I did promise myself, when I started the Cool Risk project, that I would steer clear of financial risk. I don't know enough about it and there's too much specialist jargon involved. But the run on the Northern Rock bank this week is just too tempting a story for a risk commentator. And promises are there to be broken, aren't they? Let's talk about risk and trust.

First: the facts as I understand them

When the Northern Rock Building Society converted itself into a bank 10 years ago, many people expected that it would be taken over by one of the larger British banks. But the Northern Rock prospered on its own. It became the fifth largest mortgage lender in the UK and got to be listed in the FTSE 100 Share Index. The Rock couldn't fund this rapid growth from its UK savers alone and eventually had to find 75% of the money it needed by borrowing on the international money market.

Funding long-term loans using money from short-term borrowing was a high-risk strategy. And that's how it turned out when the US sub-prime mortgage crisis reduced the availability of international credit. The Rock was left exposed and was forced to ask the Bank of England for a loan. Investors panicked and many of them ended up queueing outside offices of Northern Rock, trying to withdraw their savings. Britain had not seen anything like it for 140 years. Two billion pounds were withdrawn in 2 days!

Public statements from the government and the Bank of England failed to reassure investors that the Rock was solid. The run was halted only when the Treasury announced that it would guarantee the savings of all Rock investors. The crisis is not over, of course. Questions are being asked of the heads of the Bank of England, the Treasury and the Financial Services Authority (FSA), the UK banking regulator. Now we need somebody to take the blame.

Some Northern Rock shareholders saw the problem approaching a long time ago. The share price has been falling most of this year since its all-time high in February. Then, when the long queues were shown on national television, shareholders knew that the Rock was crumbling, the brand was tarnished. Having lost half their value over the previous 7 months, Northern Rock shares fell by half in 2 days. For sure, the FSA was monitoring the Rock during the period of the falling share price. But its job is not to protect the profits of shareholders, so it didn't see any need to act.

Second: the Public Perception

The word trust is related to truth. We tend to trust someone if we believe that they speak the truth. It's funny how there is no word in English for speak the truth. The word lie can be used both as a noun and as a verb, but not truth. To lie is straightforward but to communicate the truth is much more difficult.

Trust is important in any commercial operation, but especially in the financial sector. That's why a bank calls itself Northern Rock... Rock to suggest solidity and Northern to appeal to the loyalty of its customer base in Northern England. But these days there doesn't seem to be much trust in society. There is scant respect for many of the cultural institutions. When the government issues assurances about the safety of investments in Northern Rock, people don't trust them. Indeed, it seems risky almost because the government declares it to be safe. After many years of government spin, with the BSE débâcle and the Iraq war in mind, nobody is inclined to trust the government.

Trust is a strange commodity. So hard to build up and so easily lost. It is closely allied to risk, with each depending on the other. In today's society, risk is shunned and trust is low. Everything feels risky when we trust nobody. Somebody else is always to blame when things go wrong. Marriage is unpopular because it demands too much trust and invites too much risk. In this climate of fear and suspicion, we can't cope with uncertainty. Government assurances about Northern Rock were not enough for many people, some of whom feared losing their life savings. It was only when the government promised to guarantee all Rock investments, i.e. remove all uncertainty, that the panic subsided.

One of the bits of financial jargon I've learned over the last week is moral hazard. This applies to a situation in which a lender feels able to make risky loans, with potentially high profit, if they believe that a central bank will cover some or all of the potential losses. Moral hazard was the reason given by the Bank of England for not bailing out Northern Rock earlier. In this context, the word moral appears to mean what Cicero intended when he coined the word moralis in Latin, i.e. proper behavior of a person in society. The Bank thought it right that the Rock should suffer the consequences of its risky strategy. The falling share price reflected the expectation of lower profits. However, the public lack of trust in the authorities pushed the stakes higher. The Bank (and the government) weren't prepared to stand by and let pensioners lose their life savings, not to mention serious consequences for British banking. They were forced to intervene.