It has been five weeks since Northern Rock ran into liquidity problems, and since then, it has borrowed from the Bank of England a staggering £16 billion. During this week alone, the crippled bank was forced to borrow an additional £3 billion.
Unfortunately, Northern Rock has become a money pit, and the Bank of England is now trapped into pouring seemingly limitless amounts of money in with reckless abandon. When will the Bank of England say "enough" and move to liquidate the bank, something which it should have down five weeks ago? Will it be after it has thrown in £32 billion? Will £64 billion of bad loans be enough.
Of course, the Bank of England will argue that these loans are collateralized with "high quality assets" and that in the long run, it expects to see these loans repaid. Don't to too sure about that. Northern Rock was one of the most aggressive lenders in the market. It pushed out loans with scant regard for the quality of borrowers.
Here are two telling points about Northern Rock's attitude towards credit risk, which ultimately put in doubt the quality of assets that the Bank of England are taking as collateral. First,Northern Rock was one of the first institutions willing to extend loans at a ratio of 125 percent of the purchase price of houses. It had borrowers that had up to 25 percent of negative equity from day one of the life of their mortgages. Second, Northern Rock was one of the largest lenders to buy-to-let investors; which as we know, is one of the most ill-considered, risky and profitless investment innovations in recent history.
Bad lending decisions, offering unwarranted credits to a failing bank, is not the only problem that the Bank of England needs to consider. The Bank of England is setting some very dangerous precedents with Northern Rock, which will come back to haunt the institution. The housing bubble is unwinding faster than anyone could have imagined. Northern Rock hit trouble at the top of the market. Other banks are likely to experience trouble when the market begins to deflate. Their depositors and share-holders will expect similar treatment to that which Northern Rock received. The hasty decision to bail out Northern Rock, rather than let it go bankrupt, could generate other, even more expensive bailouts in the future.
The Bank of England poured away £16 billion of taxpayers money in just five weeks. However, this is just the start. The housing crash will present the UK economy with a much larger bill in the coming years. With Northern Rock, we have only just begun to pay.