Five years on, what does the Northern Rock crisis mean for gold investing…?

Early on the morning of Friday, 14 September 2007, nervous savers formed queues outside several branches of Northern Rock – the former building society then writing 1-in-5 of all new UK mortgages.

Waiting patiently to withdraw their money, the Rock’s customers were spooked by news that the bank had taken an emergency loan from the Bank of England, the UK central bank. And once they’d got their cash, at least a few began gold investing. At BullionVault, for instance, September 2007 brought more new UK users than the previous 3 months combined.

How did these new gold investors get on? Certainly better than those “contrarians” tempted to back Northern Rock as it fell over. Those who bought and held gold have since made over 200% gains on average. Which outside buying silver, is better than any other asset class over the last 5 years. (Silver’s paid 26.7% net of costs.) Northern Rock shares, in contrast, went to zero. Just like gold never does.

By the time TV news carried shots of the queues that Friday lunchtime in fact, shares in the Northern Rock mortgage lender had already dropped 25% for the day – and NRK stood nearly 60% lower from its high of February. Because the Bank of England hadn’t acted as “lender of last resort” since 1973, when the collapse of Cedar Holdings – a pioneer of second mortgages to UK home-owners – threatened a crisis in the country’s banking industry. The UK hadn’t seen a banking run, with people queuing up to withdraw their money, since the collapse of Overend, Gurney & Co. in 1866.

Yes, the turmoil in world credit markets starting June 2007 had hit Northern Rock hard. But it had in truth run head-first into the crisis, making a dash for growth actually known, according to ex-employees from the Rock’s Tyneside HQ, as the “Great Leap Forward” when it was introduced in 2004. Instead of Mao’s Little Red Book, staff were issued with motivational booklets to peel off and stick to their PC monitors. “Do it now!” urged one motto apparently handed to the mortgage approvals team. Which would be a great way to maintain lending standards.

Externally, the Rock strived to top the newspapers’ Best Buy tables for mortgages and loans. Internally, it pushed quarterly targets for new lending. So-called “self cert” mortgages in particular – where the borrower’s income wasn’t verified – had managers wincing. And to fund all this fun, despite also striving to be Best Buy for savers, the Rock was selling its mortgages onto investors and borrowing from the money markets, rather than waiting for new depositors’ money to lend out instead.

So, where net inflows from savers were £1.7bn in the first-half of 2007, wholesale markets lent the Rock £2.0bn. On the other side of the ledger, and with the magic of securitization taking £10.7bn of mortgages off its hands in Jan. to July, that meant it could grow its new loan book by 43% compared with the same period of 2006. So what politicians, economists and analysts both then and since called “excessive risk” wasn’t a risk at all. It was nailed on. Northern Rock was the bleeding edge of the financial crisis, even though only 0.24% of its assets were exposed to subprime US housing debt (where the air was already seeping out of the credit bubble).

The first to go, you might imagine the Rock had therefore been the most reckless. Yet incredibly, its creditors were rescued immediately by taxpayer funds. That set the template for the last 5 years, helping the crisis move on from swallowing banks to devouring sovereign governments whole. “Northern Rock is not a reckless lender,” Angela Knight, head of the British Bankers Association, claimed on BBC Radio 4 the day the run on the Rock began. Urging the bank’s savers not to withdraw their money in panic, “the mortgage lending it does well and it does in a high quality, high calibre way,” she added. Knight was in good company, withnational UK newspapers urging their readers to buy Northern Rock’s shares throughout the summer of 2007, even as the plumbing of wholesale money markets gurgled and gulped air.

The smartest hedge-fund managers couldn’t get enough of it either. Nor could politicians. The UK’s then-new chancellor, Alistair Darling, had his mortgage with the Rock. So too all too-many of the bank’s 6,300 staff. Indeed, what one ex-member of staff calls “the cult” sought to care for all its employees needs. People had their home-loans, bank accounts, pension savings (via the share-saver scheme) and even gym membership with the firm. North-east England’s biggest private-sector employer (a spot since taken by Greggs, the pie shop), it sponsored Newcastle United FC. It sponsored the arts. In 2005 and 2006, it gave more to charity than all but one of the UK’s other largest 100 companies.

Roll further back, in fact, and Northern Rock’s rise, rise and fall is all too emblematic of the UK and broader financial sector’s fortunes. The Northern Counties buillding society first met in 1850, with the boring, unprofitable aim of matching deposits with loans. The Rock was founded 15 years later, but it wasn’t until 1965 that they actually got together. Boredom continued. But come the UK housing crash of the early 1990s, the merged building society – “at the invitation of the Building Societies Commission,” according to Building the Northern Rock by Stephen Aris (a former Times journalist), published in 2000 – mounted a rescue of the stricken Lancastrian Building Society, a competitor which had in the Rock’s internal view, “spent too much money in too short a time.” Rather than trying to keep Lancastrian running, however, “shutting it down immediately and incorporating it into Northern Rock would bring substantial benefits,” writes Aris. “The reserves were liquidated to pay off current losses: closing branches, eliminating the head office and getting rid of senior staff reduced costs; while the mortgage book added to Northern Rock’s strength in the north-west.

“It was, in effect, a government-licensed asset stripping operation.”
As the early 1990s crash wore on, Northern Rock expanded further by takeover, swallowing the Surrey in 1993 and North of England Building Society in 1994. And then – with the Rock and the other players still standing getting bigger through consolidation – came 1997. That shake-up of UK banking allowed building societies to float on the stock market, paying off their members (ie, customers, but now known as “carpet baggers”) in return for voting “Yes” to the switch.

“I am going to take out the lot, every penny,” said one Northern Rock saver to Bloomberg as he queued outside the bank’s West End branch in London in September 2007. The ex-building society’s customers had said pretty much the same thing a decade before, and any search for the source of the crisis has to look at late ’90s deregulation – both in the US and UK, as well as Europe – as a catalyst.

Equity funding, plus access to wholesale capital markets worldwide, eventually led the Rock to call on that other source of bank-only cash – emergency loans from the Bank of England. Anyone choosing silver or gold investing then or now might well wonder who back-stops the lender of last resort. For now, the answer remains the printing press, and behind that remains default.

Those 200% gains might yet have further to run. But in a world where bank shares, mortgage bonds, houses, currencies and government bonds can and do go to zero, gold and silver’s real value may have little to do with their nominal price.

* By Adrian Ash – head of research at BullionVault – the secure, low-cost gold and silver market for private investors online.