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ALTIF Transcripts: The Fall of Northern Rock, Part 1

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For a few weeks in 2007, a small ex-building society in Newcastle became the world’s most famous bank as TV news cameras showed customers queuing at branches for their cash. Initially seen as a Victorian throwback, it later became clear that the collapse was a warning of much wider problems to come. As worrying tremors again strike our financial system, Neil and Jonathan ponder the lessons of Northern Rock’s failure in the first of a two part series with former chancellor Alistair Darling, ex regulator Howard Davies and banking expert Dan Davies.

Presented by Jonathan Ford and Neil Collins.

With Dan Davies, Alistair Darling and Howard Davies.

Produced and edited by Nick Hilton for Podot.

Additional editing by Ewan Cameron.

Sponsored by Briefcase.News

Hosted on Acast. See acast.com/privacy for more information.

00:06 Jonathan Ford

Hello and welcome to a long time in finance with Jonathan Ford and Neil Collins. In partnership with briefcase dot news, the service that brings intelligent curation and analysis to your media monitoring.

That was a scene in the film Mary Poppins about a bank run which Michael inadvertently starts when one of the partners of his father’s bank takes his sixpence to open an account.

Did you open your first account with a sixpence, Neil?

00:31 Neil Collins

I actually opened it with a 50 pound cheque from the local authority because they used to give you money to go to university in those days. But to show you how long it was, how long ago it was, I had to ask the bank manager who saw me how to write a check.

00:35 Jonathan Ford

Words and figures must agree I think we can both agree on that. But in truth bank runs were a thing of the past. Even in 1910 when Mary Poppins was set, the last run in Britain had been in 1866 when a young whippersnapper called William Gladstone had just come to power.

00:42 Neil Collins

I don’t remember him

00:44 Jonathan Ford

You don’t remember (inaudible) we’ll move on. So bank runs are supposed to be this thing of the past. But then in 2007, seemingly out of the blue, we had this:

00:52 Voiceover

Northern Rock is carrying on business in the normal way. And it can do that, because we have a stable banking system. If they’re not in trouble, why are they having to borrow from the government? Nobody’s given an absolute guarantee that the money is safe in this bank.

01:55 Jonathan Ford

Now the bank in question. Northern Rock wasn’t a big name like Barclays or Natwest. It was an old building society based in Newcastle, which only converted into a bank in the late 1990s. But for a brief moment, that Autumn it became the most famous ex-building society in the world. Critically, though the run looked like a 19-century run, there were big differences. Then the savers ran because they lost confidence in a particular institution. But the 2007 version was something different. It was a sign that something deeper was wrong with the financial system. That’s something then played out the following year during the financial crisis. So at a time when financial tremors are again coursing through the system with the great pension tantrum we’ve just been through, we thought we’d revisit the story of the Northern Rock, to see how a small provincial bank apparently minding its own business, briefly threatened to put a hole in the government and portended something much more forbidding to come. So let’s start at the beginning. You remember what happened with Northern Rock? You certainly remember the background tips you must do?

03:02 Neil Collins

Yes, the background is that it was formed from two local building societies in the Northeast, and was a perfectly sensible, cautiously managed business, essentially taking money from savers and lending it out as mortgages. But it caught the bug because at the time, the building societies were deciding that being building scientists was much too dull. And they could turn themselves into fully-fledged financial institutions.

03:30 Jonathan Ford

So what’s that say? What’s the difference between a building society in a bank was that building studies were really very simple, right? They were literally doing mortgages and deposits.

03:40 Neil Collins

They took money in from savers, mostly on overnight time deposits from individuals, they bundled them up, and they lent them out as mortgages, essentially, to those same individuals.

03:50 Jonathan Ford

And for a long time they had a monopoly effectively over the mortgage business.

03:54 Neil Collins

Yes, for the banks, for some reason, best known to themselves decided that this was not an area they chose to go and play in partly because their margins were never very great. But then neither were the risks.

04:12 Jonathan Ford

But anyway, in the 80s, that was swept away. And the banks, as you say, did start to move into the mortgage business. Building societies were pretty small fry being local businesses. And I think if you look at Northern Rock in 1997, which was after it been around for around 150 years, it had assets worth about 18 billion pounds. Within the next decade, when it was a bank before it went bust, they’d grown to 114 billion and it became the fifth biggest mortgage lender in the country at one point.

04:40 Neil Collins

It grew like Topsy. Yeah. And they thought that their discovered some, essentially the alchemy that they had found was that they could offer mortgages more cheaply than anybody else. And this was their USP at a time where an increasing number of mortgages were handled through mortgage brokers, and that became a big market at a time when it was not that easy to get a mortgage in the normal way, because you had to jump through quite a few hoops and join a queue. And if you went through mortgage broker, you could basically short-circuit the queue, which a lot of people did, and it was an attractive way in.

05:20 Jonathan Ford

And so Northern Rock floats in 1997. And it figures out pretty quickly that the only way it can survive successfully as a listed company is by growing quickly. Part of that is, as you say, they work out how to market mortgages, to as big a audience as they possibly can. But the other part, of course, is they have to fund those mortgages from someone cheaply, because that’s their main advantage is to do things without excessive cost.

05:50 Neil Collins

There’s a key word there was marketing, because this was almost unknown. With mortgages up to that point, the lenders waited for you to come in and assume the position so that they decided whether or not to lend to you the idea that the lender should go out into the marketplace offering mortgages was quite new, then.

06:05 Jonathan Ford

Let’s think about the funding side. Because that’s, I think, what’s the strategy there? I think the answer is that they’re the chief executive of Northern Rock is a guy called Adam’s Applegalf been there for a long time. And he comes up with a plan a clever plan, which is how he’s going to grow the bank very, very quickly. We spoke to a bank analyst who covered the sector at the time, Dan Davis, and he told us a little bit about what that strategy was and how it worked.

06:20 Dan Davis

If you go back to investor presentations of Northern Rock from that area, you’ll see them describing it as the virtuous circle. And the idea was that they would originate the largest market share in prime mortgages.

Northern Rock very rarely did subprime. They hardly ever did large mortgages. They only did two or three mortgages, literally a year that were over a million pounds. They concentrated on stuff that was easy to securitize, they would securitize them so they could reload back on capital, they would keep their costs down, because they only did this amazing commodity business. And by doing that, they would always be able to offer the lowest pricing through the mortgage broker channel – that mortgage broker channel was essential.

07:29 Jonathan Ford

So securitization in this context means that instead of funding mortgages with retail deposits, as building societies have traditionally done, Northern Rock turned them into bonds.

07:40 Dan Davis

They would hold that on their balance sheets for a comparatively short time. And then they would sell 90% of it, or 95% of it to bond investors, they would just take those mortgages, wrap them up into a bond structure and sell them mainly to US investors.

08:10 Jonathan Ford

And at first all there seemed to work pretty well, the shares, which were floated in 1997, at 4.5, it touched 12 pounds in the winter of 2006. You say it seemed to work pretty well. It actually did work pretty well. And if they hadn’t started believing their own publicity that the markets were forever open, however much they wanted, under any circumstances, they might have continued. But they made that mistake.

08:40 Jonathan Ford

Yeah, I sort of agree. But I think behind the clever strategy, the flashy new logo, they were building – always a bad sign – a smart new head office in Newcastle. I think that’s always a really bad…

09:10 Neil Collins

Yeah, a clear contra indicator.

09:20 Jonathan Ford

Yeah, I would say that the thing was that the bank wasn’t really doing anything new. It was still lending mortgages, after all, which is what he’s always done, it was pushing them harder. But really what it was doing on the funding side of its business, how it was raising the money, it was taking a lot more risks. So because it needed its mortgages to be really cheap to sell them – it had to fund them at the cheapest rates. And the cheapest rates available in 2006 from the world of mortgages were not to be found in Newcastle or even in the UK. They were found in the United States, where there was this huge subprime mortgage boom going on. And basically queues of investors keen to buy bonds, which were secured against mortgages and bundled into that pile were bonds of mortgages issued by Northern Rock.

09:50 Neil Collins

And to be fair to Northern Rock. Actually, the quality of what they were offering the collateral behind these bonds was a great deal better than the subprime assets which essentially caused the subprime crisis in America. The suffered contagion from that, and I don’t think they realised that that was going on – that’s the key point.

10:20 Jonathan Ford

So they stop funding their mortgages from you know, Mrs. Trellis in Newcastle, who is unlikely to ever yank her money out of Northern Rock, unless something untoward happens, but we’ll come to that later. But they put their faith in, you know, sort of hedge funds and specialist lending institutions or bond buyers in the United States who’ve never heard of Newcastle and don’t give a damn what it is. And because they’ve put so many of their eggs in this basket, they’re exposed to the risk that if ever, those bond buyers decide they want to do something else with their time and money, they’re the upper gum tree.

10:40 Neil Collins

Yeah, because it was all short-term money. And obviously, the short-term money when it comes to the end of its term, the lender has to decide what to do. And if you’re a retail depositor, you almost certainly leave it in there. But if you are in a market, which was as febrile as it was in 2006, and people were starting to get nervous, when it reached the end of its term, which could have been 90 days or 120 days, you just said, ‘well, thanks very much, I want my money back.’

10:58 Jonathan Ford

Exactly. And then you have mortgages on the other side, you have to fund mortgages, which lasts for 25 years, so if your money gets yanked, after six months, you still got another 24 years and six months to go. You have a problem. But, you know, Northern Rock wasn’t to be fair, the first UK financial institution to engage in this sort of what I call Jenga capitalism, where you build a tower and hope no one pulls the wrong block out. And indeed, the authorities weren’t completely oblivious to the risks that it was running.

But before we get to that, we ought to say a little bit about the way that financial regulation evolved in the UK in the 1990s. Like the banks themselves, this has been shaken up under Mrs Thatcher. But the biggest change really came in 1997, when the New Labour government, Tony Blair’s Labour government took away the supervision of banks from the Bank of England. And for the first time, the bank, which was responsible for overall financial stability is making sure the system didn’t collapse, no longer looked over the bankers shoulders and mark their homework and check they were being honest.

11:20 Neil Collins

Yeah, I think that’s a really key point, and almost led to the resignation of the governor at the time in 1997. And it meant that essentially, the bank was blindsided by this, it had no way of sensing what was happening in the marketplace, which then and now is extremely important.

11:40 Jonathan Ford

Howard Davis, who was at the time, I think, in 1997, when this change took place, was the Deputy Governor of the Bank of England, and then became the first Chairman of the Financial Services Authority, which was the institution that took over the supervision of the banks from the bank, as it were, he explained to us how this all came about, and what consequences it had.

12:20 Howard Davis

The mindset of the Treasury at the time, was strongly influenced by Johnson Mattie. Johnson Mattie, if you remember, was a small bank, which had a crucial role in the gold market. And the Bank of England intervened to bail out, Johnson Matty, without telling Nigel Lawson that they were doing so – presented him with a fait accompli. And Nigel Lawson thought this was outrageous. And he the Bank of England had put the government on the hook for potentially significant losses without telling him. And that infected the Treasury’s view of the Bank of England and most Treasury officials. And indeed, Treasury ministers assumed that the Bank of England was more likely to intervene to rescue a financial institution than it was to let one go. And of course, one of the reasons why the bank might take that view in the past was that it was also the supervisor of the banks. And therefore, a bank failing was a criticism of the bankers supervisor. And therefore, you know, there was an incentive for the bank as lender of last resort to bail out banks, which they had not supervised properly.

So the Treasury thought that the bank was mother hen of the city, likely to the rescue, save its own, if you like, and also to do so in order to conceal the errors in its own banking supervision. So that was the sort of mindset then of course, you roll this forward to 2008, because I’m talking 97/98 here when these discussions were taking place about the MOU. By 2007, when Northern Rock failed, the Bank of England hadn’t been the banking supervisor for a decade. So the Bank of England was not any longer in a position of saying, woops, we’ve probably made a mess here. We ought to bail it out. Because the mess, insofar as had been made, had been made by the FSA, which hadn’t noticed the vulnerability of this or that – that was the argument. So the position was then that the FSA said Well, unless somebody intervenes to buy this bank’s debt – because it’s funding itself in the short-term markets in order to fund its mortgage book, and the markets have close to it, and therefore it’s going to go bust – unless somebody provides the money. The FSA was inclined to say, well, you know, we should intervene to try to smooth this path, because fundamentally, it’s not that bad a mortgage bank. And the Bank of England was saying yeah!

15:29 Jonathan Ford

The new financial services authorities spent a lot of time worrying about consumer protection, and also about the competitiveness of the City of London.

15:35 Neil Collins

Yes, all right.  Light touch regulation.

15:40 Jonathan Ford

I can hardly feel it at all.

15:35 Neil Collins

And thirdly, related at all, so that the markets needed the slightest touch on the tiller, if they were drifting slightly off course. It was a wonderful idea, but it really had no chance of success.

But it was rooted in an idea, which I think we’ll come to later on perhaps turns out to be a little bit erroneous, which was, essentially you could get away with light touch regulation, because the markets themselves would solve the problems that they threw up, the market price would change and give you a warning as a regulator that someone was in trouble or that something was going wrong. And everything basically came down to the behaviour of individual operators in the market, and they can be regulated by the price. Yes, unfortunately, to continue with the analogy. By the time you realise that the boat was heading for the rocks, it was too late for a light touch on the tiller, the regulatory system proved incapable of steering it back on course.

16:20 Jonathan Ford

All that old thing about how somebody basically falls off a very tall building goes past the 16th floor and declares that everything still seems to be okay.

So we’re now in the summer of 2007. And weirdly, everything is everything still seems pretty much set – there’s been a change at the top of the British government, Tony Blair is replaced by his former chancellor of Exchequer Gordon Brown. And he in turn puts in a new chancellor, who is Alistair Darling.

16:40 Alistair Darling

When I was appointed as chancellor in June 2007. Everything we’ve seen very common settled, we’d had a long, long period of growth, there didn’t appear to be any clouds on the horizon. And certainly, you know, when you become a new minister or chancellor, the briefings you get explaining what’s going on in your world didn’t mention financial instability or impending problems with any banks or building societies. I suppose the time I really became aware of it was when I’d taken a week’s holiday, we had gone to Majorca for a week. One morning, I went out to get the morning rolls, I saw the FT. So I thought I better get a copy of that just to keep up to date.

And as I was reading it, by the side of the pool waiting for the family to get up, I noticed that a French bank had suspended withdrawals on two or three of their funds, because they couldn’t place a valuation on them. I also saw in another part of the paper that one of the German banks had got into trouble as well. I found the Treasury being the middle of August, it was difficult to get somebody who worked in that department. And actually, you know, that wasn’t a very big department because financial stability wasn’t a big deal. But clearly, there was a problem. When I got back to the Treasury a couple of days later, I said, I want to have a list of all the institutions that we might be bothered about. Top of them was a small ex-building society, a bank called Northern Rock, based in Newcastle, but had become one of the UK’s biggest mortgage lenders, not very far from the top.

18:38 Jonathan Ford

So what had actually happened is that Northern Rock had fallen into the heffalump it set for itself, some months earlier in the autumn of 2006, house prices, as they inevitably do, at some point, had started falling in the US. Mortgage underwriting standards on all those subprime loans that had been written by US mortgage breakers turned out to be awful, and huge losses started to surge through the system.

19:00 Neil Collins

So the result of that was that all the lenders took fright at the whole sector of this sort of finance. And rather than saying, well, we’ll just see who is creditworthy and who isn’t. They just pulled everything out wholesale. And it didn’t matter really, whether your collateral was good, bad, or ugly. That was one of the things that I think caught Northern Rock on the hop.

19:34 Jonathan Ford

I think that’s absolutely the key point. Basically, what no one had appreciated was that when the market died for subprime loans, it died for anyone who was trying to sell mortgages into the United States. And unfortunately, that was pretty much where all of Northern Rocks money came from. I think 75% of funding came from the US from non-retail sources at this point, much of it from the US so they were just the first to be caught out really.

20:00 Neil Collins

There were already some signs that not all was as it should be at Northern Rock, some of us were very critical of a product that they were selling, called the together mortgage, which lent 110% of the value of the house, some of us could see that this is not terribly clever for a mortgage lender, you’re essentially betting – certainly the last 10 or 20% – of the loan on continuing credit worthiness of the buyer, and a continuing increase in the value of the house.

20:39 Jonathan Ford

Yeah, I think they were also known as negative equity on day-one mortgages.

20:42 Neil Collins

Yeah. Which is exactly what they were.

20:45 Jonathan Ford

But you’re absolutely right. They were like everybody else. I suspect. We talked to Dan Davis about this as well. And he points that actually that in the general scheme of things, Northern Rocks’s mortgages, were pretty good quality.

21:02 Dan Davis

These were safe, well, collateralized loans, collateralized against UK property, mainly in the South East of England.

21:08 Jonathan Ford

This all touches on why it’s such a strange run, and why the authorities are pretty unsure how to react, because they think, Neil that the market has sort of been singled out Northern Rock for a reason – for exactly the sort of thing you’re saying that it’s been imprudently lending. And they’ve rumbled it. 

21:18 Neil Collins

I think it’s probably because nobody had really looked carefully to see what their funding strategy was. And although the balance sheet looked quite simple, it was extremely complex, because it borrowed from these short term lenders in the US, they borrowed in dollars and changed them into Sterling. And then obviously switched the Sterling back when it when they had to redeem it. So there was a very sophisticated process behind what looked like a relatively simple balance sheet.

21:28 Jonathan Ford

But I think there’s another reason to, which is that it’s got that classic thing it’s a small institution, it’s grown too quickly, its chairman is just a local tough, Matt Ridley, whose basic father was chairman, Adam Applegarth, the chief executive, had been there all his life, it wasn’t as if he’d been parachuted in. So you know, they’ve literally got a lord on the board.

21:48 Neil Collins

And the classic of having a very powerful chief executive looked suspiciously as if nobody could say boo to him. So that’s a pretty toxic combination.

21:50 Jonathan Ford

So I think the authorities kind of reached the conclusion that this is like a bit like a 19th Century bank run, it’s a recklessly run institution, which has made a mess on the carpet. And basically, it shouldn’t be let off the hook, its shareholders and its directors should take the consequences of their actions. What they don’t think, I think at this stage is that actually, we’re getting the first overture, if you like, in a great symphony of a massive panic, where all institutions become incredibly vulnerable to collapse, because actually, they’ve all sort of been weirdly doing the same thing. It’s just that Northern Rock is so dependent on this hot money, that it’s the first to run up the white flag, it’s as if the whole ship is about to go down.

22:15 Neil Collins

I think that’s right. You know, they’d all been drinking the Kool Aid, I suppose, is the way to put it. But you’re borrowing short and lending long, which is a definition of banking. But nevertheless, if you get too reliant on a single source of short term finance, you have to ask yourself, what happens when and if that particular source dries up? How do you deal with it?

22:30 Jonathan Ford

And also, it’s a market source and the market is all moving in one massive herd. Certainly, Alistair Darling remembers at this point that there were a few kinds of concerns among the regulators about these huge systemic risks we’ve just been talking about. 

22:40 Alistair Darling

The Bank of England, and indeed, the regulators have a duty to make sure there is stability in the financial system. That’s not new. And it’s still an issue, you know, 25 years later. And that means that, you know, the bank has to be ready to intervene on a wider scale. But this is where the clash occurred. The Bank of England’s view was Northern Rock was in trouble. It shouldn’t be bailed out of the mistakes it made. And you know, they should be made to pay the price of that. Equally, they recognize that you can’t you know have a bank and it’s got lots of customers who’ve got mortgages to go bust just like that. But essentially, what they wanted to deal with, the way they wanted to deal with this, was Northern Rock on its own.

My concern was, okay, the Northern Rock has got a problem, and you can maybe, you know, lend the money and act as a lender of last resort. But the contagion risk of people saying well of Northern Rock can go down. Why can’t other ex building societies or banks go down? And when that sort of talk starts, you know, in the markets, and they start worrying, not just about Northern Rock, but about other lenders as well. You get a contagion problem. And that’s where the Bank of England can, and in my view should have earlier put money into the system to make sure that you kept the system going.

25:11 Jonathan Ford

As August turns into September, the regulators, the Bank of England and the Financial Services Authority are still trying to fix the problem by the normal methods. So behind the scenes they’re trying to strong-arm Northern Rock into selling itself or persuade someone to buy it. So basically, the problem will just go away.

25:30 Neil Collins

But no one seems to be interested. No, it’s because they had worked out by then what the problem was, and they didn’t want to buy a bigger version of the problems that they had themselves. So the banks are all facing the same funding squeeze. And therefore no one particularly wants to have a bigger problem to fund than the one they already have, particularly a firm that can’t raise any money anywhere. Come early September, all attempts to sell Northern Rock prove unavailing. And the bank finally decides, well, we’re going to have to step in with a formal rescue. And of course, to do that, they need to make some sort of announcement that Northern Rock has been taken under the wing of the authorities. But before they can do that something comes along, which makes a whole situation much more memorable from our perspective, but also messy. And that’s on Thursday, the 13th of September 2007. The story leaks out somehow, nobody ever quite knew how, to Robert Peston then the BBC business editor that Northern Rock is in trouble.

26:35 Robert Preston

Now to be absolutely clear. This does not mean that Northern Rock is bust, I don’t think there’s any reason for depositors at Northern Rock to panic.

26:45 Alistair Darling

Unfortunately, somebody tipped off for them, economics editor of the BBC. And I don’t blame him for this. He was a journalist, he got a story. And he announced to BBC News that Northern Rock was going to be bailed out with the Bank of England. Far from reassuring people. The next morning queues started forming outside all branches of Northern Rock. And this gave rise to a second problem, which I’m not sure it was foreseeable. But at that time, Northern Rock had 76 branches, only four of them in London, they were small branches and typically staffed by two or three people, all of whom had been told if someone comes in to ask for their money back, you should sit down and try and reassure them, talk them through the problems, which is great in normal days. But not when there’s a queue stretching around the block it isn’t, because the longer it took the more people panicked.

The second thing that happened, which again was really you know, a function of the times in which we live – in the olden days, a bank being bailed out would have appeared in the evenings news and it would appear in the newspapers the next morning, but with 24 hour TV, what you got were endless pictures being shown over and over again, which you know, fomented this, you know, panic, basically. And people who are sitting at home who maybe hadn’t thought about getting their money out had gone to queue. I remember seeing an interview with a lady saying, or I’d seen these pictures on television.

28:08 Jonathan Ford

Northern Rocks’s lack of branches wasn’t the only problem. It never rains, but it pours. And the next thing that happens is that it just coincidentally, its website happens to be shut down for routine maintenance, as Dan Davis recalled to us.

28:15 Dan Davis

Well, the evening that the first rumours started going around that they’d gone to the Bank of England, their website was down for scheduled maintenance. So anyone watching Robert Peston on the news about Northern Rock and going oh, I just better check my online savings account is ok. Okay, got a 404 error page, they got a message saying that the Northern Rock website was inaccessible. It was probably one of the worst timed website maintenances in financial history.

28:30 Jonathan Ford

Now all of this comes together in a horrible way to create looks what looks pretty much like the sort of Victorian bank from Charles Dickens, did Charles Dickens ever do any bank runs? I can’t remember was their bank run in Hard Times? 

29:20 Neil Collins

With queues outside branches, just like the good old days.

29:20 Jonathan Ford

And pictures in the paper of the queues, but actually isn’t really an old bank run. Northern Rock is actually much more like the canary in the coal mine for something newer and more dangerous, which is just this market withdrawing liquidity and leverage across an entirely interconnected financial system.

29:36 Neil Collins

As I said a minute ago, it’s being withdrawn, regardless of the quality of the collateral on the other side. So it didn’t matter if your loan book was wonderfully well covered by your short term borrowing from the market. The market was just saying we’re not interested in extending it. Where we want our money back on the due date. And that’s it. We’re out of here. Actually. 

30:00 Jonathan Ford

There’s a  sort of slightly airy parallel with what what’s been happening in the past few days with the pension fund, which is, all of a sudden the leverage that they’ve thought they basically were going to be able to take advantage of and enjoy has been withdrawn by the market. And they’re all scrambling around saying, what do we do now?

30:30 Neil Collins

Well, it’s not so much in this case. It’s not really so much the leverage, but it’s the… if you have a market panic, a market, which looks as though it’s always there, and always competitive, can suddenly close. If everybody’s looking at it the same way and saying, we’re not in this market anymore, rather than we’re saying, well, we’ll lend to you but not to you. Then really, you are very compromised.

30:45 Jonathan Ford

Yeah, I think we should say a few things about Peston.

30:50 Neil Collins

Must we?

30:48 Jonathan Ford

Well, we’ll them keep them short. He has been criticised for having caused the Northern Rock panic with his report, which some said was rather sensationalised.

30:58 Neil Collins

It’s a splendid piece of journalism.

31:05 Jonathan Ford

Yeah. Now I think I would actually defend him. I think that setting aside how he presented it and all the rest of it. I think the truth is this, the horse had already well and truly bolted from the stable before he sounded off on the BBC.

31:10 Neil Collins

I don’t think he can be blamed for it. I really don’t think it’s his fault. It was a great story. And all us hacks would have loved to have broken it. And it was…

31:35 Jonathan Ford

That’s  enough praise of Peston. Politically, of course, setting aside the triumph of Peston the result run is for Alistair Darling and the government a disaster because it makes the government look completely caught out and at the mercy of events, which is, you know, we’ve seen in recent days, once again, is a recipe for getting yourself into a terrible pickle and possibly losing office.

31:45 Neil Collins

Yeah, I mean, that shows as I say, it doesn’t matter how big the asset classes, if the people who are essentially funding it, decide that they’re not going to for whatever reason, you” get into difficult trouble, and it can be close to catastrophic.

31:58 Jonathan Ford

Yeah, Alistair Darling then recalls what happened the next day after Peston’s famous report, on the 14th of September.

32:21 Alistair Darling

I remember going to a conference of European finance ministers when the queues were building outside Northern Rock. And I could see only too well, this crisis could bring down the government. And as I came back, I was determined that this was not going to happen. Which is why to, guarantee a bank savings is quite a major step. Although in retrospect, it was a maybe a minor thing. I was very clear that that experience, coupled with the knock of confidence in people that we took, undoubtedly when HMRC managed to lose the details of you know, a lot of people receiving child benefit, what struck me is that for governments to be able to govern, and to do the things you want to do, you must ensure that people have confidence in what you’re doing. You need to be credible in what you say. And you also need that credibility and that confidence, not just to be, hold true domestically, you need it to hold true internationally as well, because most of our debt is owned by people outside this country.

Now, when it came to the autumn of 2008, Gordon Brown and I were very clear that we would do whatever it took to make sure that we did not repeat the Northern Rock problem, and that we would take the action that was necessary to make sure the banking system didn’t collapse, which meant that you must do more than people expect. And you need to do it more quickly than people expect. And that’s what we did. And I’ll tell you the truth, the day afterwards, you know, we couldn’t be sure whether it will work or not, but it did. And it went a long way to restoring people’s confidence in our ability to run things, if you like. But the key thing, if you don’t have confidence if people don’t believe that you know what you’re doing. And also that people, your policies are credible. In other words, you can’t go around saying, Well, I can give you huge tax cuts something with money I don’t have. That’s incredible. If you lose credibility, if you lose people’s confidence as a government, you are finished.

34:19 Jonathan Ford

The government now tries to stop the rock by some pretty big steps to stop the tumbrel before it picks up too much momentum. And the first thing they do is they guarantee all of Northern Rocks deposits and a couple of weeks later, they also generally strengthen the deposit protection regime by increasing I think, I think what they do at this stage – there are subsequent improvements – but basically, instead of having an 80% guarantee up to 35,000 an account they up to 100%. So they’re trying to provide some sort of confidence to people not to yank their money out of the bank. I mean, I don’t know what you make of this. I mean, of course guarantees are a double-edged sword because they can be a little bit helpful in applying the brakes to the bandwagon that rumbling towards a cliff with a boiling frog in it.

But they can introduce, they can introduce new risks. And, you know, where we saw that was in Ireland in 2008, where, rather uncautiously, the Irish government, when they found themselves in the middle of a dozen northern rocks all happening at the same time, simply slapped a guarantee across all their financial institutions. And of course, the cost of that because the institutions still made huge losses was effectively they had to nationalise a lot of them, and they lost them, they pretty much blew their budget apart with all the borrowing they had to do to basically keep the banks afloat. And there was a point where, of course, everyone says, Well, you know, even if your guarantee is good, I’d still quite like to get my money out, you have to write a check anyway. 

35:59 Neil Collins

I think guarantees, as you say, are a two edged sword, I think that it’s important to have some element of risk to those who are depositing their money. And I would say the current setup is probably too generous. I think that people should be aware that if they’re chasing yield, they are also raising risk. And at the moment, because of the size of the government guarantees. That’s not true, up to the current limit, which I think, is 85,000 pounds have gone up a lot since then. Yeah.

36:54 Jonathan Ford

But I think that’s a good general point as well, which is the question of whether the risk and reward balance has been skewed by what sort of happens not just with Northern Rocks or First, but then with a whole series of financial crises and upsets that have followed?

Before we get onto that sort of interesting discussion, we should get just to come to the end of the opening act of the Northern Rock failure. So funding is still draining out at the banks and the regulator is trying to figure out, first of all, how just to deal with that. And more broadly, where banks do fail, like Northern Rock, how to actually put them down. Because up till then the system didn’t really have much of a mechanism to allow the regulator to even take over failing banks.

37:16 Neil Collins

Yeah, I think that’s the point that the government did not have the powers to take over a failing bank, essentially, to confiscate it from its shareholders. Which is what they had to do in the end. But at the time, they couldn’t do that – the law wouldn’t allow it. 

37:32 Jonathan Ford

Well, then well, they were inhibited by the fear that they would be sued. And of course, you know, Northern Rock. Unsurprisingly, when the share price collapses, a whole bunch of hedge fund sort of bottom feeders, buy stakes and try to terrify the government into bailing it out so they can make some money. So that’s one aspect. The other aspect is, quite simply, they’re still wrestling with this question of, you know, how they’re trying to get on top of what on earth is happening, and how, therefore, they can stop the banks seemingly endlessly sliding towards the Abyss.

38:04 Alistair Darling

During the autumn of 2007 – after the immediate crisis in Northern Rock, I tried my best to see if there was a commercial solution to this, that another bank or a group of banks might buy Northern Rock. But I think two things that happened. One is Northern Rock was a singularly unattractive proposition. And its reputation was damaged, you know, you can see why people didn’t want to do it. But secondly, I think at that time, there was a growing realisation amongst many banks and building societies, that they had more problems than they thought, because a lot of banks had built up portfolios of, you know, the CDOs, collateralized debt obligations, and so on. They were beginning to wonder how much they were worth. But just in general, the banks and Treasury and Northern Rock, and basically everyone else, except a few short sellers, just had trouble adjusting to the fact the world had changed. We’d lived in a market for decades, where there was unlimited liquidity available at a few basis points over mid swaps. And it was hard to adjust your thinking to a world in which money was not available at any price.

39:25 Jonathan Ford

So I think this is the first time that you know, the great issue of what you might call bailing out the bankers and socialising losses and privatising profits sort of comes into focus and becomes a real issue. It’s a great slogan, isn’t it? And it’s quite hard to explain why it’s wrong.

39:40 Neil Collins

And if the banks do go bust on a substantial scale, then the losses are borne by the taxpayer. The idea that there was any meaningful alternative other than let the whole system collapse is a fiction in my view.

40:00 Jonathan Ford

Actually, in my view, they obviously tried to sell the bank commercially to Lloyds or (inaudible) or one of these other institutions. But that’s a non starter because they all want some huge government support. So the only real alternative is nationalisation. And that’s the debate. I suppose that’s the final phase of the Northern Rock saga before it, then metastasizes into a much bigger crisis the next year is, is that this debate about should we nationalise it? Or could we sell it to Richard Branson or a hedge fund or something? Essentially, the concern that the government has is it’s the Labour Party, and Labour is worried about being seen as old Labour and nationalising banks.

And that’s not good for their brand. The other problem they have is the thing we’ve touched on, which is the question of how can they get the powers to do it without ending up tied up with dozens of lawsuits. So my view is that their reluctance, while it’s completely understandable, politically, does contribute to this creeping idea that the real economy is being left to fend for itself while the bankers are basically being mollycoddled in that they are being allowed to save their skins and continue to operate as before. Whereas, for example, when the recession comes, the guy who works in a car plant or a packaging company, he basically gets tossed out pretty quickly. 

And this, the contrast I would make was, there was a big systemic crisis in Sweden in the early 1990s. And the government responded, essentially, by nationalising the whole sector, it said, you’ve all screwed up. We’re not interested in allocating blame. We’re going to start again, and essentially, although Sweden, you know, maybe you could say it’s not a model for anything, they seem to come through that without the sort of political anger that was generated by this sort of sense that the bankers were cut a special deal. But I don’t know, what do you think.

41:58 Neil Collins

Politically, that looks much more attractive, because it looks as though the bankers are getting their just desserts. In practice, it doesn’t make a great deal of difference. If your banks are bust, you either support them to the point where you put taxpayers money into them, which is what they did on a massive scale, particularly with Royal Bank, and Lloyds and the general rescue of the sector. There’s not a lot of difference between doing that and essentially taking any up with 80% of the equity than nationalising them.

42:41 Jonathan Ford

Thankfully, they structured those rescues, so that with Royal Bank, they were very clearly determined not to end up owning the whole thing. And so therefore, they structured as special classes of equity, the amount they put in 20 billion or something would have been enough to buy all of the equity of Royal Bank of Scotland about 20 times over in 2008. So there was a deliberate article of policy, not to take over anyone. And I’m not saying it would have been the right thing to do, I can totally understand the concern the government has about we don’t want to be the owner of all the institutions that allocate capital in the country. But this stores up a problem for the future political…

43:42 Neil Collins

Well, I agree entirely about the political what we now call the optics of the affair. But in practice, had they taken over Royal Bank for a pound, they would still have had to put in massive amounts of money in order to make the thing solvent again. So my point is, it doesn’t really make any difference, whether you contribute shares at a silly price that you ended up with 80% of the bank, or whether you take it over for a pound and end up with 100%. Because you still got essentially a very substantial write-off in terms of resetting the value and eventually getting rid of your shareholding.

44:02 Jonathan Ford

Okay, so we’ll come back to that. But the second issue that the regulator faces, of course, in the government is the question of how do they stop the crisis and, and they do now I think, understand a little bit more about what’s happening – that it’s a panic and the one way to stop it is in the short term, or at least to cushion the falls that are going on the draining away of all this money is for the central bank to try and fill some of the gap left by departing investors. So on the 20th of September, just a week after Northern Rock’s kind of clothes are ripped away or whiskers are ripped off by Robert Peston, the Bank of England does finally agree to pour 10 billion pounds into the longer term money markets to try and ease the pressure. And that is a kind of big change, right? Because Walter Badgett the Bible of central bankers, said you know, lend at high prices against good quality collateral to individual institutions- so they’re just spraying money into the into the markets to try and save the day.

45:02 Neil Collins

Yes, I don’t think that they follow the budget line here at all. Because the money was put into… essentially put into the market by the Bank of England for the market essentially to deploy as the participants saw fit. I’m not sure that doing something else would have produced a better outcome. I think that they were essentially at that point they were running before the storm. I don’t think they really understood how bad it was going to get.

45:37 Jonathan Ford

We’ll find out whether those sorts of approaches that we’ve just been talking about how they fared when they collided with reality in the next episode.

That was a long time finance with Jonathan Ford and Neil Collins, editing and production spine, Nick Hilton, and our sponsorship partner is briefcase dot news. Join us again next week.

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