Bank Panic in Great Britain

Sep 24, 2007

For months Britain’s finance minister insisted that U.S. financial turmoil would not cross the Atlantic Ocean, that the British economy would be safe from the U.S. mortgage crisis.

In fact, the English real estate speculative bubble was similar to what happened in the U.S.! And the popping of the bubble meant that a similar crisis was unfolding in the English banking system!

No matter how reassuring British officials were, on September 13, thousands of people waited hours in line to withdraw their money from Northern Rock, the eighth biggest bank in Britain. Northern Rock is also the fifth biggest real estate lender in the country. Obviously, the bank’s depositors had little faith in the government reassurances.

Northern Rock was one of the mutual or depositor-owned savings and loans that has for years provided people with money to buy homes. The golden rule was that the total loans they issued couldn’t exceed the money put in by depositors, with administrative costs and profits taken out of interest paid by borrowers. But deregulation changed all the rules, allowing these kinds of savings and loans to convert themselves into banks.

In 1996, Northern Rock transformed itself into a bank listed on the stock market, and it began to engage in new speculative methods. In order to finance its real estate loans, it began to borrow from financial markets. Today this borrowing adds up to 80% of all the mortgages it wrote. The problem is that this borrowing from the financial markets is short term, so the bank has to constantly borrow again to pay off the loans that come due. In other words, it’s a classic pyramid scheme. And a classic panic when it threatens to collapse.

In fact, neither the bank panic at Northern Rock nor the current restriction of bank lending occurred out of the blue. Since the beginning of 2007, despite the colossal profits that the banks made in 2006, all English banks saw the price of their stock drop on the stock exchange. In the case of Northern Rock, its stock price fell by 25%. Beginning in August, bank stock prices dropped even faster. The price of Northern Rock stock declined from $25 a share at the beginning of the year down to $6 a share on September 17.

The government reacted to this incipient bank panic only because there was a risk it would spread throughout the banking system. On September 17, the government promised to guarantee all deposits in Northern Rock. It promised to cut the interest rate for emergency loans from the Bank of England to businesses. In other words, the government, using tax money, is ready to make the population pay for the cost of speculation.

These promises were enough to raise the price of bank stocks on the stock market, but for how long?

The English population, the most indebted in the world, has a total debt of 2.9 trillion dollars or 1.3 times the total annual production of the English economy. What would happen if the mechanism of the financial markets really got jammed up? For the working population, it would mean not only a decline in its standard of living, but also the closing of a great number of businesses, which would have no access to money.

What the sick capitalist system offers the population is the threat of uncontrolled crises.