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Fears grow for British economy as panic over Northern Rock spreads
Experts warn that a decade-long borrowing binge has left Britain dangerously exposed to the fallout from the global liquidity crisis

London Observer | September 16, 2007
Heather Stewart and Heather Connon

US Treasury Secretary Hank Paulson flies in to London tomorrow to discuss the worsening global credit crisis with Chancellor Alistair Darling, as fears intensify that the lending squeeze could be the last straw for Britain's buy-now-pay-later economy.

Thousands of anxious customers queued outside branches of Northern Rock to withdraw their savings this weekend, ignoring calls for calm from Darling, after he helped broker an unprecedented emergency loan from the Bank of England to rescue the bank.

City economists warned that a decade-long borrowing binge had left the UK economy dangerously exposed to the fallout from the credit crunch. 'I think the UK is extremely vulnerable to this,' said Danny Gabay, director of consultants Fathom. 'The UK has a double vulnerability. We are vulnerable because of our hugely over extended consumer sector, and because of our large financial services sector.

'This is a financial market event; but the longer it goes on, the greater the risk that it becomes a real economy event - and I think we are at a tipping point.'

As the Federal Reserve prepares to cut interest rates - perhaps by as much as a half percentage point - to restore confidence in financial markets, Darling and Paulson will discuss proposals for better transparency, to prevent a recurrence of the 'contagion' that has spread the impact of bad loans in the US housing market around the world.

But analysts are still scrambling to calculate the potential impact of the current squeeze. Ross Walker, UK economist at RBS, said: 'We were already looking for a noticeable slowdown next year, and now there are further downside risks.' He predicted that the Bank would have to cut interest rates twice by the end of next year, to prevent the downturn becoming too severe with growth slowing to 2.2 per cent, from almost 3 per cent this year.

Richard Donnell, head of research at property data firm Hometrack, said the latest evidence of the severity of the sub-prime crisis would rock confidence in a housing market already struggling to absorb five interest-rate rises.

'It's taken a good year for the impact of higher rates to reach London but, finally, the whole market's feeling the pain.'

It emerged this weekend that several financial institutions have run the slide rule over Northern Rock in recent weeks, as its advisers Hoare Govett and Merrill Lynch battled to avert a Bank of England bailout by finding a buyer.

However, most potential bidders have privately ruled themselves out of the frame. Lloyds TSB has been the favourite candidate, but banking sources indicated it was unlikely to be interested. HSBC - under fire from institutional shareholder Knight Vinke for failing to capitalise on its emerging-markets interests - is also thought unlikely to bid, despite its relatively small share of the UK mortgage market. Other leading banks, including HBOS, RBS and Barclays, are also seen as unlikely to be interested.

One bank executive questioned the logic of bidding for a bank whose name has been tarnished by the Bank of England bailout and whose customers - seen as higher risk -are paying low rates on their largely fixed-rate loans and therefore likely to move elsewhere when these expire. Rival banks are instead likely to focus on poaching that business. Nor is there much scope for cutting costs, as Northern Rock is already the most efficient mortgage bank.

'What do you get with Northern Rock?' asked the banking executive. 'You get a load of customers who are probably also ours already, and you do not get a branch network to speak of.'

Northern Rock's plight has also raised concern about the prospect of heavy losses among Bradford & Bingley's buy-to-let loans, which account for more than half of its mortgage book. James Hamilton, banking analyst at Numis, thinks the increasing threat that the credit crunch will spread into an economic slowdown means that the housing market will be hit - and buy-to-let is likely to be the first area to suffer rising defaults.

An analysis by Jon Kirk at Redburn Partners shows that B&B has the second highest ratio of loans to deposits after Northern Rock, with loans accounting for 1.8 times its savings and deposits base, compared with 3.1 times for Northern Rock. While B&B was quick to reassure on Friday that it is financially secure, securitisations and wholesale markets account for 42 per cent of its funding.

Financial disasters

2002
Investors lose millions in split capital investment trusts, devised for paying school fees

2001
Insurer Equitable Life is brought to the brink of collapse and the value of policyholders' investments crumbles

1995
Barings Bank brought down by rogue trader Nick Leeson

1992
Southdown building society forced to merge with Leeds Permanent

1991
Fraudulent bank BCCI becomes insolvent causing investors to desert smaller banks, some of which go bust

1991
Town & Country building society brought to its knees by bad loans

1988
Investors lose life savings after Barlow Clowes group closes

1973/5
Bank of England organises 'lifeboat' for small banks hit by widespread secondary banking crisis


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