The Bank Run begins in Europe

Page update: 17.02.08

The first domino has fallen. The 2007 Bank Run has begun in Europe. In the UK on Friday 14th, Saturday 15th and Monday 17th September 2007, one and a half million savers withdrew over three billion pounds (six billion dollars) from the Northern Rock bank and closed their accounts. Police had to be called to control anxious crowds all over the country. Pictures here, here and here.

More than twelve percent of the bank's 24 billion pounds in deposits was taken out over three days. Northern Rock's share price fell 31% in late trading on Friday 14th September, and another 35% on Monday the 15th. At this point Northern Rock's share price was down 77% on the year, giving it a market capitalisation of 1.2 billion pounds. The bank's website crashed as customers tried to get information and withdraw funds online.

Northern Rock is the UK's fifth largest mortgage lender. The bank is now preparing for a sell-off. One plan being discussed by City banksters is to break up the company's £100bn mortgage book and distribute it among other lenders. Justin Urquhart Stewart, of Seven Investment Management, said: "I expect that in a year's time, Northern Rock will not exist. As a brand it is shot. The question will be who will own it. It is a great shame. A perfectly good business will be strangled by circumstances."

The trouble started on Thursday 13th September 2007, when the Bank of England, as the UK lender of last resort, stepped in to offer emergency funding after Northern Rock had struggled to raise funds in the international money markets. The bank needed this money to finance its mortgage lending.

When the news got out, the bank run began. And banks other than Northern Rock were affected. In the UK, on Monday 17th September 2007, Alliance & Leicester bank shares were down 31% (50% down on the year), and Bradford & Bingley bank shares were down 15% (42% down on the year). Elsewhere, American banks, in particular, were vulnerable because of their balance sheet over-reliance on fiat paper composed of credit derivatives, collateralised debt obligations, credit default swaps and binary options. The culture of due diligence had been eroded in America during the Bush years.

Two on-the-hoof political interventions seemed to calm the bank run stampede. Both were unusual and suggested panicky, response-led economic management. First, in the UK on Monday 17th September 2007, the British Chancellor of the Exchequer, Alistair Darling, announced that the UK Government would guarantee all deposits held by customers of Northern Rock. Second, in the USA on Tuesday 18th September, the Federal Reserve Board cut American interest rates by half a percentage point in what was seen as a desperate bid to avert a Northern Rock-style banking crisis engulfing the United States. This highly unexpected decision now places extra pressure on the Bank of England to reduce British borrowing rates, as economists calculate the long-term cost of the credit crunch.

With the yen carry trade about to collapse in Japan, China aggressively on the brink of selling its primary tranche of seven trillion Federal Reserve Notes, and the NESARA announcements imminent, a worldwide collapse of the international financial system is just a heartbeat away.

This impending reality is becoming manifest in policy changes around the world. On the 19th September 2007, The Bank of England announced a surprise £10 billion cash injection into the British banking system. This action signalled a complete U-turn by BoE Governor Mervyn King from his habitual hands-off stance on issues of global financial turmoil. The Bank of England will now follow this move by allowing financial institutions access to three additional loans lasting three months. It is unclear how big this funding will be. More details here.

On the 20th September 2007, it became clear that Saudi Arabia, for the first time in its history, had refused to cut interest rates in lockstep with the US Federal Reserve Board. This signalled that the oil-rich Gulf kingdom was preparing to break the dollar currency peg in a move that risked setting off a stampede out of the dollar across the Middle East. This is a dangerous situation for the USA. The American dollar is already at an all-time low against the Euro and the Canadian dollar. Saudi Arabia has $800bn (£400bn) in their future generation fund, and the entire region has $3,500bn under management. Saudi Arabia and its neighbours face an inflationary threat and do not want to import an interest rate policy set for the recessionary conditions in the United States. More details here.

The flight from the American dollar is sharpening attention on gold stocks as a currency hedge. On the 18th September 2007, gold futures rose to a twenty seven year high (details here). Stories emerged that much of the gold held at the American Fort Knox Bullion Depository in Kentucky is not gold at all; it consists of facsimile lead bars painted a gold colour for presentation purposes. This is becoming noticeable as the gold paint fades. In the UK, it became apparent that not all the gold held by the Bank of England was fit for delivery. The gold held in the BoE vaults began to be accumulated in the early nineteenth century. It takes the form of gold bars, ingots and coins. Current methods of assessing quality have indicated flaws in the purity. Many of the gold bars contain cracks and fissures. The coins contain appreciable quantities of base metals. And much of the British gold lacks up-to-date assay certificates. More details here.

The homespun wisdom being articulated in England amongst the queuers outside Northern Rock was that it might be a good idea to travel with cash in hand for two or three weeks now, and to keep the vehicles full of petrol. Other necessary payments should be made on credit by plastic.

By the end of September 2007, when Northern Rock shares were 86% down on their year high, it became apparent that the bank had been forced to borrow £8 billion from the Bank of England in the previous two weeks just to stay solvent in the credit crunch. Northern Rock's shares had been the object of a short-selling feeding frenzy by speculators, and any attempt to sell the bank intact as a going concern looked doomed to failure. The view among the hedge funds at this time was that not only Northern Rock, but also Paragon, Bradford & Bingley, and Alliance & Leicester were UK banks which were likely to encounter serious liquidity problems soon, and would go under one by one as they were picked off by the speculators.

Elsewhere in Europe, news emerged from Frankfurt (Germany) that on Wednesday 26th September 2007, the European Central Bank’s emergency lending fund, which attracts a penal interest rate, was tapped for €3.9bn, the largest sum since October 2004. The surge in demand for the ECB’s marginal lending facility pointed to the continuing difficulties being faced by European banks as a result of the global credit squeeze. The ECB revealed no details about the borrower or borrowers involved.

Meanwhile, in the USA on Friday 29th September 2007, it was announced that Federal Government regulators had shut down NetBank because of an excessive level of mortgage defaults. At this point, NetBank held $2.5 billion in assets. This was the largest savings and loan failure in the USA for more than fourteen years. Customers with less than $100,000 deposited with NetBank were said to be protected by policies with the Federal Deposit Insurance Corporation.

In Europe, on Sunday 17th February 2008, the BBC reported that Northern Rock had finally gone under as an independent entity. After months of consultations, no private business consortium had come up with an offer for the bank which could satisfy the UK Government. Northern Rock was nationalised. It was a complete financial disaster for the City of London and a political disaster for the Labour Government. The upshot was that UK taxpayers were now subsidising the bank in loans and guarantees to other lenders to the tune of £55 billion. The decision was a body-blow to the bank's shareholders who, in the short term, would receive next-to-nothing for their shares.



Sources: BBC (London, UK) 13.09.07, 16.09.07, 17.09.07 and 17.02.08; The Press Association (London, UK) 16.09.07; Reuters (London, UK) 16.09.07; The Daily Telegraph (London, UK) 21.09.07; The Financial Times (London, UK) 27.09.07; Physorg.com (The Netherlands) 29.09.07 and The Independent on Sunday (London, UK) 30.09.07.



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