KEY POINTS:
The images could hardly have been more shocking. Over the weekend, British television showed lines of people standing outside branches of the UK mortgage lender Northern Rock desperate to get their money out.
It was an old-fashioned run on the bank, straight out of a film like "It's a Wonderful Life". Except this wasn't in grainy black and white. It was in modern high-definition television, amplified by a 24-hour news media.
The consequences of that will be profound, especially for Bank of England Governor Mervyn King, who is at the centre of this financial storm.
Although he is a decent and clever banker, the reality is that King has made a terrible hash of the Northern Rock crisis.
He has made the wrong calls, and made them too late. It now looks as if the central bank may need a new governor before confidence in the UK financial markets can be restored.
The scale of the disaster now unfolding at Northern Rock is clear. Last week, it was revealed that the lender had to turn to the Bank of England for emergency financing. Northern Rock was unable to raise the money it needed to function in the capital markets. The Bank of England said it would stand by the lender, and, along with UK Chancellor of the Exchequer Alistair Darling, assured depositors their money was safe.
The trouble was, no one believed them. As of Monday, more than £2 billion ($5.5 billion) had been withdrawn from Northern Rock. Its share price fell 35 per cent to a seven-year low and its business looked shattered. Later that day, the government took the extraordinary step of guaranteeing all the deposits in the bank.
Northern Rock and its management are at least partly to blame. When a company runs into trouble, the men in charge must be held accountable. The turmoil also reflects the British people's declining faith in their public institutions.
When the Chancellor tells them their money is safe, they go and take it out. That is the result of 10 years of a Labour Government that has made dishonesty a standard part of its governing style. But it also reflects the incompetence of the Bank of England. King has been complacent. It was clear that the UK had a subprime crisis building up that could turn out to be just as severe as the one in the US. And yet while the US Federal Reserve and the European Central Bank were pumping money into the financial system, the Bank of England sat back.
King has been treating us all to a lot of stern, academic sounding lectures on "moral hazard", meaning that by bailing out banks in trouble you only encourage more reckless lending. Just last week, he said that central banks should act only when there are "economic costs on a scale sufficient to ignore the moral hazard in the future". As Stuart Thomson, who manages £23 billion in bonds at Resolution Investment Management in Glasgow, Scotland, pointed out in a note to investors: "Mervyn King's statement to the Treasury select committee was another academic exposition of banking crisis full of warnings over moral hazard."
The position the Bank of England has put itself in is awkward. Does it support the bailout of mortgage lenders or not? If another lender runs out of cash, does it get funding? And will Northern Rock be kept alive? The answers are unclear.
The Bank of England has been lecturing everyone about moral hazard, then it rescues the first lender that gets into trouble. The reality is that the central bank has made a mess of it. , Someone should offer Mervyn King a sword. And ask him politely if he would like to fall on it.
- Bloomberg
