Articles > Recent Market Turmoil and Northern Rock

Recent events have led to moderate turmoil in the markets and thrown Northern Rock into the limelight for all the wrong reasons.

But how is it all connected? Is it a one off, or a systematic failing of the system?

Two major forces have contributed to the overall situation. Firstly, globalisation. This means that what happens in one part of the world now financially affects what happens in another part. 

Secondly, robust economies. Yes, that's right. Whenever economies are doing particularly well, there is great impetus to keep the ball rolling, cut corners, ignore concerns.

This has been the case in the American sub-prime market. Sub-prime generically refers to any non standard mortgage, such as for clients who cannot prove incomes or have patchy credit records.

It has come to light that many of these loans have been offered to people who have been less than honest. Controls naturally tighten as banks seek to reduce default loan risk.

Banks generally raise money to lend to mortgage clients in two ways. They can either use the money deposited into back accounts by their high street customers, or they can attempt to raise it on the open markets. Most lenders do a combination of both.

As lenders in America have sought to reign in lending, investors in the market have become more hesitant to invest in mortgage debt. Due to open markets, this has also affected banks and building societies in the UK as the financing has dried up.

So, why has this specifically affected Northern Rock? Northern Rock relies more heavily on raising funds in the market than most other lenders. They have far fewer ready reserves than do most other banks. So, while they have many mortgage customers who want access to funds, they simply cannot find the money.

Enter the Bank of England. They initially offered to lend Northern Rock the funds to supply their mortgage customers. The Bank of England does not intervene with banks unless they believe that the problem is short-lived and is a one-off issue.

The very fact that the Bank of England intervened should have therefore been seen as a positive queue. The market (made up of millions of individuals with their own way of thinking), however, saw the intervention as a sign of weakness.

Hundreds rushed to Northern Rock branches to withdraw their funds. Ironically, this just made the problem worse as Northern Rock had even less of its own funds to rely on.

The final step was for the Bank of England to guarantee all Northern Rock deposits. A bit of a gamble perhaps, but it seems to have paid off so far. The queues at branches have died down.

Where does this leave Northern Rock? It makes them a very good target for a buyout, particularly by an institution that has larger ready deposits to offset risk. Time will tell.