Foreign Perspectives

With 20/20 hindsight, Northern Rock was an obvious disaster waiting to happen.

When a relatively small regional bank turned out to be writing 20% of all of the UK mortgage market, weren’t some warning signals coming up? After all, that kind of growth in market share implies a very aggressive approach to marketing and indeed on pulling in money to fund all those mortgages.

Bear Stearns, along with many pure investment banks, tends to have quite an aggressive approach to running it’s own book too As it turned out, it was a little too optimistic with the projections and ended up just as bankrupt as Northern Rock for pretty similar reasons.

The approach on both sides of the Atlantic was quite different. Whereas the UK government continued to dither about and ended up taking over the bank itself, the Fed was much more aggressive in going for what needed to be done. They simply transferred the bank to JP Morgan (“sell” isn’t the word to use given the price paid) and backed only the residue of the business that couldn’t be easily transferred.

Which is the right approach and what’ll happen next time around?

Unfortunately, neither is really “right” in the sense of being a workable solution to the problem of the debt crisis. In both cases, a signal has been sent out that significant banks won’t be allowed to go bankrupt and that the government will take over the highest risk aspects of any bank when necessary. I’m not sure that’s a good message to be sending out at the moment as it implies that there’s no risk too much.

On the other hand, would it be better to have let one of those banks go bankrupt? Northern Rock had a major slice of the UK mortgage market and large numbers of savers so letting it go wouldn’t have been good for the government at the next election for sure. Although Bear Stearns hadn’t as many private clients they’d have been pretty vocal ones given the amounts involved but aside from that the bank was a major player with many interlinking deals and would have caused severe repercusions had it gone down.

Sadly, it’s looking like these two banks are merely tasters of what is to come if the credit crisis isn’t sorted out very soon.