The Bank of England and Northern Rock
Posted by markharrison on September 14, 2007
Oh joy, Northern Rock has a “short-term liquidity crisis”, does it?
For those who haven’t been watching the newsfeeds, the Bank of England did something slightly unusual today (in the sense of, they did something they hadn’t had to do since they went independent about ten years ago) – they agreed to provide a set of high-interest funding to a bank.
Right, time for a quick bit of background.
A long time ago (in a galaxy far, far, away), there were these things called Building Societies. People paid into deposit accounts, and earnt some interest. Then, the Building Societies made loans to other people, and charged them a higher rate of interest. The difference paid for the running costs of the Building Societies, and any left over went back to the people with deposit accounts in the form of extra payments.
Then the Building Societies figured that, if they were banks, they could give the “any left over” to shareholders instead of savers. Oh, and by the way, have some extra options in the kinds of transactions they were allowed to do. A set of deals were stuck whereby savers got some “free shares”, and a lot more got sold to the general public and other financial institutions.
Nowadays, some of these make loads of loans, but rather than financing them out of savers’ money, they in turn borrow the money from other banks.
Normally, this has worked.
In the wake of the US market crash, however, the banks with loads of cash have gotten cold feet about lending to each other, and jacked up the rates at which they’ll do so… or just plain stopped.
This is when the Central Banks, in our case the BoE have to step is as the “lender of last resort”. The BoE does this lending all the time on an “overnight basis”, and again, nothing unusual is seen.
Where the Northern Rock deal is odd is that the BoE have agreed to lend a LOT of money, on a rather longer basis… the day after they said they wouldn’t. (I suspect that the Treasury and the FSA have been leaning on them heavily, and reminding them that while they are bankers, they are also public servants.)
Northern Rock got into this problem because, compared to many other lenders, they borrow rather MORE on the money markets, and fund their loans far less just from savers’ money.
Under the circumstances, the savers have been queuing up to get their money out in cash, and the shareholders have seen their Northern Rock shares worth about a third less than they were yesterday.
Frankly, if I had money in a Northern Rock account, I’d probably be wanting the banknotes today as well! (There’s no downside to having cash in hand over the weekend.)
Now, some journalists are writing about how Northern Rock shares are now “so cheap” that they’ll be taken over… Well, maybe.
- It’ll turn out that Northern Rock has some seriously “toxic” loans, and that they’ll just sink under the weight of the bad debt that lives on their books.
- It’ll turn out that Northern Rock are OK, but why would anyone pay a “goodwill premium” for them at the moment? As far as I can make out, they have no goodwill.
It MIGHT be worth buying some NR shares and hoping they rebound on Monday, but it’d be a “gutsy gamble” from where I’m sitting.
Overall, though, I’m more worried about the knock-on effects. The whole idea that the US sub-prime market failure will be “contained” is, well, rubbish. The liquidity (lack of cash) issues are already knocking onto the core of the UK banking system. Every lender is going to look at those rates, and be less willing to give out cheap mortgages, or high loans-to-value, or high income multiples.
None of that would help UK house prices carry on going up.
Personally, I don’t believe we’ll see a “fast crash”, but this might, just maybe, be one of the signs that things are going to be flat for a while again…
… cashflow properties, anyone?