Monday, 17 September 2007

ECB on Northern Rock: What Northern Rock?

It’s official. The UK has become the first country to have a bank run caused by the current market turbulence. The run on Northern Rock bank that started on Friday and is continuing today is sending the public here into a panic. British commentators are speculating that there could be another Black Wednesday around the corner, while the Bank of England is trying to reassure the public that there’s nothing to be alarmed about.

Northern Rock is Britain’s fifth largest mortgage lender and is a massive bank here. So when news broke on Friday that the bank is going broke because of the worldwide credit crisis and the Bank of England has bailed it out with a limitless line of credit, the bank’s customers ran to the branches and started queuing to get their money out in cash. It was really insane, I walked by a branch on Friday and it was complete pandemonium, like that bank run scene in It’s a Wonderful Life.

Of course the reality is that the bank run is completely irrational, because the news is that the Bank of England is bailing out the bank with an unlimited line of credit, which means your money there is safe. But try telling that to worried savers while their morning tabloids scream at them to withdraw all their money. At this point it’s even boiling down to a practical decision to move funds. The run has caused the bank’s web site to shut down, meaning that no Northern Rock customers can pay their bills (cheques are no longer used in the UK, everything is done electronically) so people are taking their money out just so they can pay them, which is compounding the problem. My coworker just withdrew his money for this exact reason.

The Bank of England is coming under major fire for the bail-out, with critics saying the bank is rewarding risky lending behavior (Northern Rock made similar subprime loans to the ones that have been issued in the US). People are also questioning the bank’s apparent flip-flop. In August, When money and debt markets were seizing up globally, the European Central Bank, the U.S. Federal Reserve and even the Bank of Japan rushed in with emergency funding for banks. The Bank of England, on the other hand, took no action. Mervyn King, the central bank's governor, even gave a speech last week praising his bank’s decision to not act and criticizing the other central banks for their cash infusions, saying, “The provision of such liquidity support undermines the efficient pricing of risk by providing ex post insurance for risky behavior. That encourages excessive risk-taking, and sows the seeds of a future financial crisis."

To put it mildly, he’s probably regretting that speech now that his bank has done the exact thing he was criticizing last week. The conservatives are jumping at the chance to attack the Brown government over this. While I was at the gym today I watched David Cameron give a speech calling for greater transparency in the UK financial system. Now you know things have gotten topsy-turvy here when a Tory leader is calling on a Labour leader for greater financial transparency. But Cameron’s argument was that Brown (who was chancellor before he was prime minister) has presided over a huge expansion of public and private debt without showing awareness of the risks involved, encouraging people to take on debt they couldn’t actually handle.

Of course some of Cameron’s criticism is legitimate and some is just hyperbole. But it was striking to observe today the very different reaction from King’s contemporaries at the European Central Bank. Speaking from the Portuguese city of Porto, where EU lawmakers have been meeting for some time now to work on aspects of the treaty, the ECB’s president, Jean-Claude Trichet, had nary a disparaging word for King, even saying that the Bank of England had acted completely appropriately in the bail-out.

It’s an awkward situation to be in, and certainly heads of central banks are not well-known for criticizing one another, but it won’t help the ECB with some of its critics to be seen as burying its head in the sand about the global financial crisis currently under way. In any event, Trichet has to acknowledge that the bail-out may have caused more harm than good by triggering the bank run.

Certainly it will be more grist for the mill for French president Nicolas Sarkozy, who again was complaining about the ECB over the weekend. Le Monde quoted Sarkozy on Saturday saying he found it strange that the ECB had injected huge amounts of liquidity into the money markets without cutting interest rates, basically accusing the bank of irresponsible bail-outs that are only benefiting speculators rather than consumers.

Of course its hard to see who’s really taking Sarkozy’s war on the ECB seriously. As with his previous comments, he has no high-profile politicians backing him up on this. In fact all the ECB officials in Porto had nothing but disdainful things to say about Sarkozy to the Financial Times over the weekend. One gem was Axel Weber, the president of the Bundesbank, telling the paper, "The news value of Sarkozy's critique is zero. And it also has zero influence on the ECB.” So basically Sarkozy doesn’t know what he’s talking about, according to the ECB.

In any event it’s a sure thing that there’s going to be a lot of finger pointing going on throughout Europe over the next week, as each country looks fearfully at their own banks and prays they won’t be the next one to fall victim to the global financial crisis. At this point everyone knows that it is not the credit crunch itself that could destabilize the markets, but rather the public’s reaction to it. In this regard it’s going to be imperative that the media covers the events that are going to unfold over the next couple months responsibly. And judging by the UK coverage of the Northern Rock fiasco, this may not be a realistic thing to hope for.

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