Northern Rock 2007 and Overend Gurney 1866
A hundred and forty years ago Britain witnessed something very like what we have seen this year in the case of Northern Rock. The similarities are striking.
By 1866 Overend Gurney and Co, which had been founded in 1800, was the largest commercial bank in Britain. From their imposing headquarters in Lombard Street, the cash they dispensed helped to oil the financial wheels of merchants servicing the British Empire’s trade with the rest of the world.
They did this by discounting bills of exchange. These were in effect IOUs from the merchants’ clients, promising to pay the sum agreed for a shipment upon its arrival at their home port. The merchants would then present these bills to the bank who would take them over by paying the cash due on them less a discount, which represented the bank’s profit on the deal. The shipments themselves represented their security. Naturally such arrangements called for both judgement and caution; qualities which the Quaker founders of the bank possessed in abundance.
By 1860 however those founders had passed on, to be replaced by younger, more aggressive directors who saw opportunities in the boom in the development of railways and dockyards which they judged to be too good to miss. As a result the decision was taken to invest heavily in these essentially long term projects. The problem however was that their income stream came from short term deposits and cashflows which were now being exposed to long term investments and unsurprisingly the time came when the one could not cover the other: At this point the bank became insolvent. What followed was a depositors’ panic with queues of people outside 65 Lombard Street, looking to take their money out.
This of course is exactly what has happened with Northern Rock and for much the same reason. In the thick of the housing boom they embarked on financing rapid growth with a high proportion of mortgage offers at fixed rates in the medium term. To do this they boosted their traditional cash resources from depositors by huge short term, (largely three month) loans from other banks but once the credit cruch hit, Northern Rock was left exposed. As in the 1860s judgement and caution had been replaced by greed and recklessness.
There is a difference however. In the case of Overend Gurney the Bank of England remained aloof, allowing them to go into liquidation. Funds were injected into the market to increase liquidity as banks became nervous in lending to each other but crucially not a penny was spent on propping up Overend Gurney itself. A much smaller bank, Barclays stepped in and took the rump of the company over, making themselves stronger in the process and banking equilibrium was eventually restored. In the case of Northern Rock however the Bank of England has intervened, by sinking a potential £95 Billion of taxpayers’ money into what is nothing more than an insolvent company while falling house prices and the cost of maintaining its overheads means that the value of its collateral is depreciating every day.
Had Northern Rock been put into administration right away the depositors’ cash could have ultimately been recovered and the taxpayer would not be exposed to potentially huge losses - but Northern Rock jobs of course would have largely been lost. Instead the mortgage book is to be chopped up into bonds, again guaranteed by the taxpayers, which nobody actually wants to buy because they can't get rid of the hundreds of billion's worth they've already got on their books.
The big difference between the two stories, is that in 1866 the government of the day did not have its eye on job losses in a key electoral asset like the North East of England and rightly allowed the Bank of England to act responsibly. Sadly this has not been the case today and as a result the British taxpayer is left underwriting an insolvent bank to the tune of £95 billion. That's just short of £6 billion each to secure the votes of sixteen Labour heartland constituencies in the North East come the next election.
Click here for Wikipedia entry on Overend Gurney and Co.
Click here for a description of how a bill of exchange works
Click here for Daily Telegraph article on Labour heartland fears
Click here for Timesonline article on Northern Rock lending recklessly
This article was posted on the 19th December 2007
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