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Archive for the ‘Northern Rock’ Category

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.)

Posted in Economics, Northern Rock | 3 Comments »

Northern Rock – Savers vs. Investors

Posted by markharrison on September 19, 2007

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. I hadn’t expected, though, that so many people would still be trying to withdraw money by Monday.

The Government have now announced a “bailout”, but there is some confusion about how this might work. Certainly, on the breakfast programme on BBC Southern Counties Radio this morning, the presenter, was talking about “helping Northern Rock investors.”

In a bank, savers are not investors.

In a bank (like Northern Rock), then there are savers, who put money into individual accounts. These people were already partially covered by the Financial Services Compensation Scheme (which would cover up to £31,700 – being all of the first £2000, plus 90% of the next £33,000 lost by any individual.)

What the Government have done is said that savers are fully protected. (Though it’s a bit of an empty promise, since everyone is in agreement that the Northern Rock has plenty enough assets to cover the payouts if needed – it’s just “immediate cash” that it’s short of.)

What the Government has not done is said that investors are protected. If you bought £2,000 worth of Northern Rock shares early last week, expect to be able to sell them for only about £1,000 today.

That’s the deal with investment – it can go down as well as up. (Property as well, not just shares.)

I find it perfectly acceptable that the Government should agree to underwrite savers (just as I did with Fairpack last year), while not at all supporting any underwriting of investors.

Will Northern Rock survive? Well, would I take out an NR mortgage this week – probably, if my IFA told me it was the best package for my circumstances. I’m not rushing to open a deposit account today, though 🙂

For the record, I held a Northern Rock mortgage on one of my investment properties from about 1994 to 1996. I have never held an NR deposit account, nor have I ever bought shares in them.

Posted in Economics, Northern Rock | 2 Comments »

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?

Posted in Economics, Investment, Northern Rock | 8 Comments »