Sunset for the Rock

For the first time since the 1970s a business operating in the private sector has been nationalised. On February 17th February 2008 the government announced that Northern Rock plc was to be taken into public ownership for a ‘temporary’ period following a failure to find private sector backers for the ailing mortgage lender. This is a momentous day in British politics and a landmark too for the economy. The last public limited company to return to the state sector was Rail Track (now known as Network Rail) which was re-nationalised and made into a not-for-profit business in 2001.

After its flotation in 1997 the Rock grew into one of the UK’s largest mortgage lenders. Indeed by the summer of 2007 it accounted for almost a fifth of all new home loans – it had gone from a relatively small regional building society into a FTSE-100 blue chip company whose share price touched £12 in the spring of last year giving Northern Rock a market capitalisation of five billion pounds.

But its business model was fundamentally flawed. It was dangerously exposed to the global credit crunch because it had relied too heavily on borrowing from the international wholesale money markets to fund its mortgage lending, rather than the conventional approach of attracting savings deposits into a bank which are then used to lend out to people needing mortgages.

When the credit crunch took hold and the interest rates that banks charge when lending to each other increased, the Northern Rock was plunged into crisis. Within days, thousands of depositors were queuing up outside branches trying to withdraw their savings. The government was forced into agreeing to guarantee all deposits held by Northern Rock in order to bring about an end to this financial panic. The failure of the Bank is a classic case of regulatory failure. Northern Rock was growing much quicker than one would expect if a business opts to expand ‘organically’ (i.e. without recourse to buying up other businesses). There was insufficient ‘stress testing’ of the loans and funding arrangements that the Rock was making in the mortgage market. The Financial Services Authority comes out of the Northern Rock fiasco very badly indeed.

Six months after the first ‘run on a bank’ in over one hundred and fifty years, the government has taken the step of taking Northern Rock off the stock exchange – their shares will be suspended. The Treasury hopes that Northern Rock will be returned to the private sector ‘when financial market conditions have stabilised’ shorthand for saying that the Rock will stay under government control until we have seen the end of the current global credit crisis, who knows when that will be? At the time of the suspension of share trading the stock was valued at 92p per share and the market capitalisation of Northern Rock was less than £500 million. In December 2007 the Northern Rock dropped like a stone out of the FTSE-100 index and CEO Adam Applegarth left the business.

The Northern Rock continues to trade but the business is worth a shadow of what is what less than a year ago. And for the government there will be a heavy political and economic price to pay. Taxpayers are subsidising the bank in loans and guarantees to other lenders totalling £55bn and this money is being added to the value of the national debt throwing into the air one of the government’s fiscal rules about maintaining government debt at a sustainable level of 40 per cent of GDP.

Northern Rock shareholders have suffered a loss of more than 90% in the value of their stocks but the biggest sufferers in the short term are likely to be many of the several thousand people who work for the business predominantly in the North East – early estimates are that up to 2,500 jobs may go as the bank is restructured.

Suggestions for wider reading

Financial Times special report on the Northern Rock

BBC news special report

The Guardian