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Vol. 71/No. 37      October 8, 2007

 
London bails out bank hit
by defaults in home loans
(front page)
 
BY JONATHAN SILBERMAN  
LONDON, September 21—Financial troubles at Northern Rock bank last week triggered the most serious run on a British bank in living memory. Thousands of people lined up outside the bank’s offices to withdraw money.

Northern Rock is the United Kingdom’s fifth-largest mortgage lender. It has declared assets of 113 billion (1=US$2), mostly in its 800,000 household mortgages. The deposits of 1.3 million customers there only account for between 22 and 24 billion. The bulk of its lending is funded by short-term loans from other banks.

In an effort to stem withdrawals, UK finance minister Alistair Darling, flanked by U.S. treasury secretary Hank Paulson, announced September 17 that the British government was guaranteeing all deposits there.

Darling said that a similar guarantee would be extended to any bank requiring it during the “current instability” in the financial system.

Several days earlier the Bank of England came to Northern Rock’s aid as “lender of last resort.” About 1 billion was withdrawn from personal savings accounts the day the bailout was announced.

“During the first half of 2007, it [Northern Rock] received just 1.7 billion of new money from savers. Yet it lent a whopping 10.7 billion to new borrowers,” wrote Dan Roberts in the September 17 Daily Telegraph. “The shortfall was made up through borrowing from the City [London’s main financial district] totaling some 10.3 billion.”

This made Northern Rock vulnerable when short-term lending between banks dried up or became extremely expensive in the wake of the “subprime mortgage crisis” in the United States. The bank couldn’t raise funds. Northern Rock’s share price was cut by 75 percent.

Government policy over the last quarter century has boosted “home ownership” in the UK. Today 70 percent of households “own” their home, with mortgages totaling about 350 billion. So-called subprime loans account for around 25 billion of this total.

In recent weeks, people with variable interest mortgages have seen their rate increase by more than 3 percent. Mortgage rates hit a nine-year high last week.

Over the next three months average monthly payments for hundreds of thousands will increase by about 200 per month as their fixed low rate loans are transferred into variable rate mortgages.

Personal debt in the UK today stands at more than 1.3 trillion.

Financial commentators and ruling class figures here are debating the consequences of the tighter credit for the broader economy—what some are calling contagion.

Already this “credit crunch” has taken its toll in Germany, forcing two multi-billion euro state-sponsored bank bailouts. The share prices of every German bank have taken a pummeling.

In the UK, the share prices of Alliance & Leicester and Bradford & Bingley, two Northern Rock rivals that also tap the capital markets for funding, have been hit. Barclays, one of the top five UK banks, has seen its shares tumble.

Major U.S. investment banks Lehman Brothers and JP Morgan Chase have recorded losses of nearly one billion dollars in the third quarter of this year.

Concern that the U.S. economy might be slowing prompted the U.S. Federal Reserve to cut interest rates by half a point. One investment banker told the Sunday Times “the banks’ numbers are as important as whether the Fed cuts rates … People are spooked.”  
 
 
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