A decade on and he’s still not understood Northern Rock

Northern Rock is in trouble because it has financed its mortgage book by borrowing commercial money rather than taking deposits from customers. To do that it has issued ‘commercial paper’. And now no one wants it.

I’ve looked at that ‘paper’. I’m not surprised no one wants it. Most of this ‘paper’ is issued through a long series of special purpose vehicles which re named in its accounts.

Seriously, a decade later you’d think he would have grasped it.

That “commercial paper” isn’t in fact paper at all. Paper is, by definition, short term. It’s bonds, longer term. The Granite bonds are still paying out. They’re doing just fine in fact. I think Osborne made a profit in selling a chunk, didn’t he?

No, the gap in Northern Rock was about deposits. The model was, issue mortgages, attract deposits to finance them, get a nice pile of issued mortgages together then issue another tranche of Granite bonds. They got caught by not being able to attract deposits to finance mortgages already issued but before they could issue another tranche of bonds.

It wasn’t, at all, because of their securitisations that they went down. It was because they couldn’t get the deposits before the securitisations.

Sigh.

And more, of course. For Ritchie is telling us that not financing your lending through deposits makes you go bust. But he keeps also telling us that MMT is correct, that banks don’t need deposits to finance loans, they just invent the money there and then.

Stump thinking, they can’t both be true.

23 comments on “A decade on and he’s still not understood Northern Rock

  1. Wasn’t Northern Rock’s problem liquidity not some-other-thing? The equivalent of the till drawer being empty ‘cos the messenger boy has been delayed bringing in the float.

  2. I thought the model was borrowing the money from international commercial markets (so china) and reissuing it to UK homeowners and taking a cut, when the Commercial markets stopped lending because of US subprime worries, they didn’t have enough domestic depositors to cover the mortgage business, thus no throughput so no business,,, but the balance sheet was ok.

  3. Commercial paper? I don’t think so – that consists of bills of exchange drawn on third parties or similar obligations with in all likelihood an underlying commercial transaction which are self liquidating if the commercial transaction is completed in good order.

    Is anyone keeping a list of Murphy’s lacunae?

  4. The Meissen Bison said:
    “Is anyone keeping a list of Murphy’s lacunae?”

    I think that’s why Tim tags his blog entries; just select “Ragging on Ritchie”. But maintaining full indexed database of Murphy’s errors would be a full-time job.

  5. “The model was, issue mortgages, attract deposits to finance them, get a nice pile of issued mortgages together then issue another tranche of Granite bonds”

    Wasn’t it “attract deposits, lend deposits as mortgages, get a nice pile of issued mortgages together then issue another tranche of Granite bonds”? Or is that old-fashioned thinking now discredited by MMT?

    Then lend the bond proceeds, get a nice pile of issued mortgages together then issue yet another tranche of Granite bonds? Repeat ad infinitum?

    All works so long as you can issue more Granite bonds (which didn’t seem to be a problem, since each was in its own SPV so not affected by anything else), and that you’ve got enough deposits coming in to be able to cover withdrawals (which was the problem).

  6. BBC Radio 4 last Sunday morning. A programme called “The Reunion”. This one was about Northern Rock. A bunch of people who were actually there talking about what happened.

    Still available on iPlayer Radio and online here.

  7. All fractional reserve banking is based on the “borrow on a short dated basis, lend on a long term risky basis”. Borrowing in the ‘commercial paper’ market (i.e. wholesale loans, to the bank) and through customer deposits (i.e. retail loans, to the bank) is the exact same thing, except that commercial market is less ‘sticky’. The people that buy these notes pay attention (well, more so than depositors) and unlike individuals don’t have to set up a new bank account in order to lend (i.e. deposit).

    Anyway, I thought he liked QE. This is just like the Northern Rock situation but with the small adjustment that when depositors line up outside the bank and ask for their money back, they are told that they can’t have it back, but they can get 1 Euro for 2 Pounds.

  8. morsjon: ‘commercial paper’ market (i.e. wholesale loans, to the bank)

    That’s a new one on me!

  9. Borrowing in the ‘commercial paper’ market (i.e. wholesale loans, to the bank) and through customer deposits (i.e. retail loans, to the bank) is the exact same thing, except that commercial market is less ‘sticky’.

    Bwhahahahahahahaha…

    That one’s for the scrapbook.

  10. “morsjon: ‘commercial paper’ market (i.e. wholesale loans, to the bank)

    That’s a new one on me!”

    Been around for about 30 years. Often called asset-backed CP. NR was using ABCP and retail deposits to fund mortgages while it accumulated enough assets before they were transferred to a Granite vehicle which refinanced the assets by bond issuance and was largely off balance sheet to the NR group.

    The ABCP buyers dried up leaving NR short of cash. The went to the BoE for help with caused all the depositors to pull their deposits.

  11. Nothing wrong with what I wrote. Not sure what the hilarity is about. What I wrote is entirely consistent with what Alex said although some terminology may be different.

    – A deposit with a bank is a loan to a bank
    – Bank issues commercial paper (i.e. short dated bonds). This too is a loan to a bank

    Mortgages etc are assets of the bank.

  12. Google (I know) says that commercial paper is:

    “short-term unsecured promissory notes issued by companies.”

    Sounds like a bond to me. Maybe banks don’t call them this and it is mainly used for non-bank issuance.

  13. The point I was making in the original piece is that “paper” is short term, “bonds” are longer term. “Bills” are usually in between the two in terms of maturity.

  14. It wasn’t directed at you Tim. The people after my post seemed to object to it for some reason I don’t understand (but perhaps had to do with terminology.)

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