Northern Rock: 3 Years & Counting...

How saving the savers is costing the savers so dear...

On the MORNING of Weds 12 Sept. 2007, Northern Rock – the UK's fifth-largest mortgage bank – ran a banner advertisement across the lower front-page of Britain's best-selling broadsheet, The Daily Telegraph, writes Adrian Ash at BullionVault.

The ad promised 6.30% interest on new deposits, a return-to-cash not offered by High Street accounts in nearly a decade. To keep cash in the bank, the Rock was paying more than 220 basis points over its peers. Anyone tempted soon found out why...

Thurs 13 Sept. '07: Northern Rock asks for, and gets, an emergency credit line at the Bank of England; the BBC's Robert Peston breaks the scoop, stressing the wrong causes (and syllables) by blaming the US subprime collapse on his blog;
Fri 14 Sept: The bank's website and phonelines melt down; savers queue outside its handful of branches, waiting to empty its cashdesks and at last putting flesh on the TV news' credit-crunch headlines, now taking shape five weeks after the interbank money markets froze;
Sat 15 and Sun 16 Sept: With the stock-market closed, but NRK's shares down by one-third for the week, press reports say savers withdrew £1 billion ($2bn) of their £23bn deposits on Friday alone, adding to the £1.4bn withdrawn in July and August.
Mon 17 Sept: The bank run continues. "We're open..." is the best Northern Rock's website can claim.

The policy response? The Bank of England had been alerted to the Rock's financing gap within one week of the Aug. 9th spike in wholesale lending rates; by the start of the run, NRK's stock had already dropped 15%. But it wasn't only the Rock hitting trouble; on Sept.13th, the Bank of England threw out an emergency £4.4bn relief fund, and saw it drained by UK banks inside one hour.

City watchdog the Financial Services Authority was equally on top form. In its "judgement" Northern Rock was "solvent, meets all capital requirements and has a good-quality loan book," as the chairman (and chief banking regulator) Sir Callum McCarthy told the press that Friday. In the preceding two years, his staff had met with the Rock only six times. Only one of those visits lasted more than one day.

And over at the Treasury, meantime, Chancellor Alistair Darling – shell-shocked at first – then went to pieces. Seemingly unsure of the UK's deposit insurance limit (then £35,000, some $70,000), he mumbled and gulped through a hastily called press conference before declaring – as if on a whim – that the state stood behind every last penny households were owed by the bank. Within a fortnight, and again apparently making policy in the hope of clearing the room, he extended his largesse to the entire UK banking sector's household obligations, raising the guarantee from £31,700 to £35,000 per account and hinting at a true ceiling of £100,000.

Short of printing money of course (but what a crazy idea!), Darling's promise was only a bluff. All told that September, UK households were owed £919bn by the banks; the government's annual tax receipts only totalled £518bn. But then, maths never was the New Labour Treasury's strong suit. And either way, saving the savers was always sure to cost the savers themselves dear...

  • Northern Rock's 6.30% offer was briefer than September sunshine on Tyneside, as the Bank of England got round to slashing rates month after month, down to a 300-year low of 0.5%. There base rate's now sat for 18 months, even as the cost of living rose sharply, refinancing the banks at the cost of savers and taxpayers, who are of course one and the same;
  • On the Consumer Price measure, annual inflation has exceeded the government's 2.0% target – the Bank of England's core mandate – in 29 of the last 36 months, reaching (or breaching) the upper 3.0% tolerance eighteen times;
  • That's taken real interest rates – the post-inflation rate of return – down to their most negative level since the late 1970s, turning a Sept. 2007 deposit of £1000 into just £967 of purchasing value three years later on average;
  • House prices have fallen regardless (down by almost a fifth after inflation), while the FTSE suffered its second crash in a decade, remaining one-quarter lower in real terms from early autumn '07;
  • Gold Bullion, in contrast – that outright rejection of official money and deposit-account risk – began rising steadily as the queues formed outside Northern Rock, hitting a peak of £870 this June and now trading above £810 per ounce.

Like the mass mugging of savers, Northern's collapse now looks all-too obvious in hindsight. "In the first 8 months of [2007], Northern Rock's total net lending was up 43% over the same period in 2006, with net residential lending up 55%," as it stated to the stock market that 14th September.

Such steroid-fed growth had come thanks to its "alternative model", one which relied for 43% of its funding on the world's money markets, rather than cash deposits. The UK bank average was then 7%, but as cash savers learnt 12 months after the run on the Rock, they all had their own problems waiting to blow up as well.

No matter. "Buy" advised The Times on 27th July 2007. "Buy" said The Telegraph the same day. "I have bought Northern Rock," added an FT journalist one month later, "unable to resist a price of 645p, which gives a forward p/e of 6 and a dividend yield of 6.2%." The next day, August 25th, TD Waterhouse said private investors were filling their boots with the Rock. "Last week and the end of the week before were the busiest time we've seen since February/March this year," said the retail brokerage, where trading volumes had risen by over 50% as individual investors "focused particularly on banking stocks."

And why not? "Load up on Northern Rock – for your children, your Mum, your goldfish..." said an email, leaked to the press, apparently from a trader working at (wait for it) Lehman Brothers.

"It is not going to go bust, gives an interesting yield, is cheap, and is a realistic takeover target – buy it now."

A growing handful of anxious savers ignored such advice, and began making the switch to gold in early July. Here at BullionVault, for instance, the amount of gold added to client holdings in Q3 2007 was almost twice the volume of Q2. Additions in Q4 then outweighed the previous nine months entirely. Physical gold held outside of the banks now looks an obvious answer for defending savings against the financial crisis to date. Yet few financial pundits said they saw the need, even as Northern Rock was finally nationalized – and the shareholders destroyed – just as Bear Stearns collapsed in New York six months later.

"Steer clear of the new gold rush," said a columnist at Money Magazine in March 2008. "Don't give in," urged another hack at CNN. "Step out of the stock market, even temporarily, and you may miss the whole point of owning stocks."

Odd thing is, being late – and buying fire insurance even as Bear Stearns caught fire or Lehmans combusted, followed most recently by Athens' street protests – has still paid off to date. Gold's only continued to rise as this crisis wears on, helping defend the value of savings against the whole range of wealth-destroyers so far, from bursts of consumer inflation to bouts of asset deflation, banking collapse to stock-market routs and quantitative easing...
 
"Northern Rock wasn't my prime motivation for Buying Gold, but rather the final straw," said a BullionVault user to me this week. He began buying the metal in late-Sept. '07.

"I'd decided I didn't like the situation in January '07, and so I pulled out of the stock market completely and went substantially into cash – except for my pension plan, of course...But then I've little control there. In the July...or was it August...a German landesbank failed. That spurred me into putting money into gold."

Our man took profits earlier this year, and then bought back during the summer dip. (The gold price in Sterling fell 15% to £740 in late July; it's since risen by more than £70 per ounce.) Because owning gold, he says, means he doesn't need to forecast the bad news ahead – not its precise nature or timing, at least. Buying Gold is simply the "bad news hedge" he needs to cover any number of troubles. And for all he knows, the problems of 2008 and '09 have simply been deferred or hidden to date. So there's what he calls "sufficient possibility of a real crisis" to come.
 
Still, things could be worse. Or they might all of a sudden get better! Just ask Matt Ridley, author of new book The Rational Optimist...and Northern Rock's chairman from 1994 to its bitter demise in 2007. Ridley's book offers "a challenging counterblast to the prevailing pessimism of our age," says his publishers blurb. Or as gold investors might quote the ex-Northern Rock man – and with a grim gallows smile...

"The best is yet to come!"

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Adrian Ash runs the research desk at BullionVault, the physical gold and silver market for private investors online. Formerly head of editorial at London's top publisher of private-investment advice, he was City correspondent for The Daily Reckoning from 2003 to 2008, and is now a regular contributor to many leading analysis sites including Forbes and a regular guest on BBC national and international radio and television news. Adrian's views on the gold market have been sought by the Financial Times and Economist magazine in London; CNBC, Bloomberg and TheStreet.com in New York; Germany's Der Stern and FT Deutschland; Italy's Il Sole 24 Ore, and many other respected finance publications.

See the full archive of Adrian Ash articles on GoldNews, or get more from Adrian Ash on Google+

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