Following on

I was planning yesterday to have put the whole thing to bed, but some emails that I have had today about yesterday's post are worth discussing.

Firstly, there is a point to clarify: when I say that it is a good thing if banks are able to go to the wall occasionally, I do not mean this because I and all capitalists are evil. I mean it because that reinforces the incentive that the management have to guard against the risk of their bank collapsing. If banks could never collapse (which is looking like a danger under Brown), then there is much less incentive for them to manage their risks prudently. This would harm shareholders (many of which are your pensions, not just evil capitalists) as well as customers (through less competitive and more reckless banks).

Secondly, a former colleague of mine was laughing about the idea of the FSA supervisor of NR ensuring that the last liquidity return was appropriately filed in triplicate, and not noticing the glaring holes in the figures. I would love to have been a fly on the wall in that week's one-to-one with their line manager. My ex colleague also admitted that he had shares in Northern Rock - well done, old friend, more cash down the pan. Maybe you should put yours under the mattress.

Finally, the implications for Gordon Brown are serious. Over this, and the economic climate generally, he is now being found out as a con artist over his claim to be the prudent manager of the economy. With levels of disposable income now lower than before Labour went into power, the economy's growth predictions being slashed and taxes still going up, the picture is looking far from rosy.

So, to finish, a basic lesson in economy management for the badger. When the economy is taking a nose-dive, putting taxes up in order to increase spending will worsen, not improve, that cycle. If you would like any further advice Mr Darling, you can email me on Major Gripe at Googlemail dot com.

Can't move on

Now that the Northern Rock episode has disappeared from the papers and seems to have slipped back under the radar, let's consider what happened and how it makes Gordon Brown look.

As soon as he arrived, fresh-faced, at number 11, one of his first (and most trumpeted) acts as Chancellor was to give the Bank of England independence on rate-setting. He then proceeded to write the Financial Services and Markets Act that created a single regulator for financial services firms. This took banking supervision away from the Bank of England and gave it to the FSA, because the Bank was seen by some key people as having done a poor job of it.

At this point, I should declare some expertise (lest you think I'm being misleading). I used to work in the Major Financial Groups Division at the FSA supervising major banking groups. So I do know what I am talking about. Not that I don't normally, but in this case I actually do.

The FSA's aim (unlikely to have been approved without the evil Scot's say-so) was to 'Maintain markets that [were] orderly, clean and efficient, and to get a fair deal for consumers'. It said, rightly in my opinion, that it was the sign of an advanced and competitive banking market if a bank went to the wall occasionally (through solvency or bank runs). Capital requirements were based around solvency, and liquidity requirements around being able to survive for 5 days (i.e. to the next weekend when the bank could be sold). We focused on credit controls and risk management to assess the stability of each bank, and based their capital requirements on the likelihood of them getting it wrong, but at the same time aimed not to stifle the innovation that would be part of any banking system.

Let's summarise quickly: banks assumed not to be keen on going bust, FSA monitoring the banks' overall controls, Bank of England still as lender of last resort to give a chance to bail itself out in a crunch, and the occasional bank slipping through that system (with deposits fully protected up to £30k and 20% refunded over £30k) seen as the bi-product of an efficient and competitive financial system.

So, what happens the first time that this was properly tested? Brown bails out on the system that he so carefully constructed, and has the new Chancellor step in with full depositor protection to avoid the bank going bust. Let's assume that it is no coincidence that the bank they are trying to save is very heavily concentrated in the North-East, one of Labour's core heartlands. It still shows that 'Bottler Brown' is not so bad a nickname, that he is petrified of anything undermining his reputation. Is this the sort of man that you want leading the country?

Finally, a mention must go out for the woman who appeared on BBC Breakfast saying that she would 'never trust banks again' and that 'in future, all of [her] money [was] going under the mattress':

seriously?have you never heard of burglars before? Space-cadet...

More on Northern Rock

A few follow-on thoughts from my previous post on Northern Rock and on the housing market today.

1. If Northern Rock are facing being put out of business, why in the name of all that is fiscally prudent are they running longer opening hours to allow more people to withdraw more money?
2. There was a letter into Metro this morning saying that it is the banks' fault for over-lending in sub-prime markets and that it isn't fair that customers should be punished by higher interest rates. Sorry to pass the buck back to you, but if you are pushed closer to default by a rise in interest rates then you have borrowed too much. Yes, the banks must take some responsibility for over-lending, but you too should take responsibility for over-borrowing.

1. Another letter to Metro slated property developers for making profit from doing up flats and houses and making them inhabitable again. The correspondent said that they were to blame for higher house prices. I'm afraid that in your ignorance you have blamed the wrong people. Property developers are putting their own funds at risk to make a small profit on each property. Furthermore, they are not raising house prices. By making more places inhabitable/desirable, they are in fact increasing the supply of homes and therefore diluting house price rises.

What is most interesting of all is how the Labour government has presided over a Thatcher-style credit boom while it has been increasing its tax take.
Sorry to get all 'political and stuff'.

You are the Rock upon which I build my bank

Sorry Jesus for ripping your line off in my title.

I'm really amazed at how stupid people can be when it comes to banks. Witness the drama being made out of the Northern Rock situation. People have so far withdrawn £1bn from the bank since its announcement that it was using Bank of England emergency funding. If ever there is a self-fulfilling prophesy, this is it.

It's quite simple. The banking system is fundamentally solvent but illiquid because they make more interest lending your money than they pay you for depositing it with them by lending it out for longer. If you go and demand your money, they have to give it to you - but they have given it to someone else as a loan for a long time. So they keep some deposits lying around in cash to ensure that enough people can get their deposits in normal circumstances. Its liquidity relies on lots and lots of confidence in the system, and lots of interbank lending on the money markets to back it up.

By panicking and pulling their money out, people are going to send a liquid bank solvent. It's the same 'me first' attitude that saw us run out of petrol last year because a few people started panic buying and the rest followed like drearily stupid sheep.

I wonder if this will hit Ginko Bank again...

Ditching the second one to get a first one?

I know that the subject of this post is a few days old, I meant to write about it earlier but I've had too much other stuff to write about with trips to A&E and all the snorting of live earwigs to be able to cover this topic. (Alright, I promise I'll stop going on about that soon, ok?)

There has been much coverage of the squeeze in the credit markets (it even crept into my last post) - an interesting and little known spillover effect happened online over the last week. Ginko Bank, the bank in Second Life, had a run on deposits as people rushed to withdraw their Linden Dollars. The pictures are very funny - a whole load of people's avatars (including, in the picture that I saw, one that looked like a fox or squirrel or something) queued at the ATMs desperately trying to pull all of their cash out of Second Life for fear of Ginko Bank collapsing. The effect was so severe that the bank had to cease operations and convert deposits into perpetual bonds. So, in fact, the events mirrored how deposit runs work in real life.

There isn't a lot to comment on about this except that it's a quirky reminder of the inherent fragility of banks and the extent to which they rely on confidence.

And no, I don't use Second Life.