Imagine the scene at around 10 p.m. last Thursday night in the private apartments at Buckingham Palace. It could well have been past normal bedtime for the Queen and Prince Philip, but they were sitting up — perhaps aided by a scotch and water or some camomile tea — waiting so that Her Majesty could give gracious assent to the Banking (Special Provisions) Bill, then being rushed through the Commons.
The Queen no longer actually signs Acts of Parliament. Instead she puts her ‘sign manual’ on Letters Patent, which serves the same legal purpose of transforming a Bill into law. Even so, one cannot help feeling that this truncated ceremony was still a sort of rebuke to the Prime Minister. Its continued existence must surely get on his nerves — and never more so than on this occasion, when his economic policy was in tatters and a well-attended House of Commons was waiting for the Queen to do her constitutional duty.
The assistant private secretary, Doug King, entered clutching the papers, and told Her Majesty that a special messenger from the Treasury was waiting downstairs. As she raised her pen, the Queen must have recalled all the previous nationalisation bills brought before her by Labour governments — for the car industry, shipping and the mines — and remembered what bad pieces of legislation those turned out to be. ‘Hmm,’ she might have thought, ‘first time I’ve had to assent to the nationalisation of a bank.’
Of course, the reason she has never assented to such a unique Bill before is that banks are special. Yet I have not seen it explained clearly why the seizure of Northern Rock is so dangerous. So forgive me if I have a go.
The immediate consequences of this fiasco will probably be slightly higher taxes, as the government scrambles to find the money to pay for its City advisers’ fees and any Northern Rock liabilities not covered by assets. But the really nasty effects are more insidious and could make another bank failure more, and not less, likely.
Banks collectively make up a system of payments on which the entire economy depends. And the banking system, as the word credit implies, rests on confidence. To understand how this works, you must go back to the alleyways of 17th-century London, in the aftermath of the Great Fire, where so many of the principles on which modern finance is based were first discovered.
There, early insurers, with names such as the Hand in Hand, the Sun and Royal Exchange, came across the concept of ‘moral hazard’. These companies arose from the ashes and soon learnt, to their cost, that by providing insurance they were sometimes encouraging the outbreak of more fires. Arson increased; customers failed to take precautions; and some people did not bother getting insurance at all because they knew their neighbours had an insurance policy and so teams of firemen would come anyway, to stop a conflagration spreading.
Moral hazard is equally to be feared in banking. It is a fancy expression for old-fashioned greed, carelessness, negligence and fraud. It is shorthand for the selfish instinct of humankind to transfer risks to somebody else — to make others pay for our own mistakes. And the real scandal of Northern Rock is that the government has been so careless as to douse the banking system with this flammable liquid.
As a result, Gordon Brown and Alistair Darling have undermined the fundamental principles of honesty and trust on which the carefully constructed edifice of the banking system is supposed to rest. They have, through their painfully slow-moving intervention, provided a massive incentive for future wrongdoing and chicanery.
Start, first of all, at the top. The bosses of every high-street bank comparable to Northern Rock now know that however bad their decisions, however risky their speculations, they will be bailed out by the government. If things go wrong they can simply resign, having amassed millions in bonuses and share options over the years, as Adam Applegarth, the ex-Northern Rock chief executive, did before Christmas.
Then there are the customers. Take, for instance, a mortgagee who is finding his interest payments a bit onerous. Why should he bother keeping up with the payments? Won’t he be tempted, like a dishonest insurance claimant, to land others with the bill, knowing that if the bank which has lent him the money gets into trouble, it will be nationalised and Britain’s 30 million taxpayers will ultimately pick up the tab? All the signs are that this is already happening at Northern Rock. Its mortgage arrears doubled in December, affecting loans of £1 billion. The number of mortgages in arrears rose by nearly 20 per cent in the second half of the year, to 9,000 households. And the bank has been active in the repossession courts, increasing its stock of repossessed homes to over 1,000.
But now Northern Rock is nationalised and the customers have effectively borrowed their money from taxpayers, you can bet such toughness in the courts will not continue. Politics will come into it. Every time the Rock’s bailiffs turn up to seize the keys of some stone-clad Newcastle villa, lavishly refurbished with the benefit of a 120 per cent mortgage, a great caterwauling will be got up. MPs will lobby the Treasury, television cameras will arrive and that nice Ron Sandler, who has been asked to run the bank by the Chancellor, will be forced to give in and let the victims keep their home.
What will be the interest rates at the new Northern Rock? In order to attract new depositors, the tarnished bank is currently paying out 6.5 per cent on savings accounts. These heavily advertised offers are among the best around, which is all very well for new customers but a disaster for other banks, which fear their customers will be tempted away. This unfair competition has already resulted in a complaint to the Competition Commission.
As for the rates at which Northern Rock will lend, there is a theory that it will charge higher rates in order to encourage customers to leave and to thereby shrink the bank. Let’s hope that’s true. For the alternative — cheap loans to political cronies — would be far worse and more typical of state-owned banks from Japan to Zimbabwe.
Finally, there are the shareholders. Look how their trust has been rewarded. Granted, they should have kept a better eye on the Rock’s management, but they all made their investment on the basis that the British banking system was properly regulated and the Bank of England was a trusted lender of last resort. Those expectations have been exposed as false, to the shame of the rather pompously entitled Tripartite Authorities — the Treasury, the Bank of England and the Financial Services Authority.
Northern Rock should have been allowed to go bust, or it should have been sold to Lloyds TSB. Period. Either of those outcomes would have left the remaining banks stronger. What Brown and Darling have done is not just reckless but bad — and that is the nub of it.