🚦 The collapse of northern rock (2007)
How the first UK bank run in a century preceded the financial crisis
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Dear all,
In today’s edition of "Macro Mistakes," we look at the collapse of Northern Rock in 2007, the first major casualty of the Global Financial Crisis in the UK.
The bank’s failure, which led to the first bank run in the UK in over a century, highlights the dangers of overreliance on wholesale funding and the risks of liquidity shortages in times of market stress.
✍ The Story
Northern Rock was a UK-based mortgage lender that grew rapidly in the early 2000s, thanks to its aggressive strategy of offering 100% mortgages and relying heavily on the wholesale funding market.
Rather than using customer deposits to fund its loans, Northern Rock borrowed large amounts of money from the global financial markets.
This strategy worked well during the housing boom, but it left Northern Rock vulnerable when the global credit markets froze in 2007.
As the subprime mortgage crisis spread across the Atlantic, Northern Rock was unable to secure the short-term funding it needed to continue operating.
In September 2007, news of the bank’s troubles led to the first bank run in the UK in over 140 years, as customers rushed to withdraw their savings.
The UK government eventually intervened, nationalizing Northern Rock in early 2008, but the damage had been done.
The collapse of Northern Rock was a harbinger of the broader financial crisis that would soon engulf the global economy.
❌🚫 The Macro Mistake
The collapse of Northern Rock was driven by several key macroeconomic missteps:
Overreliance on wholesale funding: Northern Rock’s business model was heavily dependent on borrowing from the wholesale funding market rather than customer deposits. When the global credit markets froze, the bank had no way to secure the funding it needed to operate.
Liquidity risk: Northern Rock underestimated the importance of maintaining sufficient liquidity in times of market stress. When its access to wholesale funding dried up, the bank was left without the cash it needed to meet its obligations.
Lack of regulatory oversight: The UK’s financial regulators failed to recognize the risks posed by Northern Rock’s aggressive business model. By the time the bank’s troubles became public, it was too late to prevent a full-blown crisis.
👨🎓 The Macro Lesson
The collapse of Northern Rock offers several important macroeconomic lessons:
Liquidity matters: Financial institutions must maintain sufficient liquidity to weather periods of market stress. Overreliance on short-term borrowing or wholesale funding can leave banks vulnerable when markets freeze.
Regulatory oversight is crucial: Strong regulatory oversight is essential to identify and mitigate risks in the financial system. Northern Rock’s collapse highlighted the need for better regulation of banks’ funding models and liquidity management.
Bank runs can still happen: Even in modern banking systems, the risk of a bank run remains. Northern Rock’s collapse shows that when confidence in a bank evaporates, customers may rush to withdraw their deposits, exacerbating the crisis.
Northern Rock’s collapse was the first major sign of trouble in the UK’s financial sector during the Global Financial Crisis.
The bank’s nationalization in early 2008 marked a turning point in the crisis, as the UK government moved to shore up the financial system and prevent further bank failures.
In the wake of the Northern Rock crisis, the UK implemented significant regulatory reforms, including the creation of the Financial Services Authority (FSA) and new rules on bank liquidity and capital requirements.
🔒 Macro Bonus
Investors who recognized the risks associated with Northern Rock’s funding model and the broader vulnerabilities in the financial system were better positioned to avoid significant losses during the financial crisis.
Those who focused on liquidity risk and regulatory oversight were able to protect their portfolios from the worst of the downturn.
The lessons from the Northern Rock collapse are still relevant for financial institutions that rely heavily on wholesale funding or face liquidity challenges.
The collapse of Northern Rock serves as a reminder of the importance of liquidity and regulatory oversight in maintaining a stable financial system.
Next time, we’ll explore another key macro mistake: The Latin American Debt Crisis of the 1980s and how overborrowing led to a decade of economic hardship.
Alessandro
Founder of Macro Mornings
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This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. This material has been prepared for informational purposes only. Any forecasts contained herein are for illustrative purposes only and are not to be relied upon as advice or interpreted as a recommendation.