are sometimes stores of wealth but they do not create it; they are not businesses, they produce no products, no exports, and no real wealth. What Northern Rock and other mortgage banks are actually doing is disastrous for the long-term health of our economy.

The old building societies may have been dull but they recycled money in the localities they served. The old Northern Rock raised money in the North East and invested it in the North East. Like the Building and Loan Association in Bedford Falls in Frank Capra's classic film, It’s a Wonderful Life.

Mortgage holders and savers were to a large extent sheltered from the global economy. And when in the film there was a run on the Savings and Loan Association, Jimmy Stewart as George Bailey could stand on the counter and tell each saver who their money had been lent to make a new home.

Well Northern Rock, or more precisely the Northern Counties Building Society since 1860 and the Rock Building Society since 1865 before they merged to form Northern Rock in 1965, had been doing just this for almost a century and a half.

What the new Bank has been doing however is siphoning money out of the North East to give it to people across the other side of the world, whilst with their lax lending rules contributing to the inflation in house prices.

Just as the Banks who were funding the sub prime sector in the US have gone on strike, so have the banks that were funding Northern Rock’s huge expansion in the mortgages it gives. It created one in five of Britain’s mortgages in the first half of the year. That appears unlikely to continue in the second half. Who will now go to them for a mortgage?

This management team have destroyed a Northern Institution. I doubt if the new owners of this mortgage debt will be so keen to identify with the North East and support North East Sport, charities and the arts as they will have little need to attract savers from that part of the world after all only a quarter of their borrowing came from individual savers whio are now somewhat few and far between.

Unlike in the film the savers will not be able in this case to sve the bank we as a nation simply do not save enough. We are a nation living on credit and it has just been turned off.

Norther Rock are not alone in this model of lending, other mortgage banks like the Alliance and Leicester and Bradford and Bingley are also exposed, although not to the same extent as Northern Rock but they will all be affected by the increase in interest rates for inter-bank lending. There is bound to be some knock-on effect into the housing market with mortgages getting harder to come by.

Some slow down in the rate of UK House price inflation is certainly welcome, but with so much of our economy tied up in housing this could have a serious impact. Also were does this leave the great success story of the UK’s financial services sector? This past weeks global TV pictures haven’t done its reputation much good and the North East has lost a true champion that survived the Boer War two world wars and the depression and great crash but could not survive contemporary greed .