The sight of people queing up yesterday to withdraw their funds from Northern Rock was not an edifying one. Northern Rock has become a casualty of the inter- bank mistrust which pervades the financial markets.
Why has this happened and what are the political ramifications?
It all began in America with the collapse of the sub prime lending market.
Sub prime lenders are companies who loan money to people who have a higher risk rating. Unfortunately, in America, this market is not very well regulated and there are stories of money being loaned to people as mortgages without even basic property valuations having been undertaken.
This market boomed following the Federal Reserve having dropped its interest rates to 1% in order to head of a recession. Money was cheap, people borrowed and house prices boomed. But it didn’t work. The American recession still came.
People lost jobs, homes became re-possessed, house prices dropped, and those who had borrowed equity against assets, their family homes, became bankrupt.
According to last weeks FT, as many as two and a half million re-possessions will take place in America over the next year. In Phoenix house prices have dropped by as much as 40%.
The property market in America is in its boots.
Why is this having such an impact over here?
Many of the American sub prime lenders sold off their debt to European banks in what are complicated financial bundles. Those banks, including British ones, are therefore exposed to the vagaries of the American housing market collapse.
Some British banks may not even be aware to what extent they are exposed.
Given that some banks are not sure of the full liability themselves, they certainly aren’t going to tell other banks what they think their exposure may be.
Why not? Because banks borrow from each other, both in the short and long term all the time via the money markets. If you were a bank with high exposure other banks would stop borrowing from you and that would be bad for business.
The glaringly obvious, right smack in your face, we don’t trust each other any more attitude is manifest for all to see in something known as the pips rate.
Just a very short while ago the rate at which banks borrowed from each other was 2pips, today, it is 22.
This means money is now expensive between banks and will therefore become very expensive for mere mortals like us at the bottom of the food chain.
Money being expensive means interest rates will go even higher. Homes will be repossessed, bankruptcies will increase and house prices will drop.
There is a silver lining to all this. Those who have never been able to get a foot on the property ladder will be able to and those wealth creators who have been lounging back on their big fat assets may find themselves in the position of having get out into the real world and re-create more wealth.
However, taking all of this into account, imagine if you were the Prime Minister and Christmas were around the corner.
Imagine if you were well aware that the rate of re-possessions and declared bankruptcies in the UK has shot up in the last quarter and was about to do so again in the next quarter, If you couldn’t be absolutely sure of how exposed or not the British banking institutions were to overseas debt.
Imagine if you were the Prime Minister of a country where the banks no longer trust each other. What would you do?
Would you want to see many more images on the tea time news of people wanting their money back from a British building society? Would you be happy to sit back and wait as it all unravels as it is so obviously about to?
Would you even wait until the Labour party conference, or would you call an election now? Or would that act in itself draw unwanted attention to what is happening?
We may be about to witness just how long a week in politics can be.
It's an interesting concept that Gordon Brown's future might hinge on the the impact of the latest 'smoke and mirrors' products from the financial industry, but I think you're absolutely right. The use of CDOs and other products generally described as 'derivatives' has enabled the financial institutions to magically re-classify extremely risky low-grade investments as if they were absolutely safe and secure. On top of that, because of the way these products are continually re-packaged and re-labelled, these same institutions can't even quantify the extent of their own risk exposure. The darker end of the car trade has what is known as a 'cut and shut' - two cars both written-off in accidents are each cut in half and the two 'good' ends welded together. A quick respray and a new set of number plates completes the transformation of a lethal wreck into a 'new' car. One wonders what's the point in having regulatory bodies like the FSA if the banks and others continue to be permitted to produce what is effectively the 'cut and shut' of the finance world. It's no wonder that the ordinary man in the street no longer has any trust whatsoever in the financial industry and its regulators.
Having read your comments about Northern Rock and the problems in the wider financial sector against 'The Frown' calling a snap election I have to say personally I don't think he will
I'm a Counsellor with a Debt Management Charity in Leeds and the writing has been on the wall for sometime that the easy credit and lax credit checking of the banks and finance houses would eventually lead to a burst and I have to say that the Labour Government has been quite content to look the other way for far to long despite record levels of debt
Hopefully the current situation can be contained to some extent but I feel that there will be more harsh realities hitting the banks before this whole sorry business is resolved
This is likely to be headline news for sometime and the idea of an election set against this backdrop seems unlikely, much as I want to see the back of Brown & Co & the Conservatives back in, I think the election won't come this year, Brown would not want daily news stories reminding the electorate of a financial crisis, mortgage rate increases and possible re-posessions and the record levels of debt that have built up largely on his watch whilst Chancellor
I wonder if Gollum & Co would have bailed out the bank if it was based in the South East...A Southern Rock?
Your version of what has taken place is the only one I understand. Why is it that every economic journalist you listen to has a different version of events? Is it because if they all said the same thing it would make boring radio and TV? Surely the facts are the facts and it doesn’t matter if each news programme is saying the same things if that is how it is. Thank you for throwing some light on this for those of us who like to know exactly what is happening in terms we can all appreciate and understand. You will go far my girl because you know how to talk to the rest of us like a human beings, don’t lose that ability.