All About The Bank Bail Out – Part 2

In the UK the credit crunch firmly wrote itself into the history books when one of the largest mortgage lenders in the country – Northern Rock – was nationalised. The nationalisation of the bank was undertaken by the government to prevent the bank from completely collapsing, which effectively rescued thousands of jobs and a large chunk of the UK economy.

In late 2007 Northern Rock became the first real victim of the credit crunch in the UK and was a prime example of how the freezing up of the money markets was destroying financial institutions and businesses alike. Unlike many traditional banks and building societies which create mortgages by lending money secured on their customers’ deposits, Northern Rock had a relatively small portion of deposits on their balance sheet and instead wrote mortgages on the back of money obtained from other institutions on the credit market.

When these institutions stopped lending money to Northern Rock they were unable to continue issuing mortgages to their customers and subsequently faced ruin. This problem was exacerbated by thousands of customers withdrawing their savings from the bank, further damaging their liquidity. Because of the run on the bank by thousands of its customers the government stepped in and granted the lender a state loan worth £24 billion. Northern Rock pledged to repay the loan by 2010.

The crisis at Northern Rock was to be the first of several spectacular collapses in the financial services industry. At about the same time, across the pond, Lehman Brothers closed its sub-prime mortgage lending institution, BNC Mortgage. The closure resulted in 1,200 job losses and a big hit to the balance sheet of its parent company. Several months later it emerged that Lehman was facing a huge loss due to its exposure to the sub-prime mortgage market which it held because it was unable to sell the lower rated bonds it created with these low rated mortgages.

Over the course of the next six to twelve months Lehman entered a cycle of reporting record losses, enduring large drops in its share price, laying off staff, and attempting to sell off assets in order to remain solvent. During this time the US government announced that it would not be offering a rescue package to the investment bank which led to further speculation that the institution could collapse. The company eventually filed for bankruptcy in September 2008 and has since been liquidated.

Suffering a similar fate was Bear Stearns. This investment bank was also heavily exposed to the sub-prime mortgage market and began to experience trouble when the credit crunch took effect in late 2007. Bear Stearns was eventually sold to JPMorgan Chase for less than ten percent of its value.

Meanwhile, in the UK, several other large banks were coming close to suffering the fate of Northern Rock as the government unleashed a raft of measures attempting to rescue the rapidly failing banking system. Several of the largest and oldest banks in the UK were at risk, including Royal Bank of Scotland, Barclays, and Lloyds TSB. The general public watched in disbelief as once seemly impenetrable financial institutions claimed they were rapidly closing in on bankruptcy as they could no longer raise capital on the money markets.