Sir,
The growing consensus, exemplified in Martin Wolf's column 'Big lessons from Northern Rock' (November 16), as to the lessons to be learned from the crash of Northern Rock, is wrong in material respects.
The consensus that Northern Rock failed in its liquidity strategy is of course correct. For this, Northern Rock management should be blamed. However, the consensus also seems to be that the blame should stop at Northern Rock's door - that is, as Mr Wolf puts it, "the urge to discover a public sector scapegoat should stop". Mervyn King, governor, defended the Bank of England against criticism by stating that there was no way that the Bank could have quietly guaranteed the £20bn-plus of liabilities that Northern Rock's liquidity strategy failed to protect.
Mr Wolf endorses this but there is a naivety there, false or otherwise, that needs to be refuted. It implies that the £20bn was always going to have to be centrally funded in any rescue, whereas there is a strong argument that the vast majority of that amount would have happily rolled over on Northern Rock's balance sheet had it not had to reveal that it was in talks with the Bank of England, on the evening of September 13.
The true story behind the liquidity crisis at Northern Rock began on August 9, with a 'credit strike' across the world banking system, in particular a withdrawal of funding for collateralised mortgage securities. Northern Rock incorrectly assumed that those problems in the US could not possibly affect its (sounder) UK securities. That was a fatal error. But it also believed (and no one has yet suggested it was incorrect) that its mortgage securities, and all other balance sheet assets, were sound, with no large loss potential.
Unfortunately, Northern Rock was due to re-finance a large tranche of its mortgage securities in early September (another mistake by Northern Rock management, in that they had securitised in a way that there had to be frequent roll-overs of the financing). With liquidity absent, Northern Rock could not refinance this tranche of securities so had formally to approach the Bank of England. So, the queues around the block at Northern Rock branch offices on Friday 14 September only came about because of the announcement that Northern Rock, because of mortgage market illiquidity, had been supported by the Bank of England. Only then did the retail withdrawals start that led to the £20bn-plus funding hole.
Between August 9 and September 12 there was an opportunity for the Bank of England to ease the peculiar liquidity constraints affecting Northern Rock. That opportunity was not taken. The European Central Bank had meantime pumped almost €100bn into the European money markets. No European bank suffered a liquidity crisis. The Bank of England was less accommodating, so Northern Rock at that earlier stage faced a crisis based only on its inability to fund a tranche of mortgage securities, whose size was a fraction of the £20bn that Mr King quotes. The larger requirement only became inevitable on September 14. It was not inevitable the week before, or the month before.
Nor has there been sufficient discussion of the policy reversals of the Bank of England. It was unaccomodative on liquidity before September 12, a perfectly respectable approach, which many of us might endorse. But such an approach has to be followed through. If it is the belief that to keep sound money and a sound banking system at times one has to refuse liquidity to those who need it, then one must let such institutions go bust. It can be argued that the Bank of England espoused the worst of both worlds by restricting liquidity at a time when it might have helped, and then offering it so as to keep Northern Rock alive, thus creating a £20bn headache. Alternatively, if a softer, what we might call 'Trichet-esque', approach to providing liquidity - whether generally or to Northern Rock in particular - was the right initial approach (and certainly it has led to remarkably little turmoil in continental banking markets), then it should, and I believe could, have been applied from the first.
Mr Wolf states in his article: 'The big lesson, happily, is that the huge errors were by one institution.' Again, I don't know if that is correct. At least one other UK financial institution refinanced a tranche of mortgage securities just before the August 9 credit shutter came crashing down. That institution was in consequence happily liquid by the time the September 12 crisis unfolded. Had August 9 happened a week or two earlier, it is not inconceivable an entirely different name would now be in use to describe the UK mortgage securities fiasco of late summer 2007.
Jon Moynihan
Executive Chairman
PA Consulting Group
London Sw1W 9SR
