Northern Rock - Setting an example?

By GRAHAM FROST 21/09/2007

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A run on any bank is unstoppable. If depositors want their cash out it is unlikely any bank will have enough liquid assets to satisfy demand. If the bank is a mortgage provider that funds long term loans with short term wholesale paper then when the wholesale markets stop functioning, it is in big trouble.

Who is responsible for this fiasco? Was it reckless practices, poor regulation, or weak oversight? In other words was it management, the FSA, or the Bank of England? Probably all three could have done better and the crisis may have been avoided with earlier action. On the other hand, now that depositors in the Rock have their money guaranteed by government the only losers are shareholders. Perhaps it was necessary for the crisis to occur in order to avoid the moral hazard of the authorities always being ready to write out a cheque for reckless behaviour.

Our view is that the affair will blow over. The Rock's share price has collapsed and will presumably find a level where it becomes attractive to bigger predators. Big banks will benefit as depositors realise there is risk attached to higher yielding deposits at less well financed concerns. Interest rates will be higher in future as banks and building societies widen spreads to compensate for a riskier, more volatile environment.

The fun is not yet over.

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