Money
Managing your money
Northern Rock - a drama, not a crisis?
Queues of anxious account holders in the high streets...the Bank of England stepping in, assuring us there's no problem...we haven't seen anything like this in years, writes John Andrews
Is Northern Rock shakier than its name suggests? Their problem looks a bit like this:
Suppose you have a decent income, but rely on your credit card to help you get through the period between pay cheques. By temporarily lending you money, the credit card company helps ease your short-term cash flow.
Now imagine that, all of a sudden, the credit card company freezes your card – it stops lending you money. This causes you an immediate problem, even if your finances remain in reasonably good shape.
Roughly speaking, this is what Northern Rock has been facing, on a very large scale. We're told that the company is in fundamentally good shape, but is suffering what institutions like to refer to as a "liquidity crisis".
It started this summer. Financial markets have been in a state of turmoil, and still are. The most important reasons lie in the property markets, particularly in America. Over the past few years, vast numbers of mortgages have been made to people with poor credit history, who aren't good at paying their debts. While interest rates were historically low, these people could keep up with their payments; but as rates rose, many struggled to keep up, and defaulted on their loans.
To cut a long and very complicated story short, this led to huge problems for many banks and building societies, and these problems have had a knock-on effect on other financial markets. Most recently, banks have cut back drastically on the money they lend to other banks.
Northern Rock has been particularly badly hit by this. It relies on loans from other banks; there's nothing inherently wrong with this, but recently these loans have dried to a trickle.
The Government has stepped in, in the place of the banks Northern Rock would normally have borrowed from, and more or less said that "you're a solid company, so we're prepared to lend you what it takes to get over what seems to be a short-term situation."
Mr Brown doesn't want the problem to spread - it could result in widespread panic, with many other banks and building societies seeing angry crowds gathering at their doors.
Is this particular storm over? Assuming that Northern Rock is really as sound as we're being told, and in the absence of any unknown and damaging revelations, it could well be.
The underlying problems still need to be sorted out, and it's likely that changes will have to be made in this industry.
Some hard questions have to be asked, and property markets look set for a testing time. For many people, mortgages will be harder to come by. Once again, if you're a saver or investor, the old truths come to the surface: spread your risks, diversify your investments, and don't put all your eggs in one basket.
* Dr John Andrews is a British investment management consultant and writer, living in Switzerland. His views are personal, and you should always seek independent financial advice.
