What to make of the Northern
Rock bailout? To me, it looks like textbook central banking on the part
of the Bank of England. Mervyn King, the BofE’s chief, has no particular interest
in cutting interest rates or otherwise bailing out the UK financial system as
a whole if it lent recklessly. On the other hand, UK mortgage lenders also take
deposits, and it’s in no one’s interest for a bank to fail outright. So King
will lend the Northern Rock money at punitive interest rates, watching the value
of its equity plunge, and trying to ensure that no one else attempts the moral
hazard play.
For it certainly looks like that’s what Northern Rock was playing at: while
everybody else was tightening their underwriting standards, Northern Rock kept
on lending, capturing 19% of all new UK mortgages in the first half of this
year. The problem is that the Northern Rock didn’t have any money to lend, and
when they tried to borrow the money on the capital markets, the capital markets
were closed.
So now Northern Rock is having to borrow the money from the Bank of England
instead – at rates which I’m sure are higher than the mortgages they were
writing. That’ll learn’em, as they say up north.
Update: Richard
Lander, in the comments, notes Willem
Buiter’s fine blog entry on this subject, where he says that letting Northern
Rock fail – and imposing a haircut on even relatively small depositors
is – is actually a good idea. Buiter’s forgotten a hell of a lot more
about how the Bank of England works than I’ll ever learn, and the whole thing
is well worth reading, if only to get an example of how hawkish policymakers
really can be when it comes to the regulatory side of things.