I don't pretend to know much about these things - so can someone enlighten me about this:- From what I've heard on the box it seems the initial Northern Rock problems started because of people failing to meet their mortgage commitments. No doubt this is a gross over-simplification but those properties surely then became the property of the lending bank/building Soc? As such it would be put straight back on the market and another mortgage issued. I mean it's not as if the loss of the mortage payer was a loss of the value of each property to the bank?
I don't think this is the case directly, but only indirectly.
The bank's problem, AIUI, was that they were not lending their own money or that of depositors, but money they borrowed on the money markets on short term contracts. They were using this short-term money to lend to long-term borrowers, expecting that by the time the short loans were due for repayment, they would readily be able to obtain further short-term loans to take their place. This source of ready money dried up as a result of money market lenders perceiving the quality of NR's mortgage book as too risky, as a result of a perhaps somewhat above average incidence of reports, as you say, of some sub-prime borrowers throwing in the towel.
No they would not. What would happen is that the lender would repossess and sell the properties, evicting the owner, then take from the sale proceeds what they're owed on the loan, and give the rest back to the now ex owner of the property. Often, though, the proceeds won't be enough to cover the loan, and the ex-owner will continue to owe the balance but may not have the means to pay it. This may therefore leave the lender with a worse problem than before, i.e. a certain loss rather than a potential one.
In a falling market, properties can (and do) end up being worth less than the value of the loans secured on them. And repossession sales are typically done at auction, in a hurry, and will realise even lower sale proceeeds than when one takes one's time marketing them properly.
No, it's because N Rock borrowed money short term (e.g. for 6 months) and loaned it out long term (25 years). When the 6 months was up they thought they could borrow some more (or 'borrow it again') at similar rates - but nobody would lend them any, because of worries over dodgy loans (not NR in particular).
NR was loaning out MUCH MUCH more than they collected in deposits, unlike most other lenders who were closer to in balance (or who had larger cash stockpiles to start with).
No. NR financed its business using short term loans. Owing to the sub-prime fiasco in the USA, banks don't want to lend so much money, so NR could not meet its obligations.
I'm sure someone else will post a more detailed answer.
You could read my article, which explains in plain language how the mortgage markets worked and how they failed. What happened at NR was a variant on failure to resell mortgage-backs into the securitisation market. Once they couldn't raise new cash, they couldn't make new mortgages, and what they had were business costs without business profits.
The proximate cause seems to have been some form of conduit for short-term funding (I'm guessing something similar to an SIV, possibly run through Granite). That will be where cash was needed to refund some short-term loans and they basically didn't have the cashflow to do it. Nevertheless, the real problem was the seizing up of the securitisation system.
Banks usually don't. The problem was its business model broke down.
Essentially it was lending a large amount at rate X% and borrowing the this large amount at rate Y%. As long as X% was sufficiently > Y% all was ok.
However its short term borrowing rate Y% rose relative to the mortgage rate X% and the equation broke down.
The break down in correlation between Y% and X% should have been modelled in their risk management systems, both as credit risk and basis risk.
NR's problems should not be confused with the US subprime problems. Although the US subprime fiasco did trigger the rise in the cost of short term borrowing.
Bank's don't usually what? Have money to support the loans that they have written?
I think you'll find that the normal business model is that they do.
What risk management system?
NR's lending policy had 90% of their loans supported by short term funds that they renewed, IIRC every two years. The terms that they borrowed on were not linked to the terms of the loans that that gave (which *would* be normal banking practice). As soon as they found that they could not renew those loans on acceptable terms they were f****d. They had nowhere to go. They couldn't increase the rate charged to borrowers because the terms of these loans didn't allow this, and they couldn't ride out the short term loss on each unfunded loan because too big a percentage of their book were these potentially loss making loans and they had insufficient profitable ones to cover that loss.
No they borrow and lend. Normally banks like this borrow from small savers. But it isn't their money it is still just a loan.
Indeed!
I'm not sure what you mean here. There are normally differences between the borrow and lend mechanisms/rate. They maybe different terms, fixed/float based on different instruments, libor, gilts, bonds, swaps even different currencies. There is normally some kind of risk. You may try to hedge it but this is normally not perfect.
Yebbut they should have been able to ride out a few months more than they did. AIUI the collapse was triggered by a collapse in confidence as much as anything else. So not only were they facing higher funding costs due to the credit crunch they faced higher funding costs due to perceived credit/default risk. This of course was a vicious circle.
In normal circumstance one would have expected them to have been able to offload their mortgages to another bank but I guess that idea had just gone out of fashion with a vengeance. So I guess that comes under liquidity risk.
"My god how could we have known, it was a twenty sigma event!!". Tossers ;o)
Hmmmmm. So they go to the BofE and lodge mortgages as collateral. The BofE says it will give 1.00 on 1.05 of mortgages and will charge them a penalty (1% IIRC) above the bank rate for borrowing this money.
This put them in the position of running the business again? I read somewhere that the average on the mortgage book was thought to be just shy of 6% whereas the bank would have been charging 6.75% (based on the
1% penalty) then and 6.25% now.
I'm finding it hard to see how NR were doing anything more than accumulating taxpayer debt.
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