Sunday, September 16, 2007

Build upon the Rock and not upon the...whoops

What a weekend, eh? That's the first run on the bank I've ever seen, so in the future I'll be able to say "Well, I remember back in the Panic of '07...what, you don't remember the Northern Rock? What do they teach these people today? Yes, they had branches then; and cash!"

"You're not my father!!"

But snark aside, this is astonishing and worrying. Paul Krugman was in the habit of saying that the most successful government program ever was the Federal Deposit Guarantee Corporation, on the grounds that since the introduction of depositor protection there had never been a run on the bank. A run on the bank is driven by the same logic as the tragedy of the commons; what is rational for the individual is irrational for the community. If you have a guarantee that your money is safe, you have no incentive to help sink the bank, and therefore the self-amplifying process should be unable to get started. And I was in the habit of quoting him.

This is now in question; although the Rock's depositors are explicitly guaranteed by the Treasury up to £37,000 in each account, and more importantly the Bank of England is willing to rediscount everything up to the entire £113bn of assets on the Rock's books for cash, so the £24bn in deposits is covered more than four times over, it still happened. And I'm at a loss to understand why, but I suspect that trust in institutions is now very wide and very shallow. There are, as Ali C so accurately said, huge issues around trust.

So I have no sympathy with the complaints from Willem Buiter, the ex-ECB chief economist, who apparently thinks the Bank of England has gone soft. Buiter's term at the European Central Bank was characterised by the institution being seen as a gaggle of dry, distant, academic inflation hawks too scared to get their foot off the brake. He is not doing anything to change this; even though the depositors would eventually have got their money, whether through deposit protection or through the sale of the bank's assets, can you imagine the crisis fever? Dead ATMs? Crowds trying to break into locked branches?

Perhaps more importantly, the failed business model of Northern Rock gives us a clue as to the Bank's priorities. It has, or rather had, a loan-to-deposit ratio of 314 per cent; to put it another way, its huge surge of lending was carried out by borrowing in the money market and relending to customers. Very crudely, if there are (were!) £24bn of deposits (i.e. liabilities) in the Rock and £113bn of assets, there must be something not far off the difference, less the bank's enterprise value, of liabilities outstanding. If they lent £89bn more than they took in as deposits, they must have raised it from somewhere. Of course, some of this is accounted for by the bank multiplier, but a lot of it must have been the famous mortgage-backed securities; securitisation bonds, asset-backed commercial paper, and such. The Obscurer's business section reckons 75 per cent of the funds came in that way; so we're looking at £60-odd billion.

What do we know about this stuff? We know that once issued, it's hard to know where it ends up; and we also know that issuing commercial paper to speculate in mortgage-backed securities has polluted the whole market, because no-one knows where the shite has ended up. The whole point of these securities is to dilute it; but there is no guarantee that it's evenly distributed. Now, we can see clearly why the Bank didn't want another ton of commercial paper going bad; no-one can say if there isn't another bank with a big chunk of theirs on an already-dodgy balance sheet.

Meanwhile, Jean Quatremer points out that nothing like this has happened in the Eurozone...well, if you leave out the two banks that already did go bust, IKB and SachsenLB.


Anonymous said...

the Rock's depositors are explicitly guaranteed by the Treasury up to £37,000 in each account

Actually 100% of £2,000 and 90% of the next £33,000, so in effect £32k.

Trust in institutions? We've seen banks throw their social capital away; once that's gone all that's left is trust in the professional competence of the managers of money, and the sub-prime disaster suggests that that may be ill-founded. The run on NR is a bad sign, right enough, but I couldn't call it surprising.

Anonymous said...

It cannot be long before someone comes up with the accusation that all these depositors withdrawing their money are suffering a reverse form of false consciousness.

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