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How did this all happen? Could it have been prevented? What lessons are there to be learned for the future?
The Northern Rock saga is yet another demonstration of the consequences of globalisation. We live in an international economy where what happens in one part of the world can very quickly have far-reaching effects a long way away. This has many advantages, yet also many dangers.
The current crisis began with irresponsible lending to, and borrowing by, homeowners in the United States. Many of the borrowers had bad credit records – this is what is meant by that opaque phrase, ‘sub-prime’.
What was new, and dangerous, this time is that the loans, instead of staying on the books of the banks which made them, were packaged into complicated financial instruments and sold on to other institutions all over the world. Some of these institutions seem to have been less vigorous than they should have been in assessing the value of the packages they bought and, as the borrowers began to default on their payments, it became literally a question of who would be left holding the parcel.
This led to increasing distrust amongst the banks themselves and a growing reluctance to lend to each other. Northern Rock had built its business model on the practice of borrowing from other banks to finance its loans. So when other banks refused to lend to it the crisis was inevitable.
How was it handled?
This was the first real test of the new arrangements put in place by Gordon Brown in 1997. At the same time as he gave the Bank of England the responsibility for setting interest rates – a decision for which he has rightly been praised – he took away from the Bank the responsibility for regulating the banking system. It was widely reported that the Governor at the time, Eddie George, was so strongly opposed to this that he almost resigned. Recent events have, in my view, proved him right. This part of the changes made by Gordon Brown has failed its first test.
Under the old arrangements the Bank of England would have been entirely aware of the dangers and would probably have arranged the rescue of Northern Rock, perhaps over a weekend, before depositors were even aware that their money was at risk. The Financial Services Authority, which now has the responsibility for regulating the banking system, lacks the clout and perhaps the expertise to do this job properly.
So although depositors are now breathing large sighs of relief I hope that the arrangements which Gordon Brown put in place in 1997 will be looked at again. We shouldn’t have the wait for another crisis to see them fail again.
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