A run on the bank, you say?

Heading home last night, I noticed that the headline of one of the papers was "Worst banking crisis in a generation"; a reference to the secondary banking crisis of the early 1970's. The comparisons between the collapse of Northern Rock and the Secondary banking crisis are manifold and bear considering. By the late 1960's postwar growth in the UK economy was stalling and increases in personal taxes were making savings and investment less attractive places for people to put their money. In order to attempt to keep the economy growing, the government of the day kept interest rates low, meaning borrowing money was cheap - this fuelled a property boom, similar to that which we've seen over the last few years. In 1972 annual house price increases hit 50% as more and more people, spotting a fast buck, piled into the market. Financial institutions large and small piled into this market with cheap and easy credit readily available at low rates.
In any bubble, corrections are inevitable. Faced with rising inflation, the government put up interest rates to attempt to keep it in check. This had the knock-on effect of making borrowing harder, squeezing people with debt and also making it harder for banks to lend to each other with security. A rise in oil prices compounded the problem, slowing economic growth.
The crunch came with the collapse of the London and County Securities bank. In circumstances very similar to Northern Rock, London And County had its lines of credit withdrawn by the bigger banks due to its overexposure to high-risk debt in the face of rising interest rates. In the streets, people queued at the banks for their money.

Like I say, the parallels are striking.

The difference is what the government have done this time around and promised the creditors of Northern Rock that it is backed by the Bank of England. This is a rather quick shift in policy - last Wednesday, Governor of the Bank of England Mervyn King issued a statement that the moral hazard inherent in the provision of ex post insurance to institutions that have engaged in risky or reckless lending is no abstract concept. In other words, propping up Northern Rock is a bloody stupid thing to do, as it would send out all the wrong signals to people who lend to risky clients. He was promptly over-ruled by the treasury, giving a clear signal to the financial markets that so long as you lend big enough and recklessly enough, the taxpayer will be there to pick up the pieces.
In the early 1970's following the crunch inflation hit 27% and there were two solid years of recession. I'm not particularly hopeful this time round, especially as the treasury has recently been following the time-honoured and always-successful technique of printing more money when the coffers look a bit empty.

The reason I got to thinking about this is that, by an odd co-incidence, I know the guy who used to run the London and County Securities Bank. An entrepreneur, he bought the bank from a man he met in a nightclub, which I always thought a spectacularly great way of getting into international finance (I'm off to jillys and ARA next week, and I bet nobody tries to sell me a bank).