Northern Rock - important or not?

September 07

Two weeks ago, something odd happened... to put it mildly.

We have all, by now, seen the pictures of savers queuing up outside of Northern Rock branches, trying to get their savings out. We have also seen the spectacle of senior politicians making headline grabbing promises that, on closer analysis, seem to mean very little.

This article is in two parts - firstly a quick review of what happened. Secondly, some opinions about what it might mean for property investors.

Right, time for a quick bit of background.

A long time ago (in a galaxy far, far, away), there were these things called Building Societies. People paid into deposit accounts, and earnt some interest. Then, the Building Societies made loans to other people, and charged them a higher rate of interest. The difference paid for the running costs of the Building Societies, and any left over went back to the people with deposit accounts in the form of extra payments.

Then the Building Societies figured that, if they were banks, they could give the any left over to shareholders instead of savers. Oh, and by the way, have some extra options in the kinds of transactions they were allowed to do. A set of deals were stuck whereby savers got some so-called free shares, and a lot more got sold to the general public and other financial institutions. (The shares were not really free, in the sense that the savers had owned the building societies anyway, just in a slightly different way.)

Nowadays, some of these make loads of loans, but rather than financing them out of savers money, they in turn borrow the money from other banks.

For about ten years, this worked.

In the wake of the US market crash, however, the banks with loads of cash have gotten cold feet about lending to each other, and jacked up the rates at which they will do so… or just plain stopped.

This is when the Central Banks, in our case the BoE have to step is as what is called the Lender of Last Resort. The BoE does this lending all the time on an overnight basis, and again, nothing too unusual is seen.

Where the Northern Rock deal is odd is that the BoE have agreed to lend a LOT of money, on a rather longer basis… the day after they said they would not. I now understand that the Treasury and the FSA had been leaning on them heavily, and reminding them that while they are bankers, they are also public servants. (Crikey, I feel like a journalist now - I have sources!)

Northern Rock got into this problem because, compared to many other lenders, they borrow rather MORE on the money markets, and fund their loans far less just from savers money.

Under the circumstances, the savers have been queuing up to get their money out in cash, and the shareholders have seen their Northern Rock shares worth about a third less than they were yesterday.

So, investing in the Northern Rock turned out not to be that great a thing to do.

Investing in is, of course, different from saving with the bank.

The Government announced a bailout that, on closer inspection did not promise TOO much.

In a bank (like Northern Rock), then there are savers, who put money into individual accounts. These people were already partially covered by the Financial Services Compensation Scheme. This would cover up to £31,700 - being all of the first £2000, plus 90% of the next £33,000 - lost by any individual.

What the Government have done is said that savers are fully protected. Though it feels a bit of an empty promise, since everyone is in agreement that the Northern Rock has plenty enough assets to cover the payouts if needed - it is just immediate cash that it is short of.

So, what does this mean for property investors?

My take is that this is not a CAUSE of anything... it is an EFFECT of something big - the complete implosion of the US Sub-Prime market (that is to say, a huge number of mortgage foreclosures happening in the US.)

As a result of this, lenders are getting very, very, cold feet.

Expect to see the end of the days of easy finance for buy to let.

A smaller version of this happened in the specialised world of gifted-deposit mortgages about three years ago. Suddenly, lenders got cold feet about that kind of loan, and the market dried up within the space of a few weeks...

... but then it came back, within about 6 months, everything was moving again.

However, in the meantime, be very, very, careful about your creative finance deals (find a solicitor and a broker who really understand them, and the market carefully.)

In the long term, I see this as a good thing (for me, anyway.) I could do with a bit of a shakeout of the B2L market, and seeing amateurs get cold feet and leave. Of course, it would impact both cashflow (if rates go up) and equity (if the market slides down) for a short while... but there is an opportunity for the buyer in this kind of market. Getting hold of motivated vendors is likely to get EASIER.

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However, and this is important... these are INTERESTING TIMES, as the saying goes. My hedge fund friends tell me that the kinds of things they are seeing in the global markets have not happened since the 1920s/1930s. Runs on Banks were meant to be things that last happened in depression America, not last week in the North East of England.

I think the curves are going to get very jagged over the next few years... do NOT base your investment strategy on what has happened to work over the last ten.

This is just the feature article from the September 07 newsletter. Subscribe for market comment, forthcoming events, and more.

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