Nov 04 2007
Different ways of helping banks in a credit crunch
In the USA the Fed has decided to cut interest rates and make substantial sums available to the markets generally, to allow banks and mortgage institutions room to adjust to the reality that they have lost money on over aggressive lending conceived when market interest rates were much lower. At the same time US banks are coming out with substantial write offs to their CDO/sub prime books, making rapid strides towards "repricing" risk. This is important, as once it is completed shareholders and market participants can see what the underlying profitability of these businesses is, what their dividend paying power is, and whether any of them need to be put into the banking equivalent of run off or need to be taken over by stronger banks.CEOs of banks reporting large losses are under pressure to resign in the media and sometimes in the board rooms. The dollar has plunged as interest rates have fallen. Markets believe interest rates will be cut further, despite the Fed’s attempt to suggest they have now done enough and there are still some inflationary worries.
The likely outcome in the USA is a rapid movement to more conservatively stated balance sheets, some management change, and sufficient Fed action to prevent recession.
In the UK the Bank of England has been most reluctant to make money available to the seized up money markets, and has refused to cut interest rates. As a result the Bank has effectively lost control of short term interest rates, which have often been considerably higher in the market than the Monetary Policy Committee Base Rate would imply. The extra tightening of monetary conditions has been compounded by the surge in the pound against the dollar, which makes it more difficult to export from the UK to the dollar zone and makes it more attractive for businesses to divert production to the dollar area from the UK. It has the beneficial effect of limiting the impact of rising commodity prices (priced in dollars) on our inflation rate. The Chancellor and the Governor of the Bank have lectured the financial sector on the foolishness of their lending and has told them there can be no bail outs.
Yet under the pressure of a run on Northern Rock the authorities then made the extraordinary decision to guarantee all Northern Rock’s deposits and to make available however much money it took to refinance Northern Rock’s lending book.We now know this has required more than ??23 billion so far. The Bank promised to make similar facilities available to any other bank in trouble.
This website has been critical of both sets of decisions by the UK authorities. It seemed crazy to starve the money markets of cash in a way designed to trigger a run on one or more bank. It seemed odd then to offer a blanket guarantee to one institution and promise a matching policy for any other in trouble. It made all the speeches on the dangers of moral hazard meaningless.
The Bank should now change both policies.
The first imperative is to extricate the taxpayer from the Northern Rock position. This could be done by
a) finding a bidder who will take Northern Rock’s assets, paying back the Bank of England loan
or
b) finding a bidder who will take Northern Rock over and who will pay off some of the Bank’s loan and accept a timetable for paying off the rest with interest against a decent covenant to protect the taxpayer
or
c) requiring the Northern Rock to run off its business in an orderly way to generate the cash needed to repay the loan
At the same time the Bank needs to reassert control over the money markets by supplying sufficient general liquidity to bring market rates into line with Base rate. Inflation control should be exerted by gaining greater control over public spending and by raising productivity levels in the ailing public sector. As this programme starts to work interest rates should be reduced.
John Redwood has been the Member of Parliament for Wokingham since 1987. First attending Kent College, Canterbury, he graduated from Magdalen College...
Actually when we think about it Labour’s naive gesture to guarantee deposits is in keeping with Labour’s quick-fix/quick fail economic strategy. Labour just do not understand the dynamics of finance. At least Clinton had the sense to call on Alan Blinder for advice but Gordon Brown, the self-styled economics guru, is just too arrogant to listen to anyone else. I’ve always believed that the day we stop listening to others is the day we stop learning. Gordon Brown stopped learning a long time ago does not know how to deal with the problems resulting from the sub-prime crisis.
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[...] cpowell wrote an interesting post today onHere’s a quick excerptIn the USA the Fed has decided to cut interest rates and make substantial sums available to the markets generally, to allow banks and mortgage institutions room to adjust to the reality that they have lost money on over aggressive … [...]
A couple of things.
First, the sub-prime business should remind us once again that commercial banks are an ever-present danger to the world economy, and, what’s more, fundamentally ill-suited to the job they have allotted themselves. In a world where the marginal cost of distributing information is virtually zero, there is no need at all for organizations which claim to be able to allocate people’s savings better than the people themselves can. Commercial banks are a 17th century technology, and about as appropriate to today’s world as most of the rest of 17th century technology. Time to plan to get rid of them altogether.
Second, bank runs are not uncommon (I’ve seen probably a dozen or more in Asia), and there is a set play-book which gets you through. If you have enough money, or have a guarantor of last resort, you publicize the fact hugely, and then keep all branches open all night, if necessary, in order to let depositors take out as much money as they want. Ie, you pile up the money in the shop window and let the customers come. After a day or possibly two, it’s over.
The real question I think is why on earth nobody either at Bank of England or at the Treasury, or indeed in the City, knew the playbook? (Is there no-one at Bank of England who didn’t help the runs on Standard Chartered and Citibank in HK about 10yrs ago? I don’t believe it.) To repeat: bank runs are not particularly unusual in the world. And yet those in charge of institutions at all levels, cocked it up. Why wasn’t Northern Rock’s ceo all over the media saying he was staying open? Why were’t the branches open ’til midnight, once the loan guarantees were given? Why did the Darlings (and the Osbornes, I’m sorry to say) of this world get publicly involved? Why was our state broadcaster (BBC) putting out material which, in my view, was very nearly the equivalent of shouting “fire” in a crowded theatre? All institutions involved, it seems to me, played themselves down to a level of cascading incompetence which infinitely worsened Northern Rock’s plight, and has ultimately landed the taxpayer with this huge bill, and essentially destroyed the principles of prudent regulation. Heads should roll, and not just at Northern Rock!
Three. If Northern Rock really has a liquidity problem rather than a balance sheet problem, then why not turn the thing into a listed money-market mutual fund backed by the underlying assets? If it’s just a liquidity problem, and people want their money out, the value of the money-market certificate falls below its net asset value, and the market gets to work.
OK, signing off. . . . the Northern Rock debacle casts a harsh light on the deteriorated infrastructure of our public life.
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