NORTHERN ROCK - please explain??

Question

Hi. Im 15, but do have an interest in Economics, and have a very vague idea of the topic. (I do understand basic things like supply+demand, interest rates, inflation...)

Would someone please be able to explain why the Northern Rock Crisis occured, and exactly what this means? I'm sorry if I do sound naive, but - well any business section in the newspaper is too full of jargon for me to properly understand.

Please just relate this to the British Economy, and the credit crunch....


Thank you for this - I really want to understand and I have to start off somewhere!!!

Answer 1

OK, its too long, so il summarise it for you. Basically, it all started off in America, where banks were offering mortgages to home owners living there, now, lots of home owners took out these mortgages, BUT, the rise in interest rates meant their monthly repayments went up, as they had to pay more interest on the mortgage they have taken out. Most or nearly all home owners were unable to pay the repayments, as they just could not afford it, and banks such as Northern Rock thrive on international money markets and loans, thats how they make their profits basically, but what happens is banks give money to other banks at a certain interest, so for example Northern Rock, may have lent an American bank millions of money, at what ever interest, and that American bank then gave that money to home owners as a mortgage, but when home owners said thats it, we cant afford to pay these, the American banks had to tell the other bank, where it borrowed million from, that it could not afford to pay back that loan. Now, i believe Norther Rock did not lend money to another bank, they went and directly gave out these mortgages, and when people cant pay them, it left Northern Rock in millions and millions of pounds of debt, as they just gave out a hell of alot of money, thinking that they would get it all back with interest, and make a nice profit, but insted because interest rates went up, people could not afford to pay, and hence Norther Rock was in alot of debt!! Then what happened is they went and asked the Bank of England, which is the main governing body in the UK, for a loan, i think it was 25 million pounds, once the word got out that Norther Rock was in a bad situation, all is customers rushed to take out their life savings, as obviously they did not want to risk loosing it all!! And this again put Norther Rock in a difficult position, as now they had no money in their bank, and by now they recieved alot of bad publicity. So now, they have 2 options, either they sell the bank to Richard Bransons Virgin Money group, which the sharholders do not want to do, as they are getting a low value per share, or the government takes over the bank, and nationalises it, so that its owned and run by the government!

Hope that helps :)

Answer 2

Firstly, a memo to stupid Yanks:

If you don't understand UK issues, stay off the UK board! Well phrased and sensible questions are not deserving of your idiotic WMF mode when you are faced with something you do not understand.

Secondly, an answer for sneeze:

In the United States, banks were giving mortgages to people who had no hope of paying them back. These are known as "sub-prime" mortgages and is something that happens in the UK also with mortgages being offered at up to six times an applicant's salary. Predictably enough, the number of defaulters in the US rose to such levels that banks began to refuse mortgage loans. This is the "credit crunch" that you hear about. Banks like Northern Rock do not operate under a traditional banking model and are quite unlike Barclays and the other "High Street" banks. Their model is to buy money from these banks at a low rate and sell it on as a mortgage at a higher rate. It was only a matter of time before a credit crunch occured in the UK and when it did, Northern Rock took the hit. They were not any more liable than anybody else; it just happened that a financial journalist was perched in the rafters when Northern Rock applied to the Bank of England for a loan to tide them over and blew the whistle. It doesn't take much to start a panic in the financial world and we got the first run on a British bank since Disraeli. That Barclays had applied for a similar loan a month earlier passed uncommented.

The point about the credit crunch is that "proper" banks are no longer so ready to loan money. This makes it difficult for the likes of Northern Rock to continue. If people cannot get mortgages, new houses will not be built with a knock-on effect for the building industry. This retrenchment not only applies to mortgages but to business loans too. If businesses cannot get loans, they cannot expand so the economy slows down.

The credit crunch is a predictable corollary of stupidity and greed. Stupid people think they are entitled to have things they cannot afford and greedy banks are happy to provide them with the loans for them.

Answer 3

I think it's down to the fact banks lend more cash to customers to than they can afford to. They then have to lend from other sources to fund this lending. Whn these sources start to dry up for whatever reason then it puts the banks in a problem of how they are going to be able to fund their own customers. Northern Rock could not afford to pay out to it's customers so therefore as soon as people found out they started to withdraw all their cash.

I realise this is not a perect explanation as it also related to problems in America (which is when i start to get confused). Hoped it helped.

Answer 4

The Chancellor of the Exchequer deciced to help out northern rock by lending them 25 billion pound of tax payers hard earned now i could just be being cynical but the same man has a mortgage with said bank

Answer 5

I am an economist and have some factual knowledge of the Northern Rock issue. No one above has provided you with correct knowledge. Also, it is a global crisis, but precipitated in America. It would have occured, most likely, without the sub-prime debacle, how it happened would have been different and Northern Rock wouldn't have happened but another institution would have been caught short.

I am working from memory on the dates, but I believe it was on August 16th, German investment banks were trying to roll over $42 billion in short term corporate IOU's called commercial paper and banker's acceptances. Commercial paper is a promise to pay, usually within 90 days, a specific sum of money. A banker's acceptance is a post dated check that a bank has agreed to honor, even if the customer has failed to deposit enough money. It usually takes about an hour to find buyers for the paper, by noon, they had only found buyers for half the money. That meant that some businesses would be unable to meet their obligations. It didn't yet have anything directly to do with the sub-prime mortgages.

In Germany, banks usually fund their own operations through the commercial paper market and not through deposits. They were among the paper issuers needing cash to meet their obligations to their customers. They couldn't get funding either so they offered up sub-prime mortgages as collateral. No one would take them. They found themselves holding assets no one would take. It started to resolve itself, when it started spreading to the United States. The US Federal Funds market, the interbank market for overnight loans between banks seized up. Banks would not loan to one another for any collateral including Treasury securities. This spread to Britain.

Northern Rock expanded much faster than its customer base for deposits and it had used the money markets to fund about 1/3rd of their operations. They would borrow for ninety days at a time with commercial paper.

Northern Rock announced it had only a trivial exposure to the sub-prime market and there was no reason for anyone to be concerned. They were financially healthy and stable, which was true. Except, it made people start thinking about Northern Rock and the amount of exposure they had to the money markets. Since Britain doesn't have a meaningful deposit insurance scheme, depositors started standing in line for their money.

Mervyn King had already backed himself into a corner saying the Bank of England would not bail anyone out. Northern Rock found itself, and the public perceived, that in the event of stress, Northern Rock and its depositors were on their own. It was a foolish comment for King to make. Central banks must stand as lenders of last resort to otherwise financially stable borrowers. The Bank of England, in many ways, set the run in motion by stating that banks couldn't count on it.

Once in motion, the Government had to intervene. There really was nothing wrong with Northern Rock, other than over exposure to the money markets and normally this is not an issue. I cannot imagine a British bank had difficulties in the money market since the 19th century.

So what is happening is that banks have lent out more money than actually exists, which is a normal state of affairs, but from time to time it comes back to haunt them.

Ideally, the central banks will print money, create inflation and solve the crisis. Unfortunately, it will not help America with its housing crisis. It also will act like a large tax increase. Inflation hurts the poor and makes the rich richer. It doesn't do much else.

Answer 6

all i know is that it was somthing to do with americas credit crunch. i think my economics teacher told me it was because they were giving out loans to people that they knew wouldnt be able to pay them back. And the money they are giving out belongs to the public who have their money in northern rock. (how all banks work). Therefore they lost some of the publics money and people wanted to remove their money before it was lost, but nothern rock couldnt repay them as they loaned their money out etc. Therefore the bank of england had to bail the out and give them 2.2 billion(?). Some of which they have to pay back. Some of which they dont have to.


This whole thing has cost the economy 2.2billion(?).


not 100% on the total story but its somthing like that.

Answer 7

I'm sorry I haven't a clue, but I'd imagine that it wouldn't have been as bad as it was if the media had kept away!

Answer 8

The best understanding you, can put on this is "Another Rip Off"
You had better get used to this as this is UK in 2007.