Anybody watching the back entrance of the Bank of England’s Threadneedle
Street headquarters in the heart of the City on Thursday evening would have
known that something was up as the black limousines rolled in through the
gates. The grim faces of those arriving meant only one thing - a bank was in
trouble.
As well as the top executives from Northern Rock, Sir Callum McCarthy, head of
the Financial Services Authority, the industry regulator, had been summoned
by Mervyn King, governor of the Bank, for an emergency meeting. Alistair
Darling, the chancellor, was in touch by teleconference.
Gordon Brown, along with most of the rest of the new Labour establishment, was
at a Whitehall party organised by the New Statesman magazine when the news
began to come through: Northern Rock was in a hard place.
In that morning’s newspapers Darling had railed against irresponsible banks
and called for a return to “good old-fashioned banking”. Yet Northern Rock,
which increased its mortgage lending by 55% in the first eight months of
this year with deals that in some cases allowed customers to borrow 125% of
their house’s value, appeared to many to be exactly what Darling had in mind.
King, in a statement released the day before, said it was not the Bank’s job
to bankroll “risky behaviour” by the market, although he had, tellingly,
reiterated its willingness to act as a “lender of last resort” to individual
institutions in trouble, as it had done for more than two centuries.
So when Northern Rock came looking for money or face closure, the Bank
provided it. A deal was struck to extend what was in effect a £30 billion
overdraft facility on what Bank officials describe as “penal” terms: more
than a percentage point above the 5.75% base rate.
Even after the news of the rescue package emerged on Thursday evening,
officials were still thrashing out the terms of the deal. Bleary-eyed staff
finally emerged at 3am, ready for the repercussions.
Everybody knew the news would go down like a lead balloon with Northern Rock’s
customers. The bank had already ordered for its branches roughly three times
the £75,000-£100,000 in cash that they normally hold in an attempt to meet
the demand.
A few hours after finalising the deal, Adam Applegarth, the bank’s chief
executive, came on BBC Radio 4’s Today programme to assure savers that their
money was safe. His “don’t panic” message was reinforced by Darling, the
Bank and the FSA. Northern Rock, they insisted, was solvent.
However, the bank’s website had already crashed in the early hours as it was
besieged by customers seeking to remove their money. When its branches
opened later that day, the firestorm hit. Tens of thousands of customers,
many of them pensioners, queued up to withdraw their cash.
This was indeed the “old-fashioned banking” that Darling had called for, but
only in the sense that it was a run on the bank. The backing of the Bank of
England should have made Northern Rock safer than its competitors; its
customers saw things differently.
Nowhere was the crisis felt more intently than in Newcastle upon Tyne, the
bank’s home city. It sponsors Newcastle United football club, whose stadium
dominates the city’s landscape, and employs 4,300 people locally.
“I have drawn my savings out but I still have shares there, I don’t know what
to do, they will keep going down in price,” said Doreen Gardner, 74, who was
queueing outside a city centre branch. “I don’t understand how this could
happen.”
Within a day, £1 billion of savings had been withdrawn from Northern Rock,
nearly 5% of its deposit base. Its share price collapsed, losing 32% of its
value on Friday.
Yesterday the queues began at 6am and some branches were forced to extend
their opening hours. In Sheffield, police had to marshal the crowd.
Customers knew that they were playing a role in fuelling the crisis but
wanted their fears put to rest.
“Yes, we are making matters worse,” said Jane Taylor, who was queueing outside
the Kingston upon Thames branch in southwest London. “But people need
reassurance that their money is safe.”
How could this have happened? Britain’s system for regulating financial
institutions is supposed to be the best in the world. Brown never misses an
opportunity to boast of the economy’s stability under Labour’s management.
Are other banks in trouble and will the economy slide into recession? Will
house prices crash?
To explain the crisis you have to travel more than 3,000 miles across the
Atlantic to the trailer parks and rundown districts of America’s cities.
Here, lenders in the so-called “sub-prime” mortgage market - loans to people
with poor credit histories - had handed out too much money. These mortgages,
sometimes nicknamed “Ninja” loans - to people with practically no income, no
job and no assets - were concentrated among America’s blacks and Hispanics.
They provided the route to home ownership, it appeared, for the poor.
Even if America’s mortgage lenders were aware of the risk, they piled in, not
least because all their rivals were doing it. US interest rates were low and
set to remain so. Why worry about a few mortgage defaults?
However, when interest rates rose, the irresponsibility of this lending became
clear. Losses on US sub-prime loans have been officially estimated at £50
billion, but are likely to be much higher.
The problem is that these losses have not stayed with America’s mortgage
lenders. The sub-prime loans were “securitised”, sliced up into smaller
pieces and used as the basis of financial instruments sold all over the
world.
The losses are being carried by a large number of financial institutions and
private investors but, as yet, nobody knows how big they are or who is
sitting on them.
The result is a loss of confidence among the banks in one another - they no
longer want to lend to their peers. So the banks have been scrambling for
cash - liquidity - to meet their obligations and this has pushed up the cost
of money.
For Northern Rock the problem was particularly acute. Of all the banks in
Britain, it relied most heavily on the money markets for funds.
Having expanded its mortgage lending sharply in Britain, particularly this
year, it needed to be able to tap into the money markets, at low interest
rates, to fund its obligations because its level of deposits by savers is
comparatively low. When nobody wanted to provide Northern Rock with these
funds it was in trouble, hence the Bank’s rescue operation and the mood of
nervousness grip-ping the financial markets and the country.
While Northern Rock was atypical, there could be others waiting in the wings.
Those most reliant on the money markets include Bradford & Bing-ley,
HBOS and Alliance & Leicester, although there is no suggestion that any
of them are in similar difficulties and some have issued statements
insisting that they are not.
Those with long memories in the City know, however, that these things can drag
on. The Bank expects the current problems to last for months. The secondary
banking crisis of the 1970s, when it was required to undertake a series of
rescues, dragged on for three years.
Even without any further rescues, experts believe that the crisis in the
markets will hit the economy in three ways.
The City’s money machine, with rapid expansion and fat bonuses, has been the
engine of growth. But with many of the markets in which the investment banks
have made their money now moribund, financial institutions worldwide are
facing losses of about £100 billion, according to calculations by Peter
Spencer, economic adviser to the Ernst & Young Item Club, an economic
think tank. The end of the boom in global markets and company takeovers will
send a chill wind blowing through the City.
The first hint of that will come when the investment banks start releasing
their results in the coming weeks.
Volatility is not all bad news for the markets – some traders make money out
of it – but the City’s champagne bars and luxury car showrooms can expect
to see less bonus money being thrown around. After record
bonuses of about £14 billion this year, the outlook is for slim pickings and
some London estate agents are already warning of the consequences for
high-end houses. Some recruitment experts say that between 5,000 and 10,000
City jobs will be lost.
“Yes, we will continue to see deals being done and other corporate activity
taking place, but we are unlikely to see the mega-deals and mega-bonuses
that resulted from those extraordinary conditions,” said Spencer. “This will
have a ripple effect on everything from related industries to the top end of
the housing market.”
The second significant effect will be on businesses, big and small, all over
the country. In what now seems like an age ago, the Bank was warning early
last month that it was still worried about inflation and was likely to raise
interest rates again from 5.75% to 6%.
That is now off the agenda but the crisis in the markets means that most firms
will find their borrowing costs rise by much more than the Bank had planned.
This will make many companies reluctant to take on staff and could result in
job losses.
“The longer this persists, the greater the likelihood that the real economy
suffers,” said Michael Saunders, an economist with Citigroup.
The biggest fears are over the housing market. Three prominent mortgage
lenders - Abbey, Halifax and Standard Life - last week increased interest
rates on their tracker mortgages for new borrowers.
The Royal Institution of Chartered Surveyors said that house prices fell last
month for the first time in two years. Even more worrying were figures from
Rightmove, the property website. It said that house prices have dropped by
2.6% this month, although its figures were distorted by a slump in the
number of larger houses being sold as a result of the government’s new home
information packs (Hips).
Could this be the beginning of a repeat of the housing crash of the early
1990s? Families are feeling the strain. A YouGov poll for The Sunday Times
today shows that 71% of people think that their household finances will come
under pressure over the next 12 months. Most say they will respond by
cutting their spending on nonessentials.
For many householders the new interest rate squeeze comes at the worst
possible time. Between now and the end of the year, 800,000 households will
be coming to the end of their two-year fixed-rate deals and will face a
significant hike in mortgage costs. A further million face a similar fate
next year.
Jonathan Corns, a 33-year-old sales manager from Wellingborough,
Northamptonshire, and his family will have to pay about £100 a month more on
their deal.
“It’s painful because it’s gone up from 4.7% to 5.99% and we’ve unfortunately
had to extend the term back up to 25 years from the 22 we had to run,” he
said.
A recent pay rise softened the blow, but the family’s discretionary spending
will be cut. “While we can maintain our lifestyle in terms of property,
clothing and food, it’s the things like family trips that we’ll have to
think about,” said Corns.
If anything the situation will be even worse for first-time buyers. Anna
Wilkins, 30, a freelance picture editor from London, had hoped to buy a
studio flat but the uncertainty and higher interest rates have put her off.
“I keep on wanting to buy and then things like this happen,” she said.
“After hearing this, it really puts me off. It makes me think maybe I should
keep renting.”
Essentials, meanwhile, continue to rise in price. Oil prices hit a record of
more than $80 a barrel last week and will push up the pump prices of petrol.
Many food commodities are soaring in price and the average cost of a loaf of
bread now tops £1.
All this could change if the American economy slides into recession, as some
predict. This week, in response to the crisis and slower growth, the US
Federal Reserve, its central bank, is expected to cut interest rates. THE
last big crisis in the financial markets happened 15 years ago today. On
September 16, 1992 - “Black Wednesday” - the Bank of England
fought a battle with the markets and lost. Interest rates rocketed from 10%
to 15% in a single day. Britain’s currency reserves were used up in a vain
attempt to stop the run on the pound.
The repercussions were felt for years. Although Britain’s violent expulsion
from the European exchange-rate mechanism liberated the country from an
economic straitjacket, it did not feel like it. House prices carried on
dropping for three years, by which time more than 300,000 families had
fallen victim to mortgage repossessions.
Others, well over 2m households, struggled with negative equity - their home
being worth less than the mortgage they had taken out to buy it - for years.
While the current crisis is very different, few in Westminster are unaware of
the potential political parallels. On Black Wednesday the Tories’ reputation
for economic competence evaporated. John Major, having unexpectedly won an
election six months earlier, stuttered and struggled to a landslide defeat
in 1997.
The more the current crisis in the markets squeezes families, the more the
Tories will use it to challenge Labour and Brown’s reputation for economic
competence. While most economists do not expect the housing market to crash,
many warn that it would not take much to tip it over the edge. Even stagnant
house prices will feel like cold turkey after the recent boom.
George Osborne, the shadow chancellor, backed the Bank’s support operation for
Northern Rock but attacked Brown’s record this weekend. “There is a
fundamental question of why Gordon Brown allowed the creation over 10 years
of an economy built on debt, with consumer borrowing trebled and the largest
budget deficit in Europe, in a way that threatens the broader stability of
the economy,” he said.
Polls show that Brown and Darling are more trusted on the economy than Osborne
and David Cameron, but that could change rapidly.
A month ago Brown was riding much higher in the polls, having successfully
dealt with an outbreak of foot and mouth disease and wondering whether to
press home his advantage with an early election. Now his poll lead has
slipped, foot and mouth is back and the air is full of financial crisis and
foreboding. If it was not before, the Brown honeymoon is well and truly over
now.
Borrowers who are already feeling the pinch
The Corns family from Wellingborough, Northamptonshire, have already felt the
effects of the credit crunch. Like nearly 800,000 other Britons, Jonathan
Corns, a 33-year-old sales manager, and his wife Jennifer, 32, were
approaching the end of a fixed-rate mortgage that they took out two years
ago. Their previous rate of 4.7% with Nationwide had been swapped for one of
5.99% with Halifax. On their £160,000 loan this makes them about £100 a
month worse off. Treats such as “trips to the zoo” will be the first thing
to go in these new tough times, said Corns, pictured above with his
two-year-old daughter Evie. He admits to regrets about not having put money
aside in recent months. “It’s certainly something I’m looking at now for the
future,” he said.
