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Markets Shudder at Central Bank Bailout of Major British Lender

By Howard Schneider
Washington Post Staff Writer
Saturday, September 15, 2007

A major British bank said yesterday that it had to arrange emergency funding from the Bank of England to ensure that it had enough cash to keep operating, an announcement that sent European stock exchanges lower and reverberated on Wall Street.

The announcement that Britain's central bank had moved to bail out Northern Rock, the country's fifth-largest mortgage lender and eighth-largest bank, combined with a tepid report on August retail sales to initially deflate U.S. markets. The market rebounded by day's end, with the Dow Jones industrial average closing up 17.64 points yesterday, and 2.5 percent for the week. The Nasdaq closed up 1.12 points and the Standard & Poor's 500-stock index rose 0.30 points.

Although the amount of the emergency funding was not disclosed, the agreement between Northern Rock and the Bank of England was being described as the biggest British bank bailout in more than a quarter of a century. As word of the arrangement spread, lines formed outside of some Northern Rock branches as customers withdrew deposits, wire services reported.

Northern Rock said that global credit markets have been so tight that it has been unable to raise the money it needs to make new home loans and repay debts that are coming due.

"We are seeing extreme conditions in global liquidity," Northern Rock chief executive Adam J. Applegarth said in a news release. The company expected those conditions to "continue for some time," the release said. "In light of the above, Northern Rock has concluded that it is important to ensure that additional standby liquidity arrangements are available."

The announcement helped drag down London's FTSE 100 by more than 2 percent at one point and also pushed other European exchanges lower.

Along with the trouble in London, investors were looking at weaker-than-expected U.S. retail sales in August. The latest government data showed that consumer spending rose 0.3 percent last month, a result buoyed by a jump in auto purchases. Car sales often spike near the end of the summer as dealers push to make way for new models. Excluding auto sales, retail spending fell 0.4 percent, disappointing predictions of a modest increase.

Problems in the U.S. home mortgage market, where default rates have reached a record following a period of loose lending to buyers with suspect credit, have prompted thousands of layoffs in the industry and led to substantial losses at hedge funds and other financial firms with investments linked to mortgages.

The effects have been felt more broadly as investors worldwide have become less willing to provide money to lend, wary of investing in the bonds and other forms of debt that corporations use to fund operations and buyout firms use to underwrite deals.

Northern Rock's announcement showed just how far the credit crunch extends. The bank only makes prime loans, those to creditworthy borrowers, is financially strong, and reported that the number of overdue loans on its books is less than half the industry average.

But "the global credit and liquidity markets have not recovered in the early part of September," the company said. "There continues to be a severe liquidity squeeze."

The company said it was being charged a "penalty rate" by the Bank of England for the emergency funds, but did not release details.

In contrast to the U.S. Federal Reserve and some other central banks, the Bank of England has taken a more hands-off approach to the global credit squeeze, moving more cautiously to funnel extra cash into the system, concerned about coming to the rescue of banks or investors who got into trouble because of loose-lending practices.

Following the announced rescue of Northern Rock, however, British banking regulators made clear they would stand behind the country's banking system to ensure its stability.

"Northern Rock is solvent . . . and has a good quality loan book" and warranted assistance, the country's Financial Services Authority said in a statement.

"We are determined to ensure that we have a stable and strong banking system," Chancellor of the Exchequer Alistair Darling told BBC Radio, Bloomberg News reported.

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