case study of Northern Rock

case study of Northern Rock
This paper is a case study of Northern Rock, based on this case, there are 4 questions should be answer. First, you need read the case and questions carefully. And
then, following theory requirements of each question combine with case context to answer these 4 questions, this point is very important. Theory request has been shows
in red words under the questions. Relevant reference articles in CSR REF materials file.
Questions:
Guidance, instructions, and questions
Confine your answers to the moral and CSR aspects of this case. You should NOT use the case to express any personal opinions about the nature and operation of modern
capitalism.
YOU MUST USE relevant theory to answer all the following questions.
1    Is the regulation of executive pay possible or desirable? Should the shareholders of Northern Rock take action against the directors? If so, for what reasons?
2    Considering the various stakeholders in Northern Rock, do you agree that savers with Northern Rock should have their savings guaranteed by the government?
Also, does the guarantee savings scheme show that the government does apply some aspects of corporate social responsibility?
3     Who, if any one, carries any moral responsibility for this banking failure?
4     Using this case study, and from the content and discussions within the module, make reasoned predictions on the future use of CSR and ethical perspectives,
within organisational policy making.
Relevant theories:
YOU MUST USE relevant theory to answer all the following questions.
Question 1: Teleological and deontological, a lot of evidence the CEO where been mislead
Question 2: use Milton Fredman theory: he would agree governments should act as a government and business should act as business. However governments have social
response and therefore should look out for both business and people.
2.2) say what CSR is and have different opinions and it’s not a simple answer. Have different points of views
2.3) does the government apply CSR and if so which part of CSR has been carried out
Question3: three categories: personal, organisational and systemic (Schein e, 1985)
Question 4: read Buckholtz and Carol p33. chapter 2
Evolving meaning of CSR
4 dimensions: legal economic ethical and philanthropic
In conclusion: Conclude what you think should have been done better at northern rock i.e: change regulations, more disclosers of pay and bonus, shareholder agreement.
The Case OF Northern Rock:
You may refer to later developments in difficulties of international finance, but only in relation to the questions at the end of the case. You will not receive any
extra marks for extra factual research about the subsequent, so called, banking crisis.
Northern Rock: introduction and context
Northern Rock is a British savings bank that ran into trouble in 2007. Savers queued to take out their money, with loss of interest, so as to protect their capital
invested in the bank. The last ‘run’ on a bank had been 141 years before, with Overend Gurney. Not since that time had there been such a total lack of confidence that
individual customers thought they would be unable to withdraw their money when they wished to do so.
The situation in 2007 was much more severe even than the situation in 1974-75 when the Bank of England had to provide financial support to the Nat West bank. That
intervention happened when all of the following factors came together: (1) inflation peaked at 28% , (2) Gross Domestic Product (GDP), a key measure of national
economic activity fell by what was calculated then as 3%, (3) the government borrowing deficit reached 10% and (4) the government had to go to the International
Monetary Fund for a loan to see it through the crisis.
A run on a bank
Banks usually operate on a ratio of 8:1. That ratio means that the bank takes in £800 million from savers but expects to pay, say £100 million for day to day cash
withdrawals. The bank invests the other £700 million. When confidence in the bank disappears, all the savers try to withdraw their money at the same time. As the bank
cannot pay them all, it freezes customers’ accounts, and literally locks its doors to stop savers withdrawing their money.
One of the roots of the crisis in Northern Rock lay in the difficulties of the American sub prime market.  Loans were provided to people who, because of their income,
or lack of assets, or the type of property being purchased, could not obtain a loan or mortgage. Because of a booming property market from the mid 1990s to 2006, banks
and other lenders allowed much riskier lending to happen. The multiple debt problems of these people led to those debts being brought together into a single source for
the individual. However the basic problem of individuals not being able to pay back their loans remained.
A significant change in lending practices.
In 1970 the maximum mortgage to income ratio was 3:1 – that is 3 times the annual salary of the borrower. Over the next 40 years the ratio gradually rose to 5:1 or
even higher. In addition the borrower was usually expected to provide some of the purchase price of the property. This requirement was to show borrower commitment, the
ability to save, and possibly creditworthiness.  Also, building societies, which provided most of the finance, might include between a quarter and a third of the
partner’s income in calculating the loan.
The reasoning was based on a set of assumptions which, over the last 40 years, no longer apply. These assumptions were that the property would be for owner occupation
by a heterosexual couple of child bearing age, and that the couple would have children within 5 years of the mortgage, hence the restriction on ‘calculable income’ for
the woman, to avoid overstretching regular loan repayments. The recent development of buy to let loans has meant that the assumption of owner occupation is much less
appropriate.
Buy to let
Those people with above average wealth have often owned more than one property. Property companies have grown by buying and letting property. Now the scale of the
activity and the type of people involved in buy to let schemes have both altered. More people have more disposable income, but the main stimulus in buy to let activity
has been increased borrowing opportunities. That has meant rising property prices which has itself attracted more people into the market. Such borrowers have seen an
apparent no risk opportunities.
It could be argued that attitudes to debt have changed over the years, even with the risk of losses in property values. When emotion enters into calculations then
price rises and falls may be more severe than expected from a strictly economic perspective.
Negative equity could develop. This describes the situation when the borrower owes more than the property is worth. If a borrower buys a property for £300,000 with a
100% loan and the property falls in value by 10% then at sale the borrower has a gap of £30,000. (So perhaps the borrower continues to pay the mortgage,  hoping that
prices will rise to eliminate the paper debt). The emotion, before the subsequent anxiety, has been at least greed. Rates of bankruptcy rose sharply in 2007-2008.
Northern Rock collapsed because it had loaned too much money to too many people who could not repay their loans regularly.
Attitudes to debt, and the impact of changing mortgage to income ratios.
In 2008, a financial comparison website estimated that 1 in 10 adults in the UK spend more on a monthly basis than they earn. . Between 1997 and 2007 the number of
credit cards rose from 36 million to 71 million.   According to Standard Life Bank, credit is seen as a way of financing lifestyles rather than reflecting need.
Larry Elliott, Economics editor of the Guardian (26 February 2008:28) used the L’Oreal catchphrase by saying ‘Truly, this is the “because I’m worth it” generation. Our
culture is steeped in a value system that celebrates instant gratification hedonism and selfishness’. But the problem is not that simple. It is possibly not even a
matter of morality. If the deposit plus mortgage ratios of the 1970s are applied to 2007, the total loans available will not be enough to buy even a terraced house in
most parts of the UK, with 2007 salary levels. In September 2007 40% of first time buyers were borrowing above 90% of the cost of the house they were buying. Bank rate
was 5.75%
In 2008 less than 1 in 5 were borrowing more than 90% with a bank rate on the way down. Large mortgages were not available. The situation is made more complicated by
the uneven effects of taxation and benefits, which tend to favour lower income households. The problem of income rising more slowly relative to house prices meant that
people tried to service a loan beyond their ability to make regular repayments.     Northern Rock and other companies made loans that were more than the property was
worth, thus fuelling the consumer boom of the early 21st century.
In 1970 a household income of £30,000 would only have justified a mortgage of £90,000 but in 2008 Northern Rock would have lent £180,000, a mortgage to income ratio of
6:1   A gross personal annual income of £30,000 would only produce about £2200 per month. With the rise in interest rates the mortgage repayments take up more of the
total income, leading to people unable to pay their interest rates.
‘Northern Rock’s “business model” reflected a far higher willingness to make the type of loans outlined above than most other mortgage lenders.’ The company had made
loans that became worth very little. Repossessions nationally rose.
Some specific issues of regulation raised by the collapse of Northern Rock.
A House of Lords enquiry heavily criticised the Financial Services Authority (FSA). The Labour Government between 1997 and 2007 liberalised the City of London. The
style of government regulation became more remote, less detailed. The activities of supervising and regulating the financial institutions were divided between the FSA
and the Bank of England, with both answerable to the Treasury, the government department ultimately accountable to Parliament. But it was unclear to the lenders, the
banks, about who might take regulatory action.
Politically, there were those who wished the bank to fail. Huge salaries paid to business executives led to the view that they should sort things out. However, the
television pictures of angry depositors of Northern Rock caused political problems for the government.
Member of Parliament Vince Cable, a respected commentator on financial management, said ‘The run on Northern Rock was not only a failure of the bank, but also a
failure of regulation. Northern Rock’s managers behaved like a bunch of cowboys and the FSA did nothing to rein them in, or even appear to see there was a problem.’
(Brown C, The Independent, 26th January 2008)
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