All entries for Wednesday 21 November 2007

November 21, 2007

Northern Rock: am I missing something?

Many of the front pages of the front pages of yesterday’s newspapers had the following headline: of yesterday’s newspapers had the following headline:

‘Taxpayers could face a multimillion-pound bill for the rescue of Northern Rock, after Alistair Darling refused to give a guarantee that the £24 billion Bank of England loan will ever be fully repaid.’

But what is the big deal?

Northern Rock had a bank run. This meant they lacked the liquidity to give all their depositors their money back. However this doesn’t mean that they didn’t have the assets. The loans that Northern Rock held are still good. Thus then government lent the bank this money in order to provide them with this liquidity, and then when the loans mature the bank will have the money in order to pay their government loan back. No problem

The only circumstance in which the loan couldn’t be paid back was if there was mass defaulting on loans. This could happen if there was a severe recession in the economy or if there was a severe drop in house prices (thus causing people to have negative equity on their homes). Most economists appear to predict a slowdown in growth in coming years; hence the first scenario won’t happen. In the US average house prices has recently fallen by 8%; thus the second scenario is a possibility.

But surely if there is going to be a massive bursting of the house-price bubble this would make a more interesting headline then noting that the government’s loan won’t be paid back?

Indeed what if this ‘giveaway’? In practice all it really will mean is that a lot of government money is, instead of being spent by the government, is being given to the Northern Rock depositors (i.e. a large group of randomly chosen people) so they can spend it instead.


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