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Plus ça change. Both Northern Rock and Overend, Gurney & Co once
inspired public confidence: the former sponsored Newcastle United, the
latter was the Quaker-founded “banker’s bank” of the mid-19th century. And
both succumbed to the classic vice of hubristic bankers in periods of easy
credit: borrowing short to lend long. Up North, a mortgage book was
increasingly funded by short-term financial instruments and inter-bank
borrowing. In Victorian London, diversification into railways and other
investments was based on an existing trade in rapidly turned-over bills of
exchange. When, in both cases, long-term liabilities exceeded supplies of
ready cash, the result was widespread panic. Yet a comparison between the
two most recent runs on British banks is important for more than
journalistic schadenfreude. For policy-makers, the Overend Gurney
crisis of 1866 and the Northern Rock debacle of 2007 should, together,
demonstrate the eternal necessity of protecting ordinary bank depositors,
while vindicating the law’s reluctance to shield other categories of
investor from the consequences of overenthusiastic speculation.
First, all can agree that bank runs are bad news — for savers, governments, a
country's reputation, and broader confidence and stability in the financial
markets. There is a simple way to avoid them: a solid government guarantee
for all deposits at all regulated banks. Such a guarantee is important not
only to prevent nervous savers fuelling the fires of future banking crises.
It also safeguards the critical economic role of deposit-taking banks. This
role is partly to provide a safe home for money before it is spent or
otherwise put to work. But it also, significantly, underpins a model of
responsible lending — particularly mortgage lending — departed from by
Northern Rock. For this model to function, bank accounts cannot come with a
health warning that they may at some point, without notice, become
worthless. Whether officially prescribed or as a result of conventional
wisdom, such a perception would reduce funds available to responsible banks
while encouraging two dangerous approaches to personal finance. One is
literal under-the-bed saving. In a land stalked by inflation, burglars and
faulty electric blankets, this approach looks, and is, ridiculous. The other
is favouring risky investments in the hope that greater rewards will
compensate for inevitable insecurity.
This points us to the second lesson from history: the legitimate and necessary
distinction between savings and investments. The financial markets may no
longer be the sole preserve of the wealthy and the buccaneering. But even
the humblest contemporary investor views — or should be encouraged to view —
his stock portfolio differently from the savings account into which he pays
his dividends. The account represents a sacrifice of potential gain in
exchange for security. The portfolio, by contrast, is a gamble. Hopefully an
informed punt, it nevertheless implies an awareness that companies both make
and lose money. Yet today's investor already benefits from the phenomenon of
limited liability. While there was no theoretical limit to how much
shareholders could profit from their fractional ownership of Northern Rock
plc, there was no corresponding risk that creditors, employees or even the
taxman could ever seize their DVD collection to satisfy the bank's bad
debts. This was not necessarily the case for Overend Gurney shareholders,
many of whom had rushed to buy partly-paid shares. On the bank's collapse,
they thus not only lost what they had paid, but were obliged to hand over
substantial further sums. Today, the combination of limited liability and
standard fully-paid shares puts shareholders in an enviable position: those
with diversified portfolios, who avoid selling when the market has just
crashed, are likely to prosper. But it is still a gamble, and the first rule
of gambling applies whether dealing with the stockbroker or the croupier:
put up no more than you can afford to lose. It would be a strange world
indeed if this rule was also applied when paying wages into the bank.
On that note, a third historical lesson becomes relevant: that Government and
the law should combat commercial malpractice by regulation, but must at some
point accept that markets (like race tracks and casinos) are able to provide
some with large windfalls partly because others experience losses. A market
regulated to the extent that no investor can lose is one that has had its
life-blood of entrepreneurial risk-taking sucked dry. Companies must be
allowed some leeway, and investors must accept some risk. Mervyn King was
right to fear the “moral hazard” in bailing out irresponsible banks; where
he erred was in imagining that any Government would tolerate queues of
pensioners jostling to withdraw their life savings on the streets of
Sunderland. A standing guarantee for deposits is a prudent compromise,
providing certainty and a sufficient incentive for proper banking
supervision, without establishing a general policy of insulating investors
from losses. The sophisticated modelling techniques available to today's
regulators enable a high level of rolling analysis and “stress-testing” of
bank investment policies. The focus of reform should be on enabling
regulators to force banks to explain and adjust their strategies in light of
this data. No bank, for example, should be so caught up with novel financial
instruments that it is unable to evaluate its exposure to key potential
market changes. Far better to develop regulatory requirements reining in
those bank directors in danger of having their heads turned by the prospect
of easy profits, than to be put in the morally hazardous (in all senses)
position of dealing with the consequences.
A fool and his money, sneered Gordon Gekko, are lucky enough to get together
in the first place. Regulators and legislators — while of course free to
reject the fictional financier’s view that lunch is for wimps – should be
slow in ignoring this dictum. A bank depositor is not foolish to expect that
his money will be safe, and the law should not allow him to be made a fool
by his bank manager. But speculators cannot complain when fantastic market
gains are sometimes offset by spectacular losses. It would be folly for the
law to pretend otherwise.
Fraser Campbell is a trainee at Clifford Chance
Do you think the Share holders will get a fair price back and how long do you think the process will take.
lee, redcar, england