This essay's aim is to examine and evaluate an economic incident that took place at a bank in the United Kingdom.More speciffically, some facts are going to be mentioned about the history of Northern Rock Bank ,which was affected by the world economic crisis.Our basic target is to analyze the reasons that led the bank to total failure, by combining facts based on the Market Failure theory.Finally, through historical facts, we are going to find out who was responsible for the Northern Bank financial failure and how this could have been avoided.

Since 2007 the global community is facing an economic crisis and nobody can predict or be certain about when it is going to stop expanding or about when it is going to end.According to the IMF the economic crisis is spreading rapidly and affects a total of economies causing economic depression and decline in employment (Βirdsall,2009). The global economic crisis affected most banks and financial organazations all over the world. One of its victims was the Northern Rock bank which on 14th September 2007 asked and finally received a liquidity support mechanism from the Bank of England (1) because it could no longer cope with its financial obligations. This fact contributed to the Northern Rock Bank' s nationalization by the British government on 22 February 2008. Before that two proposals for the bank's acquisition were rejected by the private market (2) . The basic reason for the bank's absoprtion by the British government was its big number of subprime mortages and the danger of the clients' money commitment. After the two failed attempts ,the British governmet decided to split Northern Rock into good and bad bank so that it would be more attractive for a future purchase in the private sector. As a result ,Virgin Money finally bought the bank on 17 November 2011 from the UK Financial Investments Limited (UKFI) to the ammount of 747 million pounds.(3) From 1 January 2012 Northern Rock belongs to Virgin Money and runs under its brand (4).

In order to comprehend the reasons that led Northern Rock to failure, we will use theMarket Failure theory as our basic tool, by combining and commenting on news data.Market Failure theory explains the factors that contribute to the failure of a free market.Sometimes more than one factors are responsible for a purchase failure .Concerning the case of the Northern Bank, there were two basic factors that contributed to the bank's failure.

THe first and most importand factor was the 'Moral Hazard'.Moral Hazard describes the risk taken by an organization knowing that there is a very high probability of failure in the operation carried out,but nonetheless it keeps on following the same strategy. In the case of Northern Rock, the ' Moral hazard ' undertaken by the Bank was giving a very large number of loans, which had the risk to be subprime mortgages.

The key element to the assumption of the moral hazard was the deal that took place in April 2007 with the Southern Pacific Mortgage Limited (SPML), a subsidiary of Lehman, to find customers who have a low credit rating. (5)Just before the agreement with a subsidiary of Lehman Brothers the Northern Rock had already made a dynamic start in the market, with an increase of 42% in giving housing loans , compared with the previous year(6).The bank tried to attract a large number of borrowers,mostly for housing loans,offering consumers a very wide range of loans with benefits . Following the agreement with a subsidiary of Lehman Brothers, the Northern Rock bank followed

a clear-cut aggressive strategy with the key feature being the sale of loans.

Examining all the above we see that Northern Rock selected a very dangerous way so that it could play a leading part in the British banking sector. The choice to invest mainly in the housing loans is in my opinion a strategy of high risk. The decision to invest the biggest part of its portfolio in housing loans was aiming at increasing its profits, knowing that the risk and the danger of failure was very big. We also have to mention that the employees of Northern Rock had also big profits from this undertaking, because as long as the number of the bank customers was increasing, thetotal profits were increasing as well . Naturally , apart from the bank, the brokers of SPML enjoyed big rates of profit as they offered more customers to the bank who had low borrowing ability, that however did not interest them.

Another basic element that is involved is the Moral hazard factor is that Northern Rock changed the titles of her loans to ABS (asset-backed securities). (7) That is to say, Northern Rock by transforming its loans to ABS, legally withheld its economic investments from loans to compulsary investments and it sold them to investors. (8) Northern Rock sold the loans that it gave to the consumers so that it could aquire more foreign capitals. Naturally this was very risky , because if the borrowers did not pay their debts, the bank would be supposed to pay the ABS investors with her own capitals. (9)

Another high risk and ''Asymetric Information '' undertaking was the fact that the bank offered a very big number of ABS to potential investors .(10) (reference) With the term asymmetric information we describe a situation where between the two contractors only the one has more information and more knowledge than the other .This happens mostly when the seller knows more than the buyer, so the seller can fool the buyer because he does not have the right piece of knowledge or information.

In the case of Northern Rock , the bank had information for every client so it knew to whom it was giving the loans to . It also knew about their credit ability and was able to check them.The investors who decided to invest their personal deposits in the ABS of the bank only knew about the type of investment and that the ABS that they bought came from loans of consumers with the form of titles.The holders of ABS however couldnot know about the credit ability of the borrowers. This fact was an investors' misleading by the Bank's members.

Summing up all the above movements of Northern Rock bank we can say that the bank itself is fully responsible for its failure.The main reason was that the selected strategy of increasing its market share by selling loans was extremely dangerous.Despite this dangerous strategy, Northern Rock decided to increase the consumers through the subsidiary company of Lehman Brothers, knowing that most of these customers had very low credit ability. Basically with all these movements it was coming a lot more closer to collapse. The beginning of the global economic crisis was an important factor of course , but nevertheless the bank did not try to protect itself from any of the risks involved.

Northern Rock depended on the fact that if there were a possibility of an economic

failure it could rely on help from the Central British Bank as it had happened in 2008.Personally I believe that the bank's plan B was the support from the British government rather than a redesigned strategy.

Perhaps the bank's failure would have been avoided if its strategic decisions had been different.If the bank chose another way to increase its share of the British market, diversifying the portfolio so that if there was a failed investment , the damage would be less or they could be compensated from other profitable investments of the portfolio.

Another very basic element that could limit its failure was the regulatory framework that was in effect for the British banking system. If certain controlling mechanisms were involved for the operation of the bank then the results would certainly be different. The new Regulatory framework in the UK for the bank sector has more security valves than the previous one,in order to efficiently control the risk of failure of a financial agency(11)

To sum up we can say that in many cases of failure the real reasons are more than one.

The managers of Northern Rock bear the greatest responsibility for the failure because they selected wrong strategy and made wrong decisions. The British banking controllingsystem had also a share of responsibity as far as the Regulatory framework is concerned.

(1)(http://news.bbc.co.uk/2/hi/business/6994099.stm )(2). (http://news.bbc.co.uk/2/hi/business/7249575.stm)(3) (http://www.bbc.co.uk/news/business-15769886 )(4)(http :// www . ukfi . co . uk / releases /20120101%20 UKFI %20 completion %20 announcement . pdf)(5)http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/2785856/Northern-Rock-to-pull-out-of-sub-prime.html(6). http://www.moneymarketing.co.uk/northern-rock-launches-into-the-sub-prime-sector/139898.article7) http://www.euromoney.com/Article/1040751/Best-ABS-issuer-Northern-Rock.html (8)http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/2785856/Northern-Rock-to-pull-out-of-sub-prime.html(9)http

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uk. reuters . com / article /2007/09/17/ us - northern - rock - abs - factbox - idUKL 1743102920070917

(10)(παραπομπη)(11)http :// www . wipro . com / Documents / the - new - UK - regulatory - framework . pdf

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