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As the FSA learns lessons from Northern Rock, could it be a case of responsible funding to match the FSA’s focus on responsible lending?

The biggest threat from the Northern Rock debacle must be to funding innovation and therefore overall innovation in the mortgage market.

And yet is Northern Rock really representative of that market? The most visible signs were those queues of savers not borrowers – but the panic seems to be subsiding with the Government guarantee.

If only it meant people suffering from sleepless nights from all those money bumps under their mattresses. But there will be many many repercussions. One is apparently a mini boom for National Savings – noone, it seems, expects the Government to go bust just yet – despite the annual mugging Prudence has been getting for a number of years now.

But confidence among savers must have been dented. Try and think like an ordinary person rather than a financial services practitioner and consider what message the compensation scheme arrangements seemed to send.

The information handed to people in the queues – quite rightly by Northern Rock – said that in the event of a bank collapse they would get compensation of 100 per cent of the first £2,000 saved and 90 per cent of the next £33,000 with the rest no doubt up to the administrators.

Having read that – no wonder they stayed in line. Certainly, supposedly, savvy City of London workers were also queuing too. One might even feel a little sypmpathy for those with limited access accounts – any notice periods on withdrawals probably seemed to be conditions applying to happier times.

So one result will be a dent to savers’ confidence. As for the stock market it behaved as most stock markets do ie mostly rationally. Hedge fund managers confirm off the record that they were driving other lenders’ shares down which must have had the boards of Bradford & Bingley and A&L sweating – as it appeared to be for little or no reason though the B&B model is closer to Northern Rock. The recovery in its share price has also been muted today (Tuesday) compared with A&L’s.

What was clear on Monday was that the FSA was asking lenders about their funding arrangements to check on their sustainability. Perhaps no particular lenders were under scrutiny as some press reports suggested but the regulator was doing its job in ensuring no other panic attacks were about to hit.

Of course, the Government, FSA and Bank of England have been treading a fine line in recent weeks. They wanted to put out a message that reckless institutions or indeed institutions that met difficult market conditions would not necessarily be backed by the taxpayer. But they wanted to maintain confidence. Chancellor Darling is now under fire for not intervening faster to stop the run but clearly Government was trying to strike this balance.

So what on earth does it mean for the mortgage market? That is the $6m question or should that be the six times income multiple question? Northern Rock made it on to the front pages and the top of the news because of its savers. It was an institution that could have sat in the top twenty lending off its balance sheet rather than shooting into the top five by seeking funding elsewhere. It was that funding that dried up.

In many ways it was a special case in that its difficulties produced some very public symptoms and threatened consumer confidence in the banking system – indeed FSA chairman Callum McCarthy told Radio Four’s Today programme on Tuesday morning that this was the rationale behind the Chancellor’s move.

Financial services has found at least one way to get a Government usually adept at ducking its responsibilities – see Equitable Life, Allied Steel & Wire etc – to issue a guarantee.

As for Northern Rock’s fortunes and those of its chief executive Adam Applegarth – one City journalist noted this week that he always answered questions about moving jobs with the riposte that there were few places he would get better paid. He is likely to get little sympathy.

A statement on Tuesday from Northern Rock suggested that despite the big headlines there were no serious talks with buyers although the statement also made clear any offers would be considered.

But there is definitely something to buy for all the fact that NR offered what some might say are pretty extravagent loans – at LTVs of 125 per cent in the Together product and incomes multiples of six times depending on credit score in exceptional circumstances. Nevertheless the bank’s book is loans is viewed as very good quality.

Its most recent statement to the market this month Northern Rock said its 3 months plus arrears in the residential book were 0.47 per cent in August and June under half the industry average. On the Together product, the picture was not so good, but still better than the average at 0.86 and 0.90 in June and August respectively.

Of course, like many of these new features of the mortgage market of the last decade it has not been tested in a recession. What if it was of less quality may be a question for regulators after the present crisis has passed.

So what now? There will surely be calls for an inquiry but that always depends on its range and remit and given there has been no massive consumer detriment it will probably be resisted. The Treasury select committee made up of MPs of all parties will this week ask some searching consumer focused questions and probably issue a few lusty condemnations of Northern Rock’s board in the process. There will be pressure on the FSA to find out what happened and perhaps adjust regulations to counter this happening again.

Yet it is very difficlt to see what exactly the FSA can do about a market that choses not to lend money to lenders in the UK having been burnt by the US mortgage market.

Of course, in the old days the Building Societies Commission would have helped arrange a takeover. Those days are long gone but one expert talking off the record says one of the fundamental issue is the same – that it is still difficult to match long term lending to long term funding and sometimes these get out of kilter.

Sub-prime lenders may face calls to justify their lending to show they offer responsible funding as well as responsible lending, but only the next few months will tell if this could lead to action. Their defence will be where is the consumer detriment who is hurt if the people you owe money to go bust? Much more pertinent will be the advice and the ability to pay. Anyway even in these difficult conditions most of these businesses are marking time rather than facing going bust.

Perhaps most pertinently, questions are being asked in political circles about how chickens from the institutional market can come home to roost in a UK retail bank.

Northern Rock is the extreme example of a traditional lender that had changed model – the biggest issuer of mortgage backed securities in Europe. But almost all “balance sheet” lenders source money in this way to some extent. Probably all lenders will face some interesting questions from the regulator in the next few months.

Yet speaking to one mortgage expert, who defends the UK system Northern Rock and all, he says the problem is not with the regulator. but with stupid international investors who can’t tell the difference between a well run innovative UK mortgage bank and stupid lending to people who could not afford to pay their mortgages in the US.


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