Negotiation, Negotiation, Negotiation

UK Property Investment news and comments from Mark Harrison of YourPropertyExpert.com

Northern Rock – the difference between “Solvent” and “Liquid” explained

Posted by markharrison on September 20, 2007

There’s a lot of financial terminology flying around at the moment (and a lot of finger-pointing for that matter, but that’s another subject for another day), so I thought it would be worth stepping back and re-visiting where the problem REALLY is.

For example, earlier this week, the Telegraph wrote:

In some ways it’s flattering that the Editor believes that we all understand the difference, but until I got seriously into property investment, I didn’t.

The difference between the two is the difference between “cash” and “assets”. If you have enough cash, your are “liquid”. If you have enough assets (including cash), you are “solvent”. This is, of course, easier with an example: Consider some imaginary people, Adam, Bob and Charles. I was going to make them recent graduates owing student loans, but I decided to make them gambling addicts🙂

  • Adam, Bob and Charles each owe £10,000 to Mad Pete Trollo. (All I actually know about Mad Pete is that Carrie Fisher’s father called in her last favour with him to obtain Seven Limousines for her abortive wedding in The Blues Brothers – but I’m figuring that anyone called “Mad Pete” is not someone you want to owe money to.) An associate of Mr. Trollo is due this evening to collect.
  • Adam has £10,500 in used banknotes under his pillow. Because Adam has the ability to come up with the money, in cash, when Mr. Trollo’s collectors come round this evening, Adam is called “liquid.” Assets that are either in cash, or can be turned immediately into cash, are called “liquid” assets. Adam may only be left with £500 by the morning, but things could have been worse. (Adam is also solvent, by the way.)
  • Charles is in serious trouble. Charles has £25 in cash, plus £200 in a bank account (which he therefore could go and get out in cash.) Charles has a stereo worth about £50 if he put it on eBay, or about £20 if he offers it to Dave down the pub this evening… So, when Mr. Trollo’s associate turns up, Charles is going to have £245 in cash… provided he comes home from the pub (having sold to Dave) via the cashpoint. Charles is neither Liquid nor Solvent. It seems likely that bad things are in Charles’ future.
  • Bob’s case is more complex. Bob has about £5,000 in cash… and quite a nice car (with no finance payments hanging over it). The car’s probably worth about £6,000 if Bob sticks it in the local paper and haggles a bit. However, Dave down the pub might give him a grand for it, tops, this evening. Bob is solvent – that’s to say, given time, he could turn his car into £6,000 … so with the £5,000 already in his pocket, he can come up with £11,000… In fact, Bob is MORE solvent than Adam! Bob’s problem is that Mr. Trollo is not famous for accepting cars when he’s expecting cash. Indeed, Mr. Trollo’s car valuation scheme makes Dave look like a fairy godmother by comparison.

This is the problem, then…. In principle Bob could come up with the cash to pay off his debts (he is solvent)… but he hasn’t got it to hand (he is NOT liquid.)

Which is where we came in – Northern Rock have the assets to mean that they WILL be able to pay off all their savers, but they don’t have those assets in bank notes, or even funds that other banks will honour at the moment. (When Northern Rock try to pay money to someone at another bank, that other bank requests the money in an “inter-bank transfer”, either there and then, or batched up as part of a big overnight run.)

Northern Rock are not just solvent… It would appear (according to the Financial Services Agency, part of whose job it is to check these things), that they have rather MORE assets than they would need.

What they don’t have is cash…

… which is why the Bank of England needed to lend them some (well, lots.)

The question behind this is why only the BoE would lend them the money – normally (as per my article on Friday) the other banks would do so. (The short answer – because they’re too scared to lend to anyone at the moment, because they got burnt in the USA, but do read the article.)

3 Responses to “Northern Rock – the difference between “Solvent” and “Liquid” explained”

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