Northern Rock - A Bank Built On Sand
Below is a MRR and PLR article in category Finance -> subcategory Wealth Building.
Northern Rock ?" A Bank Built on Sand?
Introduction
The Bank of England's announcement on September 12, 2007, that it would support Northern Rock plc marked a significant moment in exposing the global repercussions of the US subprime mortgage market collapse.
Context and Impact
In the US, major subprime lenders like New Century Financial Corporation faced bankruptcy. Meanwhile, in the UK, Northern Rock, classified as a bank, received intervention to prevent widespread panic. There were rumors of liquidity issues among leading UK banks, including Barclays, prompting the Bank of England to signal that no major bank would be allowed to collapse.
Northern Rock's Rise and Fall
Ironically, Northern Rock was once considered a success story. In February, its share price stood at £12.58 but plummeted to £4.33 by September 14, 2007. The bank’s strategy involved offering 100% mortgages with an additional 25% of property value, aiming for a growth rate of 20% while the market grew at about 10%. To achieve this, they needed appealing mortgage products and flexibility towards consumers with mixed credit records.
Northern Rock secured a 22% market share of all new mortgages in early 2007. The majority of their funding, about 75%, came from the wholesale market rather than individual savers. The near-collapse of interbank lending in August led to a liquidity crisis.
Comparing the Cases
Compared to the US subprime lenders, Northern Rock appeared relatively prudent. New Century's approach sometimes involved lending to those just out of bankruptcy. Northern Rock, however, was not criticized for neglecting diligence in its lending practices. Its downfall was not due to mortgage defaults but a lack of funds to sustain rapid expansion.
Housing Market Trends
The UK housing market is expected to follow the US's downward trajectory. In places like Stockton, California, prices have dropped over 10%, with repossession rates at 3.7%.
Despite differences, both Northern Rock and the US lenders share a common cause: the relentless increase in consumer debt. In the UK, average household debt, excluding mortgages, is £8,856, rising to £56,000 when including mortgages.
A Broader Economic Picture
Some 11.8 million UK households have mortgages, with an average outstanding balance of £96,560. For those with unsecured loans, mainly credit cards, the debt rises to £20,600, raising the average total debt to £117,160 for such households.
In the US, average credit card and car loan debt per household is $18,700, while mortgage debt averages $74,000. Both countries, particularly the UK, have consumer debt fueled by expectations of rising house prices, full employment, and low interest rates. Any shift in these conditions could have severe repercussions.
Economic Growth and Challenges
The UK economy's growth in recent decades was driven by rising house prices and supported by North Sea oil. Manufacturing has declined along with the number of British-owned companies in various sectors. The financial services sector, particularly in London, has seen significant growth, surpassing Wall Street.
However, the suppression of inflation via cheap imports is unlikely to persist. Rising wages and material costs in China and East Asia may end consumer-led growth in the US and UK, likely leading to a period of readjustment marked by potential interest rate hikes.
Conclusion
Ongoing uncertainty around financial institutions will continue to unsettle the housing and stock markets in Western economies. Investors seeking substantial returns may need to explore opportunities abroad, while borrowers must reevaluate their ability to repay loans if interest rates significantly increase.
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