Banking magic: the Northern Rock
The Northern Rock mortgage bank got itself into trouble by expanding much faster than it’s deposits and thereby needing to go to the wholesale markets to borrow more money to fund it’s mortgages.
Quite ridulously it ended up taking almost 20% of the entire UK mortgage market in the first half of 2007 by doing this which is pretty amazing considering that it’s far from being a large mortgage bank. Naturally, that rapid growth was a sure sign of problems ahead and just two months after making that announcement the bank made another one saying that it was in trouble.
With such a large customer base, the government were forced to intervene to support the bank, to the tune of £25 billion ($50 billion!) which is around $2000 for each family in the country.
Naturally, they want their money back but that’s not so simple. Yes, the bank has assets behind it but those assets are mortgages and not realistically useable to get cash directly anytime soon. Therefore, all kinds of financial engineering projects have been proposed to get the bank back on an even keel. Unfortunately, nobody wants to cover that £25 billion so the government has just proposed the sale of £25 billion of bonds to fund it.
Great, but… who would buy £25 billion of bonds from a bust bank? Well, actually, the government would or rather it will back the bonds with a guarantee which amounts to the same thing. Doesn’t that mean that the government is still out £25 billion. Emm, yes, it does.
Copyright © 2007-2008 by A Time of Magic. All rights reserved.
