Musings on a run on a bank.
Much has been written over the past few weeks about Northern Rock and the supervision of the banking system.Many people now know-if they have bothered to read or listen to even a fraction of what has been written –infinitely more than they knew before about the way the markets work.Greater minds than mine have analysed the cause and consequences so all I want to do is make some observations.
1.When is a guarantee not a use of public funds.
I heard a minister being interviewed-he was asked why the government had intervened on Northern Rock but would not put more money into the bankrupt pension schemes.The minister pointed out that there should be not misunderstanding the government had not put any public money into Northern Rock.I ask myself the question-does the £8billion that the Bank of England had advanced not count?.Would his attitude change if the guarantee was called-but maybe he wasn’t worried as the vast proportion of the deposit guarantee scheme would come from the banking sector only.I am left confused-who is guaranteeing what to whom?One commentator recently pointed out that Northern Rock has around £25 billion of deposits.Even if only half was in amounts of less than £35,000 then the providers of this guarantee would need to find £12.5 billion –where was this going to come from.
2 The Bank of England was right
We read that the £10billion Bank of England lifeline was shunned. The rest of the banking community did not need the liquidity-the only one they didn’t want to lend to was Northern Rock.So what we have is a sneeze in the banking system,with the major banks and other funding institutions taking stock of their risk and Northern Rock the riskiest player in town catching a serious cold.The only question now is whether the cold is going to turn into something more serious because having been a heavy smoker a cold can always go to the chest.
3 Shit happens
The events in the money markets were described as being 10 standard deviations away from the norm.In plain english this means that the financial engineers who created the business model convinced themselves and everybody involved that it was so unlikely to happen it could be ignored.How often do we hear about 100 year events-usually in the context of the weather or some other natural phenomenon.And guess what-how often do 100 year events seem to happen close to each other.Standard deviations are a traditional analysis that relies on normal distributions and based on statistical analysis.We all know about Lies ,damned lies and statistics-maybe we should ask a few more questions about who helped create the Northern Rock business model and who got paid to continuously roll out these mortgage backed securities and given the billions involved I cannot believe that there isn’t a city bonus or two that has relied on this gravy train.
4 Consumers were right to run for their money
I spoke with a number of city contacts and friends.Without exception they said they would have withdrawn money-each subject to a threshhold determined by their own wealth and the level of deposit guarantee.No one would have left more than £40,000.(why that level I do not know) .I suspect that each of these financially sophistcated individuals would be materially richer than the average depositor at Northern Rock.The authorities have therefore had a sharp lesson in consumer behaviour and need to take note.Furthermore I dispute that runs on banks are reserved for banana republics-it is only because we have a sophisticated financial system that we could create the situation in the first place and then manage it.If shit happens that sophisticated people conclude is so remote that they could create £100billion of financial instruments then your ordinary consumer is perfectly entitled to conclude that it can happen again and take his business elsewhere.Shareholders take the equity risk and expect an appropriate return-depositors get low returns and take low risk.Risk is ckearly more about perception than it is about statistical analysis.
5 The lesson everyone has forgotten to mention
The on line banking model failed-the capacity was inadequate and the depositors had no right of branch access.I am sure that this failure added to the loss in consumer confidence.No one has yet sat down and started talking about the levels of resilience and service required to maintain an on line banking service.If we live in a 24 hour on line digital world it is amazing how fast everyone demanded the right to deal through a branch.
I am sure this will rumble on but I believe at the moment the true culprits are still free to commit the crime again-assume away the risk and anything is possible until shit happens.
The consumer was right –the consumer must also be aware of on-line limitations.
Thank you to our guest blogger - he who knows from the inside!