A decade ago this week, Northern Rock hit the buffers, the first retail bank in Britain to face a public run since the 1860s.
Queues formed outside bank branches as depositors sought to withdraw their funds and the TV footage was beamed around the world. Northern Rock even had a branch in Dublin where nervous queues duly formed, until the UK government announced that the bank had a brand-new shareholder with deep pockets the British taxpayer.
The reality
In reality, the run which finished the bank had already occurred – wholesale depositors had failed to renew maturing deposits for weeks and news leaked out that the Bank of England had taken their place, shoring up Northern Rock.
The bank, based in the northeast of England, were the shirt sponsors of the Newcastle United football team, and enterprising fake-shirt merchants were quickly hawking a version featuring the Bank of England’s name and logo instead.
Why did they go bust?
Northern Rock went bust through making mortgage loans at 100% (and more) of property value into an inflated market.
It funded most of its lending through borrowing in the short-term wholesale money markets where loans have to be re-borrowed constantly.
It had very little genuine shareholder equity to withstand losses and when its borrowers went into negative equity the bank did too. It was not the first and governments all over the developed world ended up as involuntary shareholders in dodgy banks.
In the year following the Northern Rock debacle it emerged that virtually every Irish bank had been imitating its business model.
The problem
Banks are fragile institutions, requiring careful management and rigorous supervision. Over the decades leading up to the great financial crash they had been expanding their loan books rapidly, funding the expansion with too little risk capital and had exercised little or no caution about the repayment capacity of borrowers.
Their government regulators had placed excessive faith in the prudence of bank management and warnings were ignored. Here in Ireland, the then Taoiseach had some explicit advice for the worriers, two months before the Northern Rock bank run.
“Sitting on the sidelines, cribbing and moaning is a lost opportunity. I don’t know how people who engage in that don’t commit suicide,” he advised a trade union conference in Donegal on 4 July 2007. His remarks were well received by the delegates, reflecting the widespread belief at the time that the boom could continue. People believed that large retail banks cannot really go bust.
They can and they did, most spectacularly in Ireland where, remarkably, every single significant bank went under.
Banks are at the core of the modern financial system and governments fear the breakdown of the broader economy, even of law and order, if public bank deposits are not secured. So governments everywhere bailed out the banks, appearing to reward negligence.
In the decade since the banks began to collapse, the western economies have endured low or zero economic growth and incumbent political parties have paid the price. Government debt levels are now much higher in many countries although economic recovery is finally gathering pace. The surviving banks look healthier and several governments have been able to offload some of their unwanted bank shares to investors.
The ingredients are in place for a premature return of confidence here in Ireland
The ingredients are in place for a premature return of confidence here in Ireland, where house prices are again rising sharply. There is even pressure for a return to easy mortgage credit.
Could it all happen again?
The perception that the banking crisis in Europe has somehow been resolved is not universally accepted. Numerous commentators, including well-known financial experts, have drawn attention to the recent bank rescues in Italy and Spain and to the generally weak share prices of European banks, many of which trade at prices below the net asset value shown in the balance sheet.
This suggests that investors are still not convinced that banks have fully cleansed their balance sheets of non-performing loans.
Undisciplined bubble
Should there be a repeat banking crisis in Ireland or anywhere else, the capacity of governments to ride to the rescue has been greatly impaired; most governments are themselves heavily indebted, the legacy of previous bailouts and of extra government borrowing through the years of economic downturn.
So governments could themselves struggle to borrow in the markets should they again face big bills for bank rescues.
Measures have been taken to strengthen bank capital, notably in the US, but some European banks, including Irish lenders, are still carrying far too many non-performing loans and taxpayers have not been removed from the line of fire by the eurozone reforms to banking supervision.
The best defence against a repeat performance in Ireland is the avoidance of another undisciplined bubble in lending for the purchase of over-priced residential property. Those urging a relaxation of the mortgage lending caps have short memories.
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A decade ago this week, Northern Rock hit the buffers, the first retail bank in Britain to face a public run since the 1860s.
Queues formed outside bank branches as depositors sought to withdraw their funds and the TV footage was beamed around the world. Northern Rock even had a branch in Dublin where nervous queues duly formed, until the UK government announced that the bank had a brand-new shareholder with deep pockets the British taxpayer.
The reality
In reality, the run which finished the bank had already occurred – wholesale depositors had failed to renew maturing deposits for weeks and news leaked out that the Bank of England had taken their place, shoring up Northern Rock.
The bank, based in the northeast of England, were the shirt sponsors of the Newcastle United football team, and enterprising fake-shirt merchants were quickly hawking a version featuring the Bank of England’s name and logo instead.
Why did they go bust?
Northern Rock went bust through making mortgage loans at 100% (and more) of property value into an inflated market.
It funded most of its lending through borrowing in the short-term wholesale money markets where loans have to be re-borrowed constantly.
It had very little genuine shareholder equity to withstand losses and when its borrowers went into negative equity the bank did too. It was not the first and governments all over the developed world ended up as involuntary shareholders in dodgy banks.
In the year following the Northern Rock debacle it emerged that virtually every Irish bank had been imitating its business model.
The problem
Banks are fragile institutions, requiring careful management and rigorous supervision. Over the decades leading up to the great financial crash they had been expanding their loan books rapidly, funding the expansion with too little risk capital and had exercised little or no caution about the repayment capacity of borrowers.
Their government regulators had placed excessive faith in the prudence of bank management and warnings were ignored. Here in Ireland, the then Taoiseach had some explicit advice for the worriers, two months before the Northern Rock bank run.
“Sitting on the sidelines, cribbing and moaning is a lost opportunity. I don’t know how people who engage in that don’t commit suicide,” he advised a trade union conference in Donegal on 4 July 2007. His remarks were well received by the delegates, reflecting the widespread belief at the time that the boom could continue. People believed that large retail banks cannot really go bust.
They can and they did, most spectacularly in Ireland where, remarkably, every single significant bank went under.
Banks are at the core of the modern financial system and governments fear the breakdown of the broader economy, even of law and order, if public bank deposits are not secured. So governments everywhere bailed out the banks, appearing to reward negligence.
In the decade since the banks began to collapse, the western economies have endured low or zero economic growth and incumbent political parties have paid the price. Government debt levels are now much higher in many countries although economic recovery is finally gathering pace. The surviving banks look healthier and several governments have been able to offload some of their unwanted bank shares to investors.
The ingredients are in place for a premature return of confidence here in Ireland
The ingredients are in place for a premature return of confidence here in Ireland, where house prices are again rising sharply. There is even pressure for a return to easy mortgage credit.
Could it all happen again?
The perception that the banking crisis in Europe has somehow been resolved is not universally accepted. Numerous commentators, including well-known financial experts, have drawn attention to the recent bank rescues in Italy and Spain and to the generally weak share prices of European banks, many of which trade at prices below the net asset value shown in the balance sheet.
This suggests that investors are still not convinced that banks have fully cleansed their balance sheets of non-performing loans.
Undisciplined bubble
Should there be a repeat banking crisis in Ireland or anywhere else, the capacity of governments to ride to the rescue has been greatly impaired; most governments are themselves heavily indebted, the legacy of previous bailouts and of extra government borrowing through the years of economic downturn.
So governments could themselves struggle to borrow in the markets should they again face big bills for bank rescues.
Measures have been taken to strengthen bank capital, notably in the US, but some European banks, including Irish lenders, are still carrying far too many non-performing loans and taxpayers have not been removed from the line of fire by the eurozone reforms to banking supervision.
The best defence against a repeat performance in Ireland is the avoidance of another undisciplined bubble in lending for the purchase of over-priced residential property. Those urging a relaxation of the mortgage lending caps have short memories.
Read more
Colm McCarthy: Irish Rail running empty trains
Colm McCarthy: scramble to promote carbon-reducing policies
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