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The Northern Rock Bailout
What to make of the Northern Rock bailout? To me, it looks like textbook central banking on the part of the Bank of England. Mervyn King, the BofE's chief, has no particular interest in cutting interest rates or otherwise bailing out the UK financial system as a whole if it lent recklessly. On the other hand, UK mortgage lenders also take deposits, and it's in no one's interest for a bank to fail outright. So King will lend the Northern Rock money at punitive interest rates, watching the value of its equity plunge, and trying to ensure that no one else attempts the moral hazard play.
For it certainly looks like that's what Northern Rock was playing at: while everybody else was tightening their underwriting standards, Northern Rock kept on lending, capturing 19% of all new UK mortgages in the first half of this year. The problem is that the Northern Rock didn't have any money to lend, and when they tried to borrow the money on the capital markets, the capital markets were closed.
So now Northern Rock is having to borrow the money from the Bank of England instead – at rates which I'm sure are higher than the mortgages they were writing. That'll learn'em, as they say up north.
Update: Richard Lander, in the comments, notes Willem Buiter's fine blog entry on this subject, where he says that letting Northern Rock fail – and imposing a haircut on even relatively small depositors is – is actually a good idea. Buiter's forgotten a hell of a lot more about how the Bank of England works than I'll ever learn, and the whole thing is well worth reading, if only to get an example of how hawkish policymakers really can be when it comes to the regulatory side of things.
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