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Rock or crock?

• Robert Peston
• 14 Sep 07, 12:41 AM

The good news is that the Chancellor, the Financial Services Authority and the Bank of England don't believe Northern Rock is an unviable business.

If they thought the Rock – or Northern Crock as it’s been dubbed in the markets – was an intrinisically bad bank, they would not have agreed to rescue it by providing emergency funding.

Such the was unambiguous implication of the Bank Governor’s statement to the Treasury Select Committee on Wednesday on the circumstances in which the Bank is prepared to act as lender of last resort to a troubled institution.

But that’s the end of the good news.

What Mervyn King also said is that the Bank will only provide funds to a troubled institution in this way if the risk of a collapse could lead to “serious economic damage”.

Certainly Northern Rock – with £24bn of retail depositors’ funds and £113bn of loans and other assets on its books – is big enough to wreak a fair amount of havoc, were it to fall over.

Anyway, none of us – not even Northern Rock’s depositors – probably need to panic that the Bank has had to step in.

But does that mean that Northern’s customers and shareholders have no reason to feel aggrieved at Northern’s management?

Is it anyone’s fault that Northern fears it cannot raise sufficient funds from its traditional commercial sources right now?

Well, Northern is the victim of exceptional market conditions.

Few could have predicted that problems thousands of miles away in the US housing market – notably the losses on loans to American homebuyers with dodgy credit histories – would have made investors and financial institutions wary about financing Northern Rock’s very different and very British homeloans business.

But actually that doesn’t let Northern’s management off the hook.

Banks have to expect the unexpected in the way they manage their balance sheets.

To use the ghastly City jargon, they are supposed to “stress test” their businesses all the time to ensure they can survive the market’s equivalent of a nuclear strike.

Northern’s stress tests were not stressful enough.

But perhaps the biggest criticism to be made of this bank is it massively increased its mortgage lending at the beginning of this year, when most economists were forecasting a slowdown in the housing market and when interest rates were already rising in a way that squeezed its profit margins.

In the first six months of 2007, its net lending rose 47 per cent to just under £11bn. And at June 30, it had a further £6.2bn pipeline of loans that had been agreed with customers but not yet delivered.

So it is unsurprising that other financial institutions might feel that these mortgages were provided too late in the housing-market cycle to be quite as rock solid as loans made a few years ago.

What’s perhaps even more embarrassing for Northern is that in its interim statement made earlier this summer, it was explicit that it continued to lend even as the interest rate environment turned against it.

So Northern Rock may not be going bust.

But its reputation has been badly damaged.

Which normally means that there will be a clear out of top management and also that the business may well be sold.

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