I was talking to a neighbour at a Christmas party about finance and business and forex and that sort of thing, because that’s his line of work, and he told me something that I’ve not seen mentioned anywhere else.
It goes like this. Northern Rock was funded by lending money on long-term mortgages, and then borrowing short-term money (to make up the difference, because otherwise it would be running at too low a liquidity ratio) at a lower rate from banks. As long as it could keep borrowing from other banks at that lower rate, its business model was fine – booming, even.
But when the credit crunch began, because banks suddenly started worrying about all the CDOs and SIVs and their *real* values (if they have such a thing), it suddenly became very difficult – no, impossible – for Northern Rock to borrow money from those other UK banks. Which meant that suddenly it had a serious cashflow problem: all those short-term borrowings had to be paid back, but it had nobody else to borrow it from again (at all, not even on a short-term unfavourable rate), and not enough in its deposits to cover the payback and keep within its liquidity requirements as a bank.
Uh-oh. “Hello, is that the Bank of England? We have a little.. situation.”
Now, why was it only Northern Rock that had this problem? Why not any other UK clearing bank, since they’ve all been lending and borrowing like billy-o?
One other thing you have to add to the scenario: the European Central Bank made a huge amount of credit available in September, while the Bank of England didn’t, citing the risk of “moral hazard”. Two days later, though, it was lending to Northern Rock.
So why didn’t Northern Rock get its line of credit earlier from the ECB – which that GATA link above says was being used hugely? As in…
EU sources say Britain’s banks have been clamouring for money in Frankfurt, accounting for a substantial chunk of the €190 billion (£132 billion) lent last week in the ECB’s variable tender operation. “It is fair to say they have been borrowing from the ECB on a very large scale. It’s cheap, so why not?” said one official.
The UK banks were also major subscribers at the €50 billion issue of three-month loans on September 27 at 4.63 percent, and the earlier tender of €75 billion on September 13.
Because Northern Rock isn’t a European clearing bank. It’s only cleared for clearing (if you follow) in the UK. It couldn’t get those cheap funds from the ECB.
Quite possibly if Adam Applegarth and mates had been able to see the benefits of getting European clearing benefits and signed up there, this whole story would have been entirely different: no run on the bank, no Richard Branson trying to get his hands on it (despite Virgin not having any banking licence at all), no political embarrassment, lots of sooothing words about how the UK banking sector is insulated from the US sub-prime market. None of it true, but banking doesn’t rely on truth – it relies on trust, which is an entirely different thing.