Tim Worstall

Continental Illinois

That’s the Bubba! I’ve been scratching my head for days now, there was something I couldn’t quite remember about the whole Northern Rock thing. Hadn’t we actually been here before? A bank borrowing short on the commercial markets to lend long: said bank going bust when it couldn’t roll over it’s paper? Jeff Randall reminds me:

More than 20 years ago, William Ogden, then chairman of an insolvent US
bank, Continental Illinois, warned: "A modern run on a bank doesn’t
always show up in lines at the teller windows, but in an increasing
erosion of its capacity to purchase large blocks of funds in money
markets."

Back in 1984. Guess we’re seeing that old truism in action again: you get a banking crisis once every generation, it comes along just after the people who remember the last one have retired. That is, there’s no longer anyone around to tell you not to be so damn stupid.

In

4 responses

  1. Bob B Avatar
    Bob B

    Good for Jeff Randall to be so utterly explicit in pointing out just how unusual is the North Rock’s business model.
    Other commentary has been more politely circuitous – or circumspect – in questioning whether Northern Rock is a “deposit taking institution” at all rather than “an arbitraging operation between different segments in the (vast) market for loans”.
    As reported, only a quarter of Northern Rock’s mortages were funded through cash deposits and the remainder through borrowing wholesale on the money market, which is why it came unstuck as banks (or deposit taking institutions) became reluctant to lend to other financial institutions for longer than a day for fear of being left holding duff collateral initially spun out by American institutions which had bought in securitised sub-prime mortgages. Btw it really is amazing how America, with so many Nobel laureates in economics, gets into these situations.
    The Bank of England had no special obligation to rescue whatever Northern Rock was from the consequences of its own business model. The Bank of England (rationally) changed course this week when it became evident that the immediate risks from a contagious spread of failing confidence in financial institutions outweighed more distant risks from moral hazard – namely financial institutions subsequently engaging in more risky lending in the search for greater rewards with a (new found) expectation that the Bank of England will bail them out if (or when) market events become unpropitious.
    But then we all have to contend with the northern lobby and its determination to believe that London is engaged in a permanent conspiracy against the north, as well as the scottish lobby, which believes there is a perennial English conspiracy against Scotland and is determined to ensure that whoever is found to be a fault for all this, it won’t be Gordon Brown or Alistair Darling, who are both Scots.
    Btw – I must declare an interest: Jeff Randall and I share the same alma mater.

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  2. JH Avatar
    JH

    I’ve been thinking the same thing: this has been a classic asset-liability mismatch, the last of which I’m sure we haven’t seen. But I thought this was one of the first things that anyone entering the world of finance was taught. If not, it certainly should be.

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  3. dearieme Avatar
    dearieme

    “Nobel laureates in economics”; it is my self-appointed duty to point out that the Nobel Prize in Economics is bogus: it’s a quasi-Nobel prize unmentioned in the old boy’s will, a paean of self-praise by a bunch of rampant egotists, a fakery that justly caricatures much of their “work”, a splendid piece of evidence of the hubris of a bunch of ‘social scientists’ who are oh so proud of having learned a wee bit of calculus ………

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  4. EclectEcon Avatar
    EclectEcon

    Bailing Out Banks: Can You Say “Moral Hazard”?

    Northern Rock, a smallish bank in the UK, recently faced a potential liquidity shortage when it could no longer convert some of its assets tied up in US sub-prime mortgages into ready cash because nobody would buy those assets at any price other than a…

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