a northern rock and a hard place

14Sep07

Some will be surprised by the shenanigans which led to UK mortgage lender Northern Rock yesterday tapping the Bank of England for an emergency loan facility. One pensioner, queuing outside the bank today to extract his savings, described the cold sweat and sleepless night he’d had after hearing the late radio news announcement of the bank’s difficulties.

But the bank’s chief executive, Adam Applegarth, made a most egregious claim about the predictability of recent events when interviewed rather weakly by the BBC’s The Today Programme this morning. Edward Stourton, the presenter asked:-

Would you accept that part of the problem may be the strategic decision that you made to increase the number of mortgages you offer — I think an increase of something like 50 per cent — over a relatively short period of time? Does that look wise in retrospect?”

Applegarth responded:-

We’ve been growing strongly for a number of years. Once we realised… The world changed on one day, the ninth of August. When we realised what was happening on the ninth of August we slowed down our lending. You’ll actually see that from the ninth of August onwards we’ve been deliberately running much slower lending volumes.”

Stourton:-

So that decision was not entirely wise when you took it…the decision to increase at the rate that you did?”

Applegarth:-

I think it’s fair to say that we, nor anyone else, expected what happened on the ninth of August, that’s for sure.”

Unfortunately, Stourton did not press him on this point.

Forgive me if I sound a little tetchy, but the literature on rare events is far from lying obscure on library shelves. These are the books that would have informed an expectation that the credit markets might implode one day soon:-

Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets (of course), Nassim Taleb, pub Sep 2001

The (Mis)behaviour of Markets: A Fractal View of Risk, Ruin and Reward, Benoit Mandelbrot, pub Oct 2004

The Black Swan: The Impact of the Highly Improbable, Nassim Taleb, pub Apr 2007 (See our interview series here and book review).

At the risk of labouring the point, Fooled by Randomness was the best-selling non-fiction book of 2001 in the US, Mandelbrot is regarded as the greatest mathematician alive today, while The Black Swan made the New York bestseller top 5 list earlier this year.

I bought the first two at the old Financial World Bookshop, when it was located in Bishopsgate, about 100 yards from Northern Rock’s City of London branch.

So there really is no excuse. And neither the CEO of a bank advancing one fifth of all UK mortgages this year nor the BBC’s flagship news programme should be in any doubt. The BBC produced a radio documentary on Mandelbrot in 2005, so we are not talking about the ranting Jeremiahs on house price message boards here.

Go here and slide forward 5 minutes to hear Applegarth congratulate himself on being bailed out by the UK taxpayer.

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1 Simon Fellows on Sep 15th, 2007 said:

Sir..am sorry if this is a tadge brusque.

One doesnee need to shell out and read Bernie M or NNT to know that unexpected things do happen.
Despite the fact that we know this, unexpected things do happen, absolutely from experience we seem to simply forget it on a day to day basis.

All good things to you and yours.

Sinc.

Simon Fellows
2 knackeredhack on Sep 16th, 2007 said:

Simon, I think few people actually understand how unconstrained financial markets really are. But the CEO and board of a major financial institution cannot be excused for not understanding the riskiness of their strategy in light of the mainstream literature that has come out on rare events since 1998, say. Aug 9 should not have been the starting point for a moderation in risk taking.

The fog started to descend on these markets some time ago. But as we know, people continue to drive fast to other people’s tail lights. Trouble is, it is not just themselves they put at risk. I speak as someone who’s had to help clear up such a mess.
3 Richard on Sep 17th, 2007 said:

Hi KH, sadly I didn’t hear the broadcast. What specific event were they referring to on 9 August?
4 knackeredhack on Sep 17th, 2007 said:

He did not specify, but I assume he took that day because it was the moment the ECB chose to intervene in size.