We've heard a lot about the downsides of mortage securitization recently: how spreading the risk has also made it difficult for strapped borrowers to obtain workouts, while obscuring the extent of the financial system's exposure. But here's a benefit you aren't hearing much about: no one in America is currently worried about bank runs. In England, on the other hand, where one of the biggest subprime lenders was also a major bank, the government has stepped in to guarantee all of Northern Rock's deposits in order to prevent a solvency crisis for the institution:
News that U.K. Chancellor of the Exchequer Alistair Darling, who oversees the Treasury, together with the Bank of England, had taken the highly unusual step of guaranteeing all deposits at Northern Rock, combined with an unscheduled £4.4 billion ($8.78 billion) injection from the central bank, brought a measure of calm to depositors and investors yesterday. A Treasury spokesman said the guarantee extends to any solvent bank in similar circumstances.Northern Rock said that lines at its branches and traffic at its call centers had decreased sharply. In London yesterday, Northern Rock's shares rose 8.2% to 306 pence ($6.11), after losing about 30% on each of the two previous trading days. Shares of other U.K. mortgage lenders bounced back sharply as worries eased.
Does the UK have the equivalent of FDIC insurance?
Most reporters (and, for that matter, most academics and most politicians) don't understand securitization. So an actual explanation of the mortgage market is beyond them.
Dr. Manhattan: Yes - 100% up to £2000, and 90% of the next £33,000.
Well,
we may not have bank runs, but that does not mean there are no "runs" by investors. Bear Stearns essentially had to bail out (just like the UK is) 2 of its hedge funds it manages because investors demanded their capital back.
Yes, there is the advantage that this leaves the government out of it, and the parties are all wealthy. However, the concern about the ability of parties to satisfy requests of capital have not left the building.
Now the question is this: say we left the scuritization in the dust, and never had this financial instrument in the market. I would suggest that the number of homes bought would not have risen to such obscene levels, meaning the rise in home prices would have been more moderate, leading to everyone having smaller mortgages in the first place, and many, many more people would have been denied loans as the banks would have taken on the additional risk. As such, we never would have had the bubble, creating the very financial crisis we have now, which is causing the UK Bank run.
"in order to prevent a solvency crisis for the institution"
A liquidity crisis, Megan_McArdle, not a solvency crisis.
No, they already had their liquidity crisis. It was the fact that a bank run threatened to turn this into a solvency crisis that caused the BOE to step in.
Megan_McArdle: A "solvency crisis" arising purely from illiquidity counts as a liquidity crisis and not a solvency crisis. If you're going to count insolvency arising purely from illiquidity as an insolvency crisis, the distinction between the two is meaningless. (Incidentally, I do happen to think the distinction is meaningless -- but you don't.)
As the excerpt makes clear, the BOE is only offering protection for solvent institutions, and the problem here was merely timing of payments.
Megan,
I think your analysis doesn't hold. Northern rock is not a subprime lender. It suffered a liquidity crisis because it relied heavily on securitisation to fund its loans. When the demand for all mortgaged backed assets dried up they had to get emergency funds which precipitated the run by their depositors. So the run was caused by securitisation and cannot be used to show what securitisation prevents.
At any rate that's my understanding of what Martin Wolf's saying in the FT.
Northern Rock is not a subprime lender.
I bet there are lots of Blackadder jokes about "Chancellor Darling" flying around over in England...
Imagine the press conferences..."Chancellor Darling, could you comment on your recent action related to Northern Rock?" "If I may follow up, Chancellor Darling, ..." Poor guy.
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