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He can’t even get a bank run right:

Let me give you an example. In 2007, the Northern Rock Building Society, by then actually a bank, went bust because its directors had been irresponsible. There’s no way around that observation. They had lent people who had applied for mortgages 125 per cent of the value of the properties against which they were lending for the purposes of security. In other words, if you wanted to buy a house which was going to cost £200,000, the Northern Rock Building Society offered you £250,000 in mortgage. It was reckless because they were using other people’s money. And that building society ran out of road. It could not pay its creditors. The government had to bail it out.

That isn’t what happened in the slightest. The creditors – those Granite mortgage bonds – all paid off.

Northern Rock was illiquid, not insolvent.

They couldn’t attract the deposits to match their loan book. But of course Spud insists that banks don’t in fact need deposits, doesn’t he…..

NRock was a wholesale bank run, nothing more and also nothing less.

20 thoughts on “Jesu Christe”

  1. Interestingly the line of thought on LLCs isn’t dissimilar to Jim of this parish. I would say, though, that when challenged many years ago by me that perhaps moral hazard meant Northern Rock should not have been bailed out he responded furiously that that would have caused ‘mass social panic’ (which was rather the point as a spur to Banking reforms) he doesn’t really care about those damaged by company failure. It’s simply a means to expand state control and provide him,as an ‘interested party’ with an employment stream in an advisory capacity.

  2. Northern Rock would not even have been insolvent if the BoE had acted as “lender of last resort” in accordance with its statutory duties. The minor league accountant hired by alastair Darling to justify his theft of the shareholders property had to invent not one but *three* different fictions in order to *pretend* that NR was insolvent, including the idea that NR would have to sell its book of good mortgages at a discount to its auditors’ fire-sale valuation and that NR would get no tax relief on its losses – but the one that took the biscuit was that the fee paid by HM Treasury to Goldman Sachs for a report on NR was a debt owed by NR not HM Treasury.
    No, NR did *not* offer an extra £50k on a £200k mortgage – it offered to loan the cost of furniture to first-time buyers who didn’t have furniture of their own in addition to the loan coverring the house. Murphy is, as usual, ignorant of the subject about which he is talking: northerners with negligible savings do not spend £50k on furniture.

  3. John77 has it. Northern Rock merely recognised that the first thing new buyers do (as a generality) is go load up on debt so the nest builder and nest builder’s partner can have carpets, furniture, and all the other things they like. Why let the credit card finance that at 25 – 50% p.a. when Rock could lend the money at a lower rate and keep the debt under the umbrella of its first charge? And it charged a rate of interest commensurate with the lending risk. The media and politicians fell over themselves (as ever) to wave their virtue and exhibit their complete ignorance, all in a single smooth movement. As Tim says: Illiquid, not insolvent. And it was in essence a change in the liquidity rules that ensured the problem, not NR’s erstwhile lending practices.

  4. Isn’t NR also the bank not run by bankers that Murphy used to point to as the ‘better’ way of doing things?

  5. “Isn’t NR also the bank not run by bankers that Murphy used to point to as the ‘better’ way of doing things?”

    I thought that was the Co-Op bank, run by the crystal-Methodist Paul Flowers?

  6. Spud – “advertising makes people miserable and is bad”

    Spud “my son is working on monetising my YouTube channel “.

  7. Northern Rock was insolvent. It could not pay its debts as they fell due. This was related to, but not strictly caused by, offering mortgage loans as such high loan to value ratio. NR financed loans by short-term borrowing and deposits. When the short term loans fell due, it became unable to raise further loans to pay them off, which meant that it was insolvent regardless of it having long term loans whose book value covered the debts. One way to pay off the short term debts would have been to sell off the loans. This is where the loan to value becomes relevant as the economic climate at the time meant that the loans looked very risky and could not be sold. This is effectively the same problem as being unable to borrow, since lenders were unwilling to lend to a business where such a large value of it was based on the loan portfolio. To make matters worse, deposits are also short term loans, and the depositors took fright and there was a run on the bank further increasing the shortfall.

    The problem with a high loan to value ratio is that the value of the property acts as a guarantee that even in the case of default the loan can be paid off. With excessive LTV, a fall in the value of the property (possibly as part of a widespread fall in house prices) can leave the property with insufficient value to repay the loan and the associated fees incurred by repossesion.

  8. The Meissen Bison

    The Northern Rock proposition was to combine a 100% mortgage with a credit card that allowed the borrower to increase their indebtedness to a theoretical 125% of the value of the mortgage. Notionally this allowed house buyers to furnish their new homes from a single source as john77 said but the interest chargeable on the card account was at card rates for highly geared borrowers.

    It was fairly standard practice among some card lenders at the time to allow borrowers generous limits so that exposed borrowers would find it hard to take advantage of balance transfer deals to move their high card balance to another lender. MBNA was one such and the NR mortgage and card deal was intentionally designed to lock the borrower in albeit at the risk of leaving the lender with a riskier book.

    The upshot is that NR had a portfolio of very highly geared customers at considerable risk of negative equity if the housing market wobbled.

    The other side of the problem, as john77 points out is the role of the BoE. Alistair Darling had a Ceaucescu moment on television as Chancellor and the situation quickly ran out of control. The NR book was hopelessly out of kilter but left to its own devices with BoE support the situation could have been manageable.

    The wholesale slicing and dicing of politically motivated motgage products for the derivatives market in the US is the bigger backdrop against which this minor British drama played, worse luck. If there’s a lesson to have been learned it’s that the mutuals should never have demutualised.

    formertory raises an interesting point. Card borrowing is an expensive way to borrow but is is by definition unsecured. However, the value of the security must correspond to the value of the capital some advanced – the bricks and mortar are the security and not the curtains and carpets. Hence the Mortgage + Card deals

  9. @ Charles
    Northern Rock was insolvent ONLY because Robert Peston (son of one of the New Labour peers appointed to give Tony Blair a majority in the House of Lords) catalysed a bank run while the BoE defaulted on its statutory obligation at the behest of the New LabourChancellor of the Exchequer.
    FYI Northern Rock *had* refinanced a large amount of its loans through its “Granite” which kept only the net losses on discrete portfolios of loans offloading the capital and future repayments. At that time, with house prices having increased by more during ten years of “New Labour” government than in the previous thousand years, mortgage books were highly saleable: the high loan to value ratios shrank fairly quickly after the first year or so of the life of the loan and the 100-125% loans were high profile but a fairly small minority of the loans.
    The NR board deserved a good kicking but NR was not a basket case.

  10. Northern Rock was bust. Its business model was to fund its mortgage lending first by short-term borrowing, then by selling on the mortgages. The secondary market in mortgages collapsed, and the short-term lenders didn’t fancy it any more. The BoE did act as a lender of last resort, but that’s supposed to be a temporary thing, not medium -term funding.

    With an ordinary business model, in which lending is funded by deposits, the secondary-market value of the mortgage book doesn’t matter very much. The way NR was operating, it was the only proper way to value the business, and on that valuation it was toast.

  11. @ C T Wayne-Kerr
    Northern Rock was *not* bust.
    Try reading the Accountant’s report, as I did.
    Every building society funded its mortgage lending with short-term deposits (“borrowing”); Adam Applegarth wanted NR to expand faster so he securitised a lot of their mortgage book, but most of its mortgages were funded by members’ deposits; after demutualisation most shareholders remained depositors. I am unsure as to who were the “short-term lenders” you cite.

  12. Short-term lenders in the money markets.

    By summer 2007 only 23% of NR’s liabilities were retail deposits. That is nothing like “most of its mortgages”. In September 2007 money-market lending to NR disappeared and it went tits up.

    This paper gives a summary of NR’s funding position.

  13. @ CTWayne-Kerr
    At end-2006, the last balance sheet before the Peston bank run retail funds were £20,537m, Securatisations were £41,840m, Debt securities in issue and medium-term notes were £17,866m, “other customers” £4,234m jointly funded 97% of its mortgage book of £86,796m. If you net off the securitised mortgages from both sides you’ll £45bn funded by £24.8m of customer deposits, £17.9bn of debt securities & notes, and £2.3bn of miscellaneous (deposits *with* banks exceeded deposits *from* banks). The £45bn of securitisation liabilities were NOT short-term lending
    The Peston bank run wiped out 57% of customer deposits but none of the securitisation liabilities.

  14. The position at the end of 2006 is not entirely to the point. NR were enthusiastic mortgage issuers in 2007 – they increased their lending to 18.9% of the UK market.

    You seem to have forgotten that the run on the bank happened because it became public that the BoE was providing massive emergency funding – NR first informed the FSA of its difficulties on 13th August, the bank run started on 14th September. The bank run was a consequence of NR’s problems, not the primary cause of them.

    NR reported 26.7 Bn of “wholesale funding” in June 2007, collapsing to 11.5 Bn in December 2007. For it to have fallen so fast, a lot of it must have been short-term money-market borrowing. Your category of “medium-term notes” in fact includes short-term stuff, which grew a lot during the first 8 months of 2007.

  15. Not *my* category – the Auditor’s . You want to play Humpty Dumpty, go ahead but don’t blame me for using the auditor’s definition of what is or isn’t “short-term”

  16. The bank’s reports call it “wholesale funding”.

    If you actually believe it was medium term, you’re going to have to explain to yourself how 15Bn of it disappeared in H2 2007, just when NR needed it most.

  17. @ CT Wayne-Kerr
    I quoted from the notes to the Balance Sheet (note 31) ref: Companies House
    Bonds and medium-term notes actually *rose* oduring 2007 from £9.228m to £9.362m
    You are taking rubbish
    Please DO YOUR HOMEWORK before you next post and stop making a fool of yourself

  18. I can’t see the 2007 accounts (feel free to post a link) but here are the 2008 accounts.

    You’ll see (p24) that wholesale funding fell by 11.7Bn in 2007.

    The facts are clear. Northern Rock failed because it was relying on wholesale funding which dried up. That caused it to ask the BoE for help in August 2007.

    I am baffled as to what you imagine actually happened. Why do you think NR went to the BoE if everything was as healthy as you absurdly claim?

    Please try to think straight.

  19. I know – mildly – Matt Ridley who was, as we know, Chairman at the time. We have discussed this.

    Basically it suffered a wholesale run.

    Issue mortgages, borrow overnight (or similar, from wholesale mkt) to finance. Then when nice pile built up, issue bonds about the same tenor as the average mortgage book (because moves and refinancings, say 14 years). Granite was the name of the bond program.

    Everything was fine. Then the overnight market decided not to roll over, so illiquid. BoE declined (for whatever reason) to finance against those mortgages already issued. But couldn’t get another Granite issue away either.

    Given that all Granite have paid off, in full, hard to say they were insolvent. With BoE they could well have survived, without not.

    That still leaves all sorts of details to have fun with but that’s the basic story.

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