Contagion was the risk the Bank of England hoped to avoid by standing behind Northern Rock with emergency finance.
In the event, its actions seemed only to add to the general sense of alarm. Shares in Alliance & Leicester and Bradford & Bingley plunged yesterday on speculation that they too might suffer a run on deposits similar to that already witnessed at Northern Rock.
Will last night's further commitment from Alistair Darling, the Chancellor, to put in place arrangements that would guarantee all the existing deposits of Northern Rock over and above that already offered by the deposit protection scheme operated by the Financial Services Authority do the trick?
First, let's examine the quite breathtaking implications of an announcement which on a quick ring round the City last night was widely thought to be without precedent. It is one thing to guarantee the £24bn of deposits held by Northern Rock in the hope that this might calm nerves and convince depositors that they don't any longer need to queue round the block in the pouring rain to get their money out. The Government wouldn't be doing it unless it thought Northern Rock essentially solvent and therefore ultimately of no risk to the taxpayer.
Yet if the authorities are to underwrite Northern Rock, the implication is that they stand behind the entire UK banking system. Any government that is prepared to guarantee the creditors of one bank must surely offer the same facility to everyone else?
In the event of a more generalised run on UK banks, it would be in no position to provide such support. The sums involved would overwhelm the ability of the tax system to pay, or indeed the money printing presses to cope. The Bank of England's position as lender of last resort would be stretched to breaking point.
What at first, then, seems like no more than a neat trick to restore confidence in Northern Rock on reflection looks much more high-risk. Mr Darling had better hope it works. If it is Alliance & Leicester, or worse, one of the big high-street banks, which next comes calling, cap in hand, then it won't be just his job that's on the line – the Government's entire future would be at risk.
In order to implement his guarantee, Mr Darling would, in the event of a continued run on Northern Rock, in effect have to nationalise the mortgage bank by taking both its assets and its liabilities on to the Bank of England's own books. What are the consequences for the public finances of that? Again, the implications are almost too shocking to contemplate. What if it doesn't work? What if there are runs on other banks? Will the Government then nationalise Alliance & Leicester (A & L), Bradford & Bingley, and others too?
Mr Darling insisted yesterday that no other bank had so far approached the Bank of England asking for emergency funding. A & L likewise insisted that it knew of no reason for the 30 per cent-plus plunge in its share price. It was continuing to fund its business normally. Yet it is easy to see why investors have become so spooked. Shares in mortgage banks across Europe took a beating, but particularly so in Britain, Spain and Ireland, the three countries which have experienced the biggest housing bubbles and the biggest growth in domestic debt.
In all three countries, growth in the mortgage market has far outstripped the capacity of retail deposits to fund it, forcing lenders to tap into the international money markets on an ever more ambitious scale. With the markets essentially closed to mortgage- backed securities, all these lenders will be experiencing difficulties in finding the rollover finance to meet their obligations. A more fragile state of affairs is hard to imagine.
As for Britain, it is no wonder that Mr Darling has been forced to resort to desperate measures. The Government's reputation for economic competence, a key factor in its electoral support, is being shaken to the core. Questions are being asked not just about its handling of the crisis but also more generally about the credit-fuelled nature of Labour's economic miracle.
The decision to split key regulatory and support functions with regard to banking between the Financial Services Authority and the Bank of England has also been called into question, with the Bank of England accused in the City of being too divorced from the banking system to have understood the gravity of the crisis or what needed to be done to quench it.
David Cameron, the Leader of the Opposition, is plainly right in demanding some sort of public inquiry. The credit crisis seems to have been handled better in both the US and Europe. We need to know why this is the case and what improvements can be made to ensure the system functions better in future. Yet there is now also a danger, as there is with all disasters, of regulatory overkill.
Do we really want to go back to an era of more heavily regulated access to credit? Few would thank the politicians for that. As ever, it would be the least well-off who suffered most if mortgages and credit once more become restricted by order of government. Such an outcome already looks inevitable in the US. Let's hope we don't engage in the same overreaction.
Greenspan's disingenuous analysis
Somebody shut him up. Ever since he retired as chairman of the US Federal Reserve, the previously cryptic and taciturn Alan Greenspan has become progressively more outspoken and trenchant in his observations.
With a book to sell, the Age of Turbulence, his utterances have reached deafening proportions, and pretty apocalyptic reading a lot of them make too. Mr Greenspan seems to have turned into a fully paid-up prophet of doom. He also pulls no punches in his verdict on the Bush administration.
With regard to the UK, he predicts that Britain will soon follow the US into a sharp housing market correction. Inflation will also pick up sharply over the years ahead and interest rates may hit double figures again. Well, he's entitled to his point of view, and, now he's off the leash, he can give the full uncensored version.
Nor would anyone necessarily disagree with a lot of what he's got to say, even down to the view that Iraq was basically only about securing Middle Eastern oil supplies, a common assumption among ordinary mortals but quite unusual among senior US policy wonks of either political bent. Mr Greenspan, by the way, is a Republican in his leanings, which is one of the reasons he feels so let down by President Bush Jnr.
Yet, ultimately, Mr Greenspan is also being disingenuous. If he thought all this, why didn't he say more of it at the time, and why also did he take the actions that he did, repeatedly cutting interest rates in response to crises in a manner which only stoked up new difficulties for the future?
So it doesn't do for a central banker openly to criticise his own government, yet, far from lambasting the Bush tax cuts in the aftermath of 9/11, which he does in his book, at the time Mr Greenspan seemed to welcome them. In his book he excuses himself by saying he was misinterpreted. How come it has taken until now to correct any misunderstanding?.
From the point of view of sales, the timing of Mr Greenspan's book, slap bang in the middle of a banking crisis, could hardly have been better. The reader is none the less left thinking it a bit rich for the former Fed chairman to be capitalising on a turmoil in financial markets which his own policies helped to create.
He's not entirely unrepentant. Mr Greenspan admits that he really didn't "get it" about US sub-prime lending until it was too late. What he was very good at was crisis management, a quality apparently lacking in today's generation of central bankers. All the same, if all you are doing in dealing with a crisis is sowing the seeds for the next even more serious one, it's not such a great achievement. Mr Greenspan recognised when he cut interest rates all the way down to 1 per cent in response to the threat of deflation that by so doing he risked creating an unsustainable credit bubble. At the time, he thought it a price worth paying. On this, too, he seems to have changed his view.