Major Mortgage Lender Struggling to Restore Confidence

by : Andrew Regan

Unless you've been abroad or sleeping for the past couple of weeks, you'll be aware of the mire in which major mortgage lender Northern Rock are in. The panic started after news of their approach to the Bank of England to secure loan funding surfaced, sparking fear amongst their customers that the bank was insoluble and in danger of collapse. But, whether the turmoil in the loans industry is real or over-hyped, unwarranted media-led hysteria remains to be seen.

Because of the way that financial institutions such as banks and building societies raise their retail funds, the collapse of the sub-prime market in the USA has had a knock-on effect throughout the world. Financial institutions lend to each other and make similar risk evaluations to those they perform on retail customers. So, as a result of the turmoil on the American markets, UK lenders are now looking at the exposure they have to higher risk lending and raising their prices accordingly.

Traditionally, loans secured on property are bundled up into parcels of debt and 'sold' to other lenders. However, because of the amount of defaulters and the slim chance of recovering bad debt from them due to the fall in USA house prices, added to fears that the phenomenon could become worldwide, is causing uncertainty amongst lenders. They are now suspiciously eyeing each other and trying to assess how much of this potentially damaging debt each of them are exposed to, making them incredibly reluctant to buy any more bundles of debt from each other. That is what caused the Northern Rock to go cap-in-hand to the Bank of England to get a line of credit that the market had effectively turned off.

The secured loans market in the UK is basically sound, but lack of consumer confidence may undermine that. The recent run of withdrawal of funds from the Northern Rock from jittery customers may actually induce a crisis that didn't exist in the first place. Because customers are rapidly reducing the liquidity in the Northern Rock, then it is actually placing further pressure on the business itself, which may require more even lending from the Bank of England at higher rates than from the commercial lenders.

One thing is certain, the UK loans market has braced itself for some turbulence ahead, with lending institutions attempting to restore customer confidence, and calmly reassuring the public that nothing is amiss. Whether the Northern Rock will recover, be forced into a merger or become the target of a takeover remains to be seen.