Pyramid Comment

This journal takes an alternative view on current affairs and other subjects. The approach is likely to be contentious and is arguably speculative. The content of any article is also a reminder of the status of those affairs at that date. All comments have been disabled. Any and all unsolicited or unauthorised links are absolutely disavowed.

Monday, October 22, 2007

Northern Rock

The business
The savers
On it goes - August 2008

Building society-turned-bank. Just 10 years after its floatation on the stock exchange, the bank is the fifth largest lender in Britain (total mortgage market = £334bn), relying less on local branches (saver funds) and more on the international money markets (borrowings) to raise funds to lend to its customers. Around 75% of funds would be raised by short term borrowing from these markets and only 25% from saver investment (70 branches and 1.5 million savers).

Norther Rock - Update (November 2007)
Adam Applegarth And Northern Rock (April 2008)
Northern Rock - Lending Policy (January 2009)
Northern Rock - The Depression (March 2009)
Northern Rock - Another Update (March 2009)

The end of easy and 'cheap' money. The Bank of England increased interest rates and raising a loan will probably become more difficult. Northern Rock has been providing around 20% of home loans and required emergency funding from the Bank of England, though according to the Financial Services Authority, Northern Rock has no solvency problems and the Bank of England insists that it is part of its job to supply liquidity to financial institutions that are having 'temporary' problems.

Liquidity problems...
but no solvency problems?

Rather a contradiction

    This is money talking so don't expect logic or common sense and government getting involved, so expect some spinning to begin. The Chancellor of the Exchequer has approved a bail out. The British Bankers' Association patronisingly insisted there was no reason for alarm

    "Everyone should calm down and refrain from making simplistic comments in a very complex area which just causes unnecessary worry and concern."

    For the Bank of England to make such moves, it must believe that the crisis at Northern Rock could damage the financial system and the economy and illustrates the placement of priorities.

    Protect the system at all costs...
    but sacrifice the saver

    The international banking system is complex and possibly quite fragile. Excessive credit has been globally available with banks virtually throwing money at borrowers without heeding the risks involved. Northern Rock's troubles started in the US sub-prime mortgage market (euphemistically: poor credit risk). Banks make the loans then sell them on to other financial institutions, which presumably (for whatever reason) did not fully understanding the risks involved. Some buyers were European banks.

    No doubt everybody expected their cut in the profit

    US house prices started to fall and borrowers defaulted. The price of the loans collapsed. Takeover rescues have already happened: a couple of regional German banks. Northern Rock did not have any of these 'loans', but the potential instability in the banking community caused by this collapse of the market led to banks keeping their money. This directly affected Northern Rock since to balance its books it has relied on borrowing from these banks that have now stopped lending.

    To restart the money supply enter the Bank of England.

    Interest rates have been very low (below the rate of inflation in some countries) and so it made sense to borrow 'cheap' money and invest in property, hedge-funds and private equity. So, prime property asset prices have rocketed and lending terms (mostly for property) have become somewhat lacking in rigor. Asset prices go up and borrowing is fuelled as a result with the banks very willing to lend against such a 'good risk'.

    The six-times' salary for new mortgages had arrived. Borrow more to eventually buy more, but in the meantime owe more. Incomes have fallen behind outgoings. Spending less and saving more has started, but will such cutting back on buying result in recession? The financial markets are in panic mode and a run on any bank in a 'developed' country is a serious state of affairs and troubled times are ahead. Maybe saving will become more popular as credit becomes harder to obtain. Shares in Northern Rock and other leading banks on the London Stock Exchange fell as investors raced to sell up their holdings. Northern Rock holds deposits of £24bn from its 1.5 million savers and lends to 800,000 homeowners (mortgagees). It has expanded its mortgage lending aggressively in recent years by raising funds in the money markets and selling its mortgages as bonds to investors. However, the US sub-prime crisis caused investors to panic blowing a hole in the Northern Rock strategy by closing down the market for these bonds.

    Adam Applegarth (Northern Rock chief executive) disclosed:

    The emergency funding had not been used,
    but warned that mortgage costs would rise

    Until a few years ago, it was solid and respectable, but recent events have wiped out much of its stock market gains and its reputation has 'taken a hit'.