Britain Rocked

Story Summary:

• British lender Northern Rock had to tap the Bank of England for some emergency funds, sparking panic as people lined up to withdraw their deposits
• Northern Rock's liquidity issues are specific to Northern Rock, a pure mortgage lender with little product diversification
• The British government has agreed to guarantee all of Northern Rock's deposits
• There is little evidence of a widespread credit crunch in the UK or globally. This is merely more panic. The global economy remains fundamentally sound

dir="ltr">Since telling King George III where to go and how to get there, Americans and Brits have enjoyed a symbiotic, almost sibling-like relationship with many familial similarities. Our political and legal system. Our monetary system. We speak a somewhat similar language. We even share a disdain of the French. And so it is with exasperated yet fraternal fondness we watch the UK struggle with its first legitimate subprime fallout (if you can even call it that). Apparently, British lender Northern Rock hit up the Bank of England for some emergency liquidity.

Stocks, Sterling Falls as Northern Rock Woes Deepen
By Natsuko Waki, International Business Times
https://www.ibtimes.com/articles/20070917/global-stocks.htm

Not to be outdone by American subprime hysteria, Brits actually queued up to withdraw their assets from the troubled bank—withdrawing as much as $2 billion from the bank on Friday.

How Bad Debt Infected the World
By the Staff, The Sunday Morning Herald
https://www.smh.com.au/news/business/how-bad-debt-infected-the-world/2007/09/16/1189881341872.html?page=fullpage#contentSwap2

Americans get a lot of grief from the rest of the world. We're allegedly loud, crass, profligate slobs, but at least at the height of subprime prime time here, we had the good sense not to line up outside a bank like extras in It's a Wonderful Life. Of course, the Brits do have a flair for the dramatic with their cravats and high teas. (We have nothing but love for our British brethren. Good natured ribbing is natural between siblings.)

What's going on here? Do Northern Rock's woes signal systemic problems? Nah. First, as we've discussed extensively in this space, this is a fake credit crunch. See MarketMinder commentary "Best Credit Crunch Ever" for more.

Second, Northern Rock's current issues are specific to Northern Rock. The company is nearly a pure-play mortgage lender, with limited exposure to other product lines. In fact, unlike a more traditional bank, 73% of its funding comes from wholesale markets rather than customer deposits. Because of recent credit market volatility, Northern Rock tapped the Bank of England for capital. Is this a death knell? Hardly—banks and lending institutions hit up central banks all the time to ease them through short-lived credit issues. It's what central banks are for.

So why all the howling hysteria? We honestly have no idea. The UK has its own version of the FDIC—the Financial Services Compensation Scheme (FCSC)—which insures deposits against bank insolvency. But Alistair Darling, the Chancellor of the Exchequer, announced the British government would guarantee all—not just the FCSC limit—but all Northern Rock's deposits. Maybe Brits just really enjoy standing in line—a national pastime, if you will, like cricket or bad cooking.

What's more, as this article points out, the reason there have been delays in getting deposits is not because the bank is insolvent, but operationally they were overwhelmed by so darned many people turning up at once!

UK's FSA Reiterates it Judges Northern Rock Solvent
By the Staff, Reuters

People have it backwards. They panicked because Northern Rock got a short-term loan, but the short-term loan is what's allowing Northern Rock to keep transacting withdrawals. Getting the loan was a rational, healthy business decision and a good thing for the bank and its customers, not a bad thing worthy of riot.

For a hint of what's to come in Britain, nervous investors should look to America. Starting in about February, the entire world went subprime-mad, convinced a relatively tiny sector could infect all of financials and even take down the economy. So what's happened? New Century filed for bankruptcy, but the traditional lenders are weathering the storm just fine. Some have tightened lending standards, but other than that, it seems to be business as usual. In fact, mortgage rates are lower today than this summer, and globally long-term rates are falling again—which you generally don't see in a legitimate credit crunch. Sure, the US economy took a breather in Q1 but roared back in Q2 and US stocks are positive on the year. We haven't seen blistering returns just yet, but it's hardly the Armageddon the media's insisted.

The world's far more correlated than folks fathom, which means it shouldn't surprise that those copycats across the pond have a troubled lender or two. But it also means a healthy growing global economy will drag both the UK and US along with it. There are plenty of reasons to be bullish right now—this article points out four good ones:

4 Reasons to Be Upbeat About the Economy
By James Pethokoukis, US News
MarketMinder thinks there are plenty more than four, but this is a good start.

Brits queuing up outside one troubled lender isn't evidence of systemic problems. Long-term rates are benign, earnings are walloping expectations (and no one's talking about it! Bullish!), the global economy is growing, and stocks look cheap to us. What the Brits need now is a good dose of relative thinking, global perspective, and maybe a noogie or two.