UK economic problems.

In the last week there has been a severe failure by our government and regulatory bodies to calm jitters in the UK economy.

I saw the treasury select committee MPs grilling the head of the Bank of England, but can't help but feel they missed the point.

Northern Rock is in serious difficulty. Their balance sheet is comprised mostly of mortgage lending with a small proportion of deposits. Because of the fallout from the recent US sub-prime mortgage lending crisis the cost of inter-bank lending (which NR was more reliant on than was prudent) has risen sharply, with banks much more reluctant to lend one-another money for fear that the securities offered for the loan may be overvalued.

The select committee seemed to focus entirely on the Northern Rock situation which I see as the symptom, not the actual problem.

Northern Rock had been looking for a solution for its problems for about a month before the issues bit. The problems were directly caused by fallout from the economic problems in US. These pleas had fallen on deaf ears and the problems left to grow.

In my opinion this is what went wrong:

1) The Bank of England took an extremely hard line. They were aware of the situation with the interbank lending. Banks were keeping all their cash in case they hit problems in the near future. The Federal Reserve in America noticed a similar problem and they took action. They injected cash into the system promptly, offered banks a reduced borrowing rate and have since dropped the main interest rate by two 'notches'. Our bank sat there and did nothing. Had they improved access to short term funds I feel none of the current problems with Northern Rock and the banking sector in general would have happened.

2) Northern Rock asked the Bank for a 'lender of last resort' loan. This request was immediately made public. Mr King informed the Treasury Committee he would have rather used 'covert' lending so the bank could sort its problems without causing the large public panic causing queues of savers withdrawing their savings. Covert lending was made illegal by the EU Market Abuse Directive. I wait for the day I hear of an EU directive that is in our best interests.

3) Approximately a week before the crunch hit, Lloyds TSB wanted to buy Northern Rock. From what I have read they pulled out becuase the Bank of England refused to extend the terms of loans to Northern Rock to a buyer.

Today it looks like the Rock is struggling to find a buyer at any price! It is looking increasing likely the government will have to support it over the longer term.

Fortunately last week the B of E woke up and intervened by guaranteeing no depositors of NR would lose any savings and to offer £10 billion funds to lubricate the markets. Such a U-turn was well overdue. The Bank of England definitely neglected one of their core duties to ensure market stability. The MP committee forgot to ask them why.

Chris