ABSTARCT

            London being one of the major hubs of global financial market due to its centrally geographical location, holds so much to the global economy to the extend that if any instability is experienced within the market it have a profound effect to the global monetary system. In this view, the erupted Northern Rock crisis made the entire global monetary system to be shaken. As a result, mortgage business have experienced the difficulties and more operational inefficiencies linked to the crisis. Therefore, this essay shall look at the causes and implications of the crisis to the citizens, shareholders, the entire global financial system and other related firms.

Introduction

            Northern Rock Bank is one of the major mortgage firms in the global market and UK. This is in a view of 180,000 shareholders, 800,000 mortgage holders and over 1 million savers which translates to its UK mortgage market share of a bout 18.9% (Victoria 2008). Despite this achievement, in 2007 Northern Rock Mortgage Bank experienced credit crisis which led the bank to request the Bank of England as a lender of last resort in United Kingdom for a liquidity support facility. But statistics indicated that, a total of  £2 billion had been withdrawn by the time Northern Rock Bank had applied for emergency fund from Bank of England. The request followed bank’s problems raising from shortfall of funds in the money market, hence it was necessary so that the bank can replace maturing money market borrowings in its transactions (Kavaljit 2000). This problem however can be traced back to the sub prime crisis in the United States that caused difficulties in most banks in the Europe. In that respect, the bank had sufficient assets to cover its liabilities (Victoria 2008), but had a liquidity problem because institutional lenders became nervous about lending to mortgage banks following the US sub prime crisis. During this period, Northern Rock Bank borrowed £3 billion from the Bank of England in an attempt to meet its liquidity deficit (Victoria 2008).

            The crisis worried many of the customers who flocked to branches of  Northern Rock Bank to withdraw their savings, in that event a total of £1 billion was withdrawn (Victoria 2008) within a very short period of time. To indicate how serious the crisis affected the customers, the chancellor had to call the police officers to control the customers in some of the branches like Cheltenham and Gloucestershire. In addition to that, the  joint Internet  account holders barricaded the bank manager in her office, who in their views refused to  allow account holders to withdraw £1 million because  website had problem to open up, as it was congested as a result of many customers trying to log on to withdraw their savings. In turn of event at the stock market the Northern Rock’s shares lost 32 percent, which further dropped by 40% from 438 pence to 263 pence respectively. The bank’s chairman Mr. Ridley Matt could not stand the heat from the public therefore, he was forced to resign for failure to recognize the risk of the bank financial strategy and defacing the reputation of the British Banking Industry (Paul 1997).

            Due to this events that unfolded it, made the government to intervene and assure customer’s  investments that was held by the Northern Rock Bank. In conjunction with the legislators assurance, chancellor stated that the nationalization of the Northern Rock Bank was only a temporary measure. This however, was evidence to the  breakdown of global finance market since London money market is key to global financial system. In addition, it consumed a total of  £100billion of tax payer’s money and many jobs to be lost in the process of credit criss (Victoria 2008). In this connection, the main question is whether the financial market stakeholders are efficient and competent enough to navigate the economic sector to the expected and desired yield requirements of international standards. If such an incident can occur and key policy makers did not project the risks to the finance market, how safe and secure are peoples investments in the global financial market.  This is a question many people on the globe are asking today. After UK’s  5th largest mortgage lender collapsing in the overturn of event that was not even projected by economic financial strategists in relation to London role in global financial market.

            This is deep and great concern since London is the hub of global finance due to its geographically centrality between the US and Far East and the key money market and global finance (Kavaljit 2000). This is an area of greatest concerns since the  it touches on one of the key economic component of the country and globe at large. The matter that lead to the credit crisis in the Northern Rock mortgage institution needs to be investigated in depth to unearth what really happened for that lead to the  crisis. This shall include the possible causes, consequences and necessary precautions to be adopted to avoid recurring of such events in the near future in the economic arena (Victoria 2008).

 Cause of the Crisis

            London  is the epicenter of the global finance system, therefore the possible crisis is rooted both locally and internationally. The credit crisis that destabilized the operations and transactions of the institution has its source from the low interest rate environment created by the United States Federal Reserve, in addition to that newly adapted financial strategies which were flowed as a result of these low interest rates which resulted from US federal Reserve adoptions (Victoria 2008). This can be further traced back to the incidence of sub prime crisis in the United States (Michalos 2000) that caused difficulties in most banks in the Europe and entire global economy. This is because most institutional lenders became nervous about lending to mortgage banks following the US sub prime crisis incident. However this is not strong enough to be the major attribute of the criss (Victoria 2008).

            The UK monetary policy committee and all stakeholders in the financial market in relation to  Northern Rock crisis contributed to the problem.  For instance, the United Kingdom financial regulatory body and UK Monetary Policy Committee (Victoria 2008) blindly raised up interest rates in the summer of 2007 without accessing and analyzing the profound effects of their actions. In addition to failures attributed to the monetary regulator body and committee, they did not realize the flawed financial model that allowed Banks to use offshore tax havens to avoid taxes which in similar sense, the Northern Rock also used complex offshore structures (Robin 1999) to obfuscate its accountability in regard to its transactions. However, to what is not common as far as the regulation practice and ethics are concerned, the Banks continued to publish opaque financial statements and auditors continued to provide duff reports to the public. In contrast, the FSA report contained no proposals for eradicating the offshore games or reforming auditing, accounting and corporate governance structures in the financial market (Robin 1999). This was the major cause of the circumstances that have led to pathetic Northern Rock crisis in UK.

            The management team of Northern Rock Bank came up with one of the riskiest and ill thought through its strategies and model of mortgage lending that was based on attracting funds from depositors and pay them a rate of interest below those the financial market rate deposits which are for medium and long term periods  (Kavaljit 1999). The money they harness from lenders in the money market would then be lent out to the mortgage borrowers on a long term basis in form of mortgages which would yield a higher interest rate to the Northern Rock firm, that would be above that available in the financial markets of London . This kind of transaction would in give the Northern Rock bank good and higher profit, when computed on the difference between the rates at which the lending institutions lends the bank and the interest rates the bank will obtain from the mortgage borrowers on a long term basis. Therefore in order to realize this strategy the condition was the bank to maintain or replace the the lenders to enhance continuity of the business circulating aspect. And by doing so the continuity would translate to sustainability of business and make good returns on the investment to finance the operational costs of the mortgage firm (Michalos 2000).

            Secondly, using the earlier mentioned strategy the management of the Northern Rock mortgage  financial institution borrowed short term money from the London money markets at the low rates, then  lent it out for long term basis to home buyers or mortgage borrowers at a higher interest rates that fetched high profits to the bank. Therefore in this case continuity of operation of the Northern Rock entirely depended upon the willingness of the lending banks to continue lending their money to the bank at an affordable rate. In return it would enhance and support their strategy to enable the bank run and make good business returns(Paul 1997). However this would be possible on condition that the firm keeps on renewing these short term loans from the financial markets.

            The strategies which were designed by the bank were good ideas but lacked vision of the possible changes of future  during their formulation. This is in light of UK inflation which made the monetary Policy Committee to raised the interest rates curb inflation in the UK economy, which  resulted from demand for raw material, food product and cheap money from China and other  developing nations (Victoria 2008). After the problems that were as a result of inflation in the UK economy,  the US sub prime mortgage crisis that lead to drying up of the money markets especially US and UK, which made banks and lending  institutions to stop lending to  banks because were not certain of credit worthiness the borrowers Northern Rock not exempted. Hence it became extremely risky to lend money in the London money market.

            Due to these two events, they posed a great challenge to institution. The  short term loans which the Northern Rock institution had borrowed matured, but  there was no mean and source which they could replace old loans with fresh loans, secondly the rates that  which were applicable could not enhance Northern Rock to harness profit, while at the same time the rates translated to low profit to lending financial institutions and major banks thus lenders were not willing to lend money because they were uncertain of the borrowers ability to repay the loan back in agreed terms and time (David 1995).  Therefore at this moment the banks which had earlier on  lent money to Northern Rock wanted it back, but due to financial situation it was difficult for Northern Rock to repay the money because it had traded off to long term home buyers in the mortgage industry  (Alex 1997).  Therefore this was the real problem that led to the credit crisis of the Northern Rock mortgage institution. In this connection this crisis caused a wave of faults, instabilities and bankruptcies in the London money market due to its huge outstanding loans to lending financial institution and banks in the entire financial market of the UK and the globe since London is the epicenter of the global financial market. This is when the British government  jetted in £110 billion to pay off Northern Rock’s huge debts and loans which is the tax payers money.

            This unfolding of events indicate that Northern Rock management and the Labor government bear some responsibility. Firstly the Northern Rock management for coming up with strategy without analyzing, synthesizing and accessing the possible consequences this strategy and factors which could change that will affect the model and strategy to work (Kavaljit 1999)  . Secondly the government is to blame for formulating and adapting  a financial regulatory framework that is inadequate to govern the financial sector. This is because framework which was adapted was Mr. Brown’s government and FSA   (Financial Services Authority) centered.

             It is shocking and disgusting turn out of event its not well understood how can FSA and monetary committee, which is  packed with accountants and administrators can lack knowledge of how financial markets operates with its products (Victoria 2008)Therefore in this case the political parties, legislators and entire leadership who are supposed to  represented the interests of capital of the state were rather careless when dealing with the excesses of the market and policies relating to the financial market (Michalos 2000). This in return have translated to poor management systems and can be strongly linked to the collapse. This does not in any way remove or exempt the linkage of the Northern Rock bank management  from the crisis.

The impacts of Northern Rock Crisis

            The crisis is profound consequences was not only felt in UK but also in the entire global financial system. This is simply because in London, money markets was where the Northern Rock Mortgage institution was borrowing its money, with a bearing that London money market is key to global finance system (Victoria 2008).  Therefore the crisis created a problem in the London money markets (Alex 1997) that translated to global panic in financial markets system globally (Robin 1999). As a result the crisis had a strong profound effect on the global money market. Therefore the act of  government to save Northern Rock was not  about saving or rescuing Northern Rock depositors and clients but rather saving the global financial system that its equilibrium was adversely affected (Michalos 2000).

            The greatest losers are the UK taxpayers as most likely the government may not be able to recover  pat or full of the $110billions back of tax payers money. The employees and other job opportunities related to bank and financial economy are lost as the size of staff will have to be reduced. For instance the 6,000 staff will be cut down to below 2,000 work persons to even more less than that (David 1995). The lending banks and institutions will have to reduce the quantity of  loan to Northern Rock bank. They do this through offering unattractive rates to Northern Rock, thus in return the Northern Rock will offer same poor rates to the homeowners that discourages new borrowers and make existing borrowers move their mortgages to another banks in the market. In this way the both the customers and the bank looses including the economic system (Victoria 2008). Shareholders  are bound to loose since the bank is worth nothing hence lower dividends on their shares. The RAB Capital and SRM Global firms and many others who were partnering with Northern Rock firm are bound to loose heavily (Victoria 2008).

Conclusion

            To sum up the essay the the credit crisis that the Northern Rock bank experienced is not the first one in the financial market in UK for failed financial regulators. This follows after the  Equitable Life and Independent Insurance, without forgetting the BCCI debacle that closed in 1991. Up to date there have been no conclusive investigations which gives a hard to take lesson today. In this connection the bank nationalized, then government to embark on compensating small scale shareholders and turn the  bank into a social bank offering low cost loans to citizens. It is evident that financial framework has failed, therefore there is a need to replace it with a more rational system which is people’s need based.

REFERENCE

Victoria C, 2008, Contribution to political economy; crisis at Northern Rock, oxford journal, vol, 27, p. 115, oxford university press, oxford.

Kavaljit Singh, 2000, Taming Global Financial Flows, St Martin’s Press, Inc, New York.

Michalos Alex, 2000, A Handful of Sand in the Wheels of Financial Speculation, Working Paper, University of Northern British,  Columbia.

David Greenway, 1995, The Wheels of International Finance, Economic Journal, vol, 13 p. 61

Paul Davidson, 1997, Are grains of sand in the wheels of international finance sufficient to do the job when boulders are often required, Economic Journal, Vol, 107, p. 686

Kavaljit, 1999,  Globalization of Finance,  Zed Books, New York.

Alex C, 1997, The case for taxing foreign currency exchange and other financial transactions,New York, Duncan Press.

Robin Hahnel, 1999, Everything you need to know about the global economy, South End Press, Massachusetts.

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