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Major British lender gets help

Northern Rock, caught in a credit crunch, receives emergency funding from the Bank of England.

September 15, 2007|Kim Murphy | Times Staff Writer

LONDON — Uneasy customers formed lines outside Britain's fifth-largest mortgage lender Friday after it had to ask the Bank of England for emergency funding because it had been hit hard by the credit crunch tied to the U.S. sub-prime mortgage crisis.

The emergency loan for Northern Rock was the first such action by the central bank since the 1970s, and it came after the northern England bank said it couldn't arrange short-term loans from other financial institutions amid the international money-market squeeze.

Treasury Chancellor Alistair Darling said the move was an attempt to restore stability to a fiscally responsible mortgage lender caught up in a U.S.-generated crisis, and did not bode ill for Britain's banking system as a whole.

"The problem here is that there is a lot of money in the system. The banks have got money, but they're reluctant to lend it to each other at the moment because of the problems in America," Darling told the BBC. "So when you get a situation like that, in order to create a stable banking system, the Bank of England steps in. . . . Northern Rock will be able to carry on its business."

Analysts said the bank, which has $226 billion in assets and $48.7 billion in deposits, was not in danger of failure but could become ripe for takeover with a continuing decline in its stock price, which plummeted more than 30% on Friday.

Northern Rock's woes were a drag on the British banking sector. Alliance & Leicester, a commercial and consumer bank, fell 6.9%, HBOS, the nation's largest mortgage lender, lost 3.6%, and Paragon Group Cos., a lender to landlords, tumbled 17%.

Northern Rock has very little involvement in the sub-prime mortgages that got U.S. lenders into trouble, with the bulk of its business in prime mortgages.

It ran into trouble because of its aggressive involvement in the wholesale market for funding its loans. When markets dried up in recent weeks, it was left without access to cash.

"It's a typical example of what happens if you have all your eggs in one basket," said Justin Urquhart Stewart of London-based Seven Investment Management.

"Northern Rock is pretty uniquely exposed in that it's only a mortgage bank. It doesn't do other things banks do; it just does mortgages very well. Their mortgages are very competitive because they used money markets to get rates down," he said. "But as a result of what happened in the sub-prime market, mortgage banks like Northern Rock have no access to liquidity, and liquidity is the lifeblood of capitalism. If you haven't got any blood, you shrivel up and die."

Willem Buiter, chairman of the department of European political economy at the London School of Economics, said it was unclear why the Bank of England came to the aid of Northern Rock. "It's a niche institution. It's not systemically important in the U.K. They could have let it go under without causing any systemwide disruptions in the U.K. So it's a bit of a mystery why they decided to bail it out," Buiter said. "Maybe they feared some risk contagion effects."

The danger now, Buiter said, is sending a message to other banks that the central bank stands ready to intervene in the event of trouble.

"Northern Rock was an accident waiting to happen. Everybody who knew anything about mortgage lenders knew they were first in line. The other banks have not got the same imbalance between assets and liabilities," he said.

"But what the bailout did do, of course, is make a future crisis more likely, because it makes it clear to banks that if they do act recklessly -- not because they invest in unsafe assets but because they grew too fast and went for risky and volatile sources of funding -- they know there is a public sector daddy with deep pockets ready to pick up the pieces."

But Darling, the Treasury chancellor, emphasized that he was drawing a line between institutions like Northern Rock and banks that made risky loans to borrowers. Earlier in the week, in an interview with the Daily Telegraph, he leveled an attack on reckless lending practices and called for a return to "good old-fashioned banking."

"They [borrowers] need to ask themselves, 'Can I repay this?' And lenders need to ask themselves, 'If it goes wrong, can I get it back?' " the chancellor said. "Institutions themselves need to open their own eyes and be more honest. When someone comes up with a fantastic way of making money, they need to ask, 'How is this money being made, and what are the risks?' "

In a statement to investors Friday, Northern Rock Chief Executive Adam J. Applegarth admitted it would be "inevitable, albeit disappointing" that the bank's profit would be affected.

"We are seeing extreme conditions in global liquidity, which have impacted on world markets. As a result, we have taken prudent action to rein back our lending until markets normalize," he said. "We remain focused on prime lending in the U.K. mortgage market, and our credit quality remains robust."

He said the central bank's support "reflects a recognition that Northern Rock is solvent, exceeds its regulatory capital requirement and has a good quality loan book."

Nevertheless, some patrons were not reassured.

"I would not put a penny into that company again," Tony Looch, a 68-year-old who withdrew his savings after standing in line for nearly two hours outside a branch in central London, told the Associated Press. "There are a lot of older people who must be really scared."


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