Northern Rock does not not deserve a bail out but not giving them one could be a recipe for disaster
I wasn't planning to blog while I was at conference but I've changed my mind because of a rather extraordinary sight, I saw this morning. Out hunting for an internet cafe, I passed the Brighton branch of Northern Rock and one of the longest queuses I have ever seen. I had initially opposed the bail out of private bank with public bank but that sight has changed my mind. It brought home to me the danger of financial panics and how important it is we avoid them.
Northern Rock does not deserve a bail out. It took a gamble and lost. Rather than relying as most banks do on a combination of money from individual depositors and money borrowed from other banks, Northern Rock relied almost entirely on the later. This worked fine so long as interest rates in the inter-bank lending markets were low but when the credit crunch pushed borrowing rates up it found itself in trouble. Being so relieant on one source of finance was a risky move and if Northern Rock's shareholders do not pay the price when gambles such as this backfire, then that will have no incentive to be careful how they do buisiness. Economist call this a 'moral hazard.'
However, the queue has made me doubt this logic. We have hundreds of people pulling there money out of a perfectly safe bank. Not only has Northern Rock been declared safe by the bank of england but it has also been given access to the worlds biggest overdraft courtesy of the bailout. These withdrawls are pure panic.
My concern would be that if Northern Rock were to collapse, then people would panic and begin to loose confidence in the banking sector as a whole and we could start to see runs on other banks as well. This could become a particular problem if some of the other smaller banks that have run in trouble also collapsed. This is perhaps unlikely but the result would be so disastrous not just for the UK but perhaps for the world economy as a whole. We should do everything on our power to avoid it, including rewarding careless companies.