Nationalisation of Northern Rock was due to a lack of
funding, the bank was heavily dependent on securitisation issuance and funding
from the wholesale markets. As defaults increased on the mortgages Northern
Rock was faced with a crises of not receiving payment from its long term loans.

The credit crunch led to a shortage of funds due to an increase in defaults in
sub-prime mortgages, banks and investors became less willing to lend to other
banks particularly those that were involved in securitisation issuance. Northern
Rock failed to meet its short-term obligations which led to its customers
rushing to withdraw their money, at the time Northern Rock had short term whole
sale obligations of 60% . Due to its lack of funding Northern Rock reached out
to lender of last resort the Bank of England for liquidity assistance, to provide
stability and reduce the bank run the labour government had to step in
nationalise Northern Rock.

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The nationalisation of Northern rock led to a number of
outcomes some of which were positive and negative. Nationalisation of Northern
Rock was intended to be a temporary solution that would provide stability until
market conditions improved and then the tax payer would gain on the sale of the
assets acquired.After the nationalisation Northern Rock was under pressure from
the government and cut its interim dividend, at this point shareholder wealth
had been at a loss from the already falling share price. Other steps taken to
restructure Northern Rock included breaking up the bank from its retail and
asset management, the asset side of bank which contained the toxic assets was
to be held by the government and the rest sold off.Nationalisation not only
affected the share price and caused equity loss but structural changes had to
be made such as staff downsizing which resulted in job losses and changes to management
such as Bryan Sanderson replacing Matt Ridley as chairman. The nationalisation
of Northern Rock began to provide some form of stability and confidence as
interests from the private sector began to come in, one of them being the
Virgin group interest which resulted in a sale of one part of the bank between
£747 million and £1 billion.

The nationalisation of Northern Rock was essential to its
survival at a time of panic and instability it provided reassurance and helped
to restore confidence in the bank, it gave the perception that since it was
backed by the government the government would not let it fail. However these
changes were not beneficial to all stakeholders, shareholders lost their equity
when the share price collapsed and , some shareholders such pensioners and
those who had self invested pensions (SIPS) in Northern rock lost all their
life savings. After nationalisation of Northern Rock shareholders lost control
of the mortgage bank, legislation was proposed that the government should not compensate
the shareholders for any value.The tax payer that helped fund the bailout
benefited from the sale of assets from the Northern Rock Asset management side
that received loans and was kept under the government.

The nationalisation had a negative impact, it resulted in
loss of wealth for shareholders and control of the mortgage bank to the public.

Nationalisation of the bank was funded by the tax payer, eventually the tax
payer did benefit from the sale of banks assets but the initial funding cost
the tax payer, returns on the initial funding was dependant on the governments
ability  to find a buyer for the banks
assets.

 

After the 2008 financial crises it became more apparent that
changes needed to be made to the financial system to prevent another one from
happening. Reforms were put in place such as the Dodd- Frank Act (2010)
USA,  it was designed to place major
regulations on the financial industry . Its main goals are to prevent banks
from growing and becoming “too big to fail”, It authorises oversight that
allows these banks to be broken down if they are seen to be a posing a systemic
risk. Under the Dodd Frank act better supervision has been put in place over
banks that pose a systemic risk,the act requires banks with over $50 billion in
assets to submit to annual stress test with similar conditions to those that
were experienced in the 2008 financial crises.

Another important change in the Dodd –Frank act was the
Volker Rule which prohibits banks or other regulated intermediaries from
sponsoring or owning non regulated firms such as hedge funds, private equities.

Its main purpose is to prevent banks that are big enough to receive federal or
tax backing from engaging in risky trading activity, trading with high-risk
derivatives without efficient risk management were one of the reasons banks
incurred huge losses.

In the run up to the 2008 banks were not the only ones who
played a major role in housing and credit bubble but rating agencies such as
Moody’s and Standard & Poor who rated sub primes as safe, have also been
placed under regulation by the Dodd-Frank act. Before the crises ratings
agencies would rate sub-prime as safe (AAA), banks would also receive high
ratings which allowed them acquire more funding from wholesale markets.

There has also been an in increase in the capital
requirements which requires banks to hold more capital in the event of a crises
it would be able to absorb the losses. During the crisis most banks had
inadequate capital to absorb the losses and were highly over leveraged, with
these changes banks will be able reduce their losses. Although an increase in
capital would prevent banks from lending out more but it does help prevent
banks from being over leveraged. Updates to other existing regulation were made
such as the Basel Accord III, this
was founded in 1974 (Basel Accord 1) with the purpose of ensuring that
financial institutions have enough capital to absorb losses. The new Basel
Accord  is an extension that focuses on
increasing bank capital and reducing bank leverage, before 2008 banks were
highly leveraged due to the low interest environment and had low capital
buffers.

In the UK we have seen changes in regulatory structures such
as the introduction of Prudential Regulatory Authority (PRA) which is over seen
by the bank of England , its core function is to oversee banks or institutions
that may pose a systemic risk to the financial system. Changes in the UK such as ring-fencing that are still yet to be
implemented would see the separation of retail banking from investment banking,
deposits would be kept in the ring fence and the trading activities outside the
ring. This helps prevent normal retail deposits from being affected by the
investment banking activity. In the run up to 2008 financial crises banks would
engage in risky activity when losses were incurred it wasn’t only the
investment bank that was affected but also the retail bank, these changes help
to provide security to depositors.

 

There are many factors that caused the 2008 financial crises
some of which are still being addressed. It helped to show the weaknesses on
both the private and public sector side. In the public sector side it revealed
regulatory and oversight weaknesses. Looking back as far as 1929 stock crash it
resulted in Glass-Steagall act that separated commercial banking from
investment banking due to the risky activity that banks had engaged in and
unsound loan practices. It was later removed by Bill Clinton which promoted
financial liberalisation resulting in unsound loan practices such as sub primes
and risky investments such as Collaterlised debt obligations. When all this was
happening oversight was lenient, there was no oversight or understanding of
derivatives trading. Regulation plays a crucial role in preventing financial
crises but too much oversight does pose a treat towards innovation and growth
in the financial industry.

 Changes in regulation
such as Basil Accord, Dodd-Frank have tackled the issue of capital requirements
which was a critical issue before the 2008 crises as banks didn’t have
sufficient capital to cover their losses, but it doesn’t prevent banks from
engaging in risky activity. More emphasis should be placed on the need for
banks to act in an ethical manner that doesn’t result in loss of shareholder
wealth, an example being Northern Rock. Although it was bailed out and its
assets were sold off and the tax payer recovered the loans  but the shareholders were at a loss. Northern
Rock growth objectives were often seen as being too aggressive they were more
concerned with profit maximisation which was short termed rather than growing
shareholder wealth which would be a long term objective. The rescue of Northern
Rock could be considered as a bad thing as it gives big banks the perception
that the government will always step in, in the event of a crises and even when
government steps in it doesn’t guarantee that shareholders will retain value in
their equity. A separation of retail banking and investment banking will reduce
the need for government intervention in the case of failure by the investment
banking side the retail bank wouldn’t be affected. This has been addressed by
implantation of ring fencing in the UK and Volker Rule in the USA.

Some of the key issues that triggered the 2008 financial
crises have been addressed such the capital requirements and separation of
retail and investment banking but the banking culture of profit maximisation
that is short termed and agency problems hasn’t been addressed, banks should
able to take on a long-termed approach of maximising shareholder wealth.