In the end, UK’s fifth largest mortgage lender, Newcastle-based Northern Rock, had to go cap in hand to the Bank of England (or BoE) for some extra lending, after spending best part of last week doing some explaining to BOE and the Chancellor of the Exchequer.
Here is a bank with a solid mortgage book, which cannot raise the money it needs in the short-term money markets.
Northern Rock has enough money sitting in savers’ deposits accounts (£24bn to be exact), but it still required help from BoE. Why? Because it got caught up in its other, more important, source of funding – the money markets!
In short, this is what Northern Rock (and most other banks) have been doing in the past decade: bank borrows a chunk of cash from money markets world wide, lends this cash to mortgage borrowers, bundles up this loan in small chunks (called securitisation) and then sell chunks of this loan to other institutions to release its own cash… then repeats the trick… again, and then again!
However recent problems in US housing market stopped these cogs from turning on this perpetual motion machine. If the markets won’t provide capital at a reasonable price, Northern Rock can’t provide mortgages.
As Telegraph puts it:
“These recent seizures in the wholesale money markets are just the tip of the iceberg, the latest in a long line of debt problems that have been developing for several years. High street lenders are putting up their mortgage rates because money sourced in wholesale markets is getting more expensive because banks are getting more risk averse.
Suddenly a seemingly arcane problem that emerged in City dealing rooms is now a very real problem in the nation’s front rooms.“
Will it have any effect on wider mortgage market? Most certainly – because Northern Rock is not the only one feeling the pinch – they just happened to the first to come out in open. Observers think that Rock has been lending rather freely in recent years – to keep its mortgage business growing. It has been the first port of call for many buy-to-let mortgages, for mortgages at five times a borrower’s income, and for mortgages representing 125% of a home’s market value… and so on.
Rock (or Crock, as BBC’s Robert Peston called it) will not get this bailout from BoE for nothing. It will incur a penalty (1% of the borrowed amount), will face an uphill struggle to get its lost reputation back (its share price was already down 23% this lunch time)… and some heads are bound to roll – mainly in its senior management.
Is this a wake up call for other banks? Hardly… because many bankers have already been staying up all night for days wondering how they got in this mess in the first place!
Does It Affect Housing Market?
One thing is sure: banks’ lending criteria are bound to get tighter – so the easy credit is thing of the past. This may not be a bad thing in the long-term, but many people will find it harder to get a foot on to the property ladder.
What about BMV market then? Expect more deals in coming months as banks get tighter and letters demanding increased payments start landing on nation’s doormats.
Will these BMV deals stack? Well, that is another matter, and only time will tell.
As Alistair Darling said the other day, banks need to return to “good old fashioned banking”. Many bankers probably felt wide-eyed indignation on these comments but he had a point…. after all it took some one else to point out that the emperor had no clothes.
[tags]northern rock, debt, bmv, bail out, uk housing market, mortgages, cost of lending[/tags]
