Negotiation, Negotiation, Negotiation

UK Property Investment news and comments from Mark Harrison of

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.

Two possibilities:

  • 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?


8 Responses to “The Bank of England and Northern Rock”

  1. suzymiller said

    At last, finally a financial analyst who speaks English and makes it interesting.

    For those of us coming out of a fixed rate term interest only mortgage and wanting to move to a variable, I presume that would be a good idea, rather than to go for another fixed rate?

    Suzy Miller

  2. Suzy,

    Firstly – I’m not an IFA, and there’s no way that I can give you financial advice about mortgages.

    So, recommendation one is that you find a good IFA, who can understand YOUR circumstances.

    The way I look at it is as follows:

    – If you take a floating rate mortgage, you are taking on the risk.
    – If you are taking on a fixed rate mortgage, you are getting certainty.

    The flip side of you getting the certainty is that you are BUYING the certainty… ie – you are paying someone else to take on the risk. There are three parts to this:

    Part 1 of this “buying certainty” is in the fees – application fees for fixed rates need to be taken into account. (I wrote an article about this for this time last year. The article can be found here:

    Part 2 of this “buying certainty” is in the penalties. If you need to re-mortgage, or sell, within the period of a fixed (or discounted) rate, then there are penalties to pay which often far exceed the rate saving you’ve made.

    Part 3 of this “buying certainty” is in the rates themselves. When the markets believe that rates are going to be going up over the next few years, the “starting” rates on fixed-rate mortgages are somewhat higher than they would be on variable rate ones.

    It’s a minefield. As I said before, a good IFA can help. (A mediocre one will just sell you a high-commission product, so find a local landlord who can give you a good recommendation – I trust the recommendations of landlords more than owner-occupiers, because typically they have far MORE mortgages, and therefore experience with a wider range of IFAs).

  3. Justin said

    Unusual to bail-out NRK? Yes Mr King intimated he wouldn’t unless the Bank going under would possibly de-stabilise the banking system. So that counts for at least half a dozen of the big boys then.

    What I don’t understand is why he came out with that statement in the first place, flying headlong into conventional wisdom in the ECB and Fed? Was it in a moment of egotistical superiority, or self-delusion?

    What with his (relatively) aloof attitude, the weather, kids with guns and the Tube/postal worker strikes I wouldn’t blame the city boys for upping sticks and setting their post-crunch stalls up on Wall Street, Madrid, Berlin or even Sydney!

  4. Justin,

    You wrote:

    > “What I don’t understand is why he came out with that statement in the first place”

    You and me both! It was an odd thing to say for any Central Banker, particularly one who is normally as guarded as him.


  5. Northern Rock – Savers vs. Investors

    Well, Friday’s post about Northern Rock has proved to be my most popular blog post ever, and it’s certainly an odd situation.
    On Friday, I said “There’s no downside to having cash in hand over the weekend” and I stand by that….

  6. […] by markharrison on November 20, 2007 Back in September, I wrote a series of articles about Northern Rock, the troubled UK bank. It would appear that the shouting is […]

  7. […] Posted by markharrison on January 4, 2008 Alistair Darling, the UK Chancellor, is intending to give more power to the Financial Services Authority (FSA), to help prevent a repeat of the Northern Rock fiasco. […]

  8. […] There has been plenty written over the past few weeks and months about the situation at Northern Rock. I – like everybody else – was surprised at how the British Government managed to make a pig’s ear out of what started out as a simple request for temporary funding, which was approved by the Bank of England. […]

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