The Northern Rock Bailout: Sign of a Much Bigger Problem?

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In response to the Northern Rock (OTC:NHRKF) crisis, the British Treasury pledged to not only guarantee the deposits at troubled UK lender mortgage rock, but guaranteed the bank’s commercial paper as well. Rightly so, the London Telegraph called the move for what it was, “effective nationalization of the lender.

From the Telegraph:

Northern Rock has effectively been nationalised by the Treasury's unprecedented guarantee this week to protect all deposits at the beleaguered mortgage lender.


Details of the arrangement, published yesterday, revealed that the bank's commercial paper has been entirely underwritten by the taxpayer.

Sources said the move had effectively turned billions of pounds of Northern Rock's liabilities into gilts.

"They can't go bust now," one banker said. "We're back to the 1970s."


The Treasury said: "This is not a nationalisation as we'd have to own it." A spokesman added that underwriting Northern Rock's existing debt would encourage investors to leave their funds with the bank and so limit the liquidity squeeze that has been the cause of its problems.

"The signal to the market is that there should be confidence in the bank so it can get up and running again," one source said. The guarantee will be extended to other banks in the same position as Northern Rock.”

The thing that struck me about the article wasn’t the bailout of Northern Rock in of itself, but the British Treasury stating that it would give the SAME BAILOUT to any other banks who find themselves in the same position as Northern Rock. That’s right, the British Treasury has effectively stated: “In Britain, we have a system of “Capitalism without Risk. Which begs the question, are they really worried about a much larger problem that goes well beyond Northern Rock, as opposed to this being an isolated incident? Could it be that there is a very real chance of a mortgage/debt precipitated banking crisis in the UK, hence the reason the Govt. is effectively issuing a carte blanche guarantee to the entire banking system?

Consider the following:

  • Britons currently have the highest household debt to personal income ratio in the G8, currently standing at 1.62, compared to 1.49 for the US and 1.36 for Japan.
  • Foreclosures increased 30% over the first six months of this year
  • The majority of mainstream lenders offer “self-certified” mortgages which provide no proof of income; a larger % of British borrowers take on these loans due to the easier documentation requirements.
  • Many lenders will lend people up to six times their annual salary (but usually only for people who earn over £100k pounds for year), however, a recent London Times story revealed that Northern Rock had no problems giving a reporter who only earned £30k pounds per year, a mortgage for £200k. Other banks cited in the same story, would’ve approved him for a loan amount of somewhere around 4-5X his salary, which isn’t really much better. To put things in better perspective, a loan with a payment that’s 25-28% of your monthly gross is solid standard, but that’s only about 3X your annual salary. A loan that’s 6X your salary has a payment of about 60% of your monthly gross income, in a nation with much higher taxes than the U.S.
  • Loans that are 125% of the property’s value are quite common as well

Does any of this sound similar to the factors that caused our own mortgage crisis?

British financial institutions dealing with mortgage and credit market related losses, on top of already having lost billions due to the U.S. mortgage crisis could precipitate a massive banking crisis in Britain, perhaps, that’s what the treasury is trying to avoid.

After all, the U.K. financial press is already calling the Northern Rock situation a “Banking Crisis”, which shouldn’t be a surprise, if our Government was completely bailing out one of our country’s top banks we’d be calling it a crisis too. Now, the Government could be doing this to prevent a panic and to keep a major bank from failing, but with everything that’s happened over the past six months, I’m going to err on the side of skepticism for the time being.

Disclosure: The Author doesn’t own shares in Northern Rock.


The Telegraph: “Northern Rock effectively 'nationalised' by state guarantee” – September 21, 2007

The Sunday Times: “Northern Rock still lending ‘recklessly” – September 23, 2007

The Telegraph: “Northern Rock fiasco ends era cheap and easy credit” – September 21, 2007

Bloomberg: “U.K.'s Subprime Crisis May Be Worse Than in the U.S.” – August 8, 2007