Northern Rock and the Crisis in Britain

How the crisis reached Britain

Six steps, about nine minutes, a question at most of them. You need no economics and no preparation, only a willingness to guess before you are told.

Module 3 of 7
9 min
6 steps
5 questions

Step 1 of 6

The question

One British bank ran out of lenders in 2007, and it took five months to decide what to do with it. The reason lay in what British banks had borrowed, not in what they owned.

Britain's biggest banks had bought some of the American mortgage bonds. They had also lent far more than their savers had paid in, and they borrowed the difference from other banks and large investors a few months at a time. In August 2007 that lending stopped.

Why it matters and what it covers

Northern Rock ran out of lenders first, and savers queued outside its branches for the first time in more than a century. Five months passed before anyone decided what to do with the bank. Responsibility had been divided between three bodies: the Treasury, which controls government money, the Bank of England, which sets interest rates, and the Financial Services Authority, which checked banks one by one. No rule said which of the three decided.

Six steps take it in order: who was watching, how far British lending had run ahead of British saving, the bank that ran out of lenders, what the American bonds actually cost, the dollars European banks could not find, and the five months it took to decide what to do with the bank.

What this module covers

Who was supposed to be watching the banking system
How much more British banks had lent than their savers had paid in
Northern Rock, and the morning the market closed to it
The American bonds, and what they actually cost
The dollars European banks could not find
Three bodies, and the five months between the queue and the answer

Written for every level. Tap any underlined word for what it means, and open the boxes below for the economics behind each decision. If you already know the theory, skip both and the history reads straight through.

Step 1 · who was supposed to be watching

Each agency watched one part

By 2007 responsibility for watching the banks was split between separate agencies on both sides of the Atlantic, and none of them had power over the whole system.

Each agency was given one class of firm to look after, so a firm that fitted no class had no agency of its own.

The Congressional Research Service prepares briefings for members of the United States Congress. It wrote afterwards that American financial regulation was spread across many agencies, each given one kind of firm to look after. No , it said, covered every firm big enough to bring the others down.

Supervisors could tell whether one bank was sound. None of them could tell what would happen when every bank had done the same thing at once.

regulator: An official body set up by law to watch over an industry, with the power to cap its prices or set its rules, without owning it.

Step 2 · the funding gap

More lent than saved

By the first half of 2008 the major British banks had lent out far more money than their customers had paid into them. They borrowed the difference from other banks and large investors, a few months at a time.

The mortgages that money pays for run for decades, so the borrowing falls due long before the mortgage is paid off. Each time it falls due the bank has to find the money again, which was easy until August 2007.

HBOS was then one of Britain's largest banks. By 2008 it was borrowing more from other banks and investors, £248 billion, than it held for savers, £243 billion. The Commons Treasury Committee, the MPs who question the Treasury and the banks, published both figures.

The Bank of England watches that gap because the lenders, not the bank, decide when that money has to be paid back and whether to lend it again.

In the first half of 2008, how much more had the major British banks lent than their customers had paid in?

Give it in billions of pounds. Guess: close scores almost as well as exact.

For scaleIn 2001 the same measure was close to nothing: what those banks had lent was comparable to what their customers had deposited with them.

Step 3 · Northern Rock

The bank that ran out of lenders

Northern Rock, a mortgage lender based in Newcastle, took only a small part of its money from savers. On 9 August 2007 the firms it borrowed the rest from stopped lending to it.

It paid for new mortgages in three ways: money savers put in, bundles of mortgages it had already made and sold on as bonds, and borrowing from other financial firms.

On 9 August 2007 its own traders recorded that the market it borrowed in had stopped working, and after that neither of the two borrowed ways was open.

Money a bank holds for a saver is money it owes them. In 1997 savers' money was 62.7 per cent of everything Northern Rock owed, and over the ten years that followed the bank grew on borrowed money instead.

Savers queued outside its branches from Friday 14 September 2007 until the Monday. The Treasury Committee said it was the first time savers had queued at a British bank since Victorian times.

By the end of 2006, what share of everything Northern Rock owed was money it held for savers?

Give it in per cent. Guess: close scores almost as well as exact.

For scaleHalf of what Northern Rock owed came from mortgages it had bundled up and sold on as bonds. Those arrangements ran three and a half years on average, against mortgages that ran for decades.

Step 4 of 6

What happened next Next module Next: The Collapse of Lehman BrothersTwo rescues in six months taught the market that a big firm out of money would be lent to or taken over. Then one was not. The weekend of 13 and 14 September 2008, and everything that had to be rescued instead.

Module 3 of 7 in The 2008 Financial Crisis