Why Northern Rock Matters To The World

The reality is that the Bank of England is lending taxpayer money against dodgy mortgage collateral, a lot of which is very likely to turn bad. The British central bank governor has, therefore, massively accentuated moral hazard; which is precisely what King claimed on Wednesday he was determined not to do for fear of encouraging a future financial crisis. Wood is certainly not suggesting there is a systemic issue at hand with Northern Rock – after all, he notes, the building society only has 76 branches. “But this business was run in such an aggressive manner that it was always likely to be the first prominent casualty of any real downturn in Britain’s long ludicrously inflated housing market”. This is clear from a cursory glance at its balance sheet. The facts, he notes, “would not disgrace a Thai finance company prior to the Asian Crisis”: Northern Rock has £80bn in mortgages outstanding supported by just £2bn of shareholders’ equity and £78bn of mostly short-term debt. And the company has set aside only 0.04% for bad debts. On an average mortgage lent of around £180,000, this amounts to a miniscule £67. It is amazing that the Bank of England has felt it necessary to come to the rescue of an institution that had been run in such a reckless fashion. Securitised wholesale money markets account for about 40% of Northern Rock’s funding while its net residential property lending has risen by a shocking 55% YoY in the first eight months of this year. It is also an amazing fact that Northern Rock, as a result of its imprudent dependence on wholesale funding, has managed to reach such a financially disastrous point - even before the British housing market has started turning down. But a real downturn in Britain’s mass-housing market is now surely inevitable, as suggested by the market action in British mortgage lenders and homebuilders. http://ftalphaville.ft.com/blog/2007/09/17/7326/greed-fear-flash-edition-why-northern-rock-matters-to-the-world/

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