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Northern Rock, Was This Fun To Watch Or What?

By Andy Shaw | January 23, 2010

Originally Posted 19th September 2007

First off I’ll cover why I think it happened, what the fallout will be and I’ll cover why you can make money thanks to this. I will also cover the events that caused this and why it may help to bring about changes in the future.

On a personal note this was the first time that I’ve been in the spotlight and been interacting with a lot of people when this sort of financial crisis has hit. I must admit to the fact that I really enjoyed it (a bit sad I know), but it sure beats Eastenders (well watching paint dry does that, but that’s not important right now), especially since this crisis is going to make me a lot of money.

What happened was that the sub-prime crisis in the states, led to losses and all the banks getting worried. This led to a reduction in the cash that flows around between them all. This meant that it was harder for the banks to borrow money and then in the end for the most exposed bank, who was only short term funded, it became too hard. So they had to tell the Bank of England (BOE) that they may not be able to meet their cash flow and asked to borrow some from them. They could not do this as they had to follow the rules laid down in banking codes of practice. Even if they could have met their commitments they were below the line and that meant speaking to BOE.

Then came into play the great British public, the BOE and especially The Federal Reserve (The Fed) really weren’t expecting that. But nothing motivates British people more than the threat of their hard earned being lost when they could have just moved it to another place. We are lazy, but not that lazy.

What this showed to me was the lack of financial literacy that there really is in people who have savings, which are actually the ones that you would expect had a fair bit of it. It is understandable that they were concerned to start with as you don’t expect to see people looking at a bank balance sheet and going, ‘well this is still quite safe’.

But when the BOE said that they would support them, then that should have been an end to it. From then on Northern Rock was the safest place in the country to have your money. But thanks to the lack of financial literacy this meant nothing to the public. So finally when the government stepped in and guaranteed the deposits, it brought an end to it.

But even then there were still some queues and I saw one person interviewed who really summed it up. ‘Why are you still looking to withdraw your money?’ asked the reporter, ‘Well I don’t believe a word the government says!’ Made me laugh.

The problem occurred (and I’m very grateful it did) because Northern Rock cashflowed itself very poorly. Primarily their market is mortgages and the average repayment time for a mortgage is 5 – 7 years. In other words, they’ll be getting their money back in 5 – 7 years. They have very low repossessions and arrears situations, so when you hear people say about their irresponsible lending they are not talking about the lending of 120% of purchase price.

It is that they geared themselves too highly on their cashflow. They were buying paper on a 30 day time, which meant that they had capital that came back every 5 – 7 years, but cashflow in place for 30 days. This was irresponsible and I didn’t know they were that exposed.

Northern Rock is very different from most lenders, most banks have protection from the fact that they are in so many markets whereas Northern Rock is very exposed in one area. Most banks gear themselves to 95% and then they have deposits that give them spare cashflow if you like.

So reckless lending in their case means poorly organised cashflow. It is almost unthinkable to believe that a bank had such a cavalier attitude towards its cashflow. But then we only get to see a very little bit of what really goes on anyway.

Well the good thing is that the BOE has now set the precedent and that means that money should now be safe in all banks, which means they will feel confident to lend again. So this crisis is adverted. I was sort of getting a bit of a sick pleasure watching it continue as I was thinking how much longer would the government and the BOE let it go on, as they were clearly trying to teach the money markets a lesson. I sort of hoped that they would wait a little while longer so that we could see which of the next financial institutions started to come unstuck. Even though it wouldn’t have happened, I would have really liked to see a queue at Barclays. This really would have put the cat amongst the pigeons!

I think the main area of further risk is from the fund managers who at times gear their investments to 99.999%, and this was looking like becoming a reality with all the falling values of shares. If the capital value of their assets (shares) fell by too much, then all of a sudden one or more of them could go under and they are the pension funds.

So that’s somewhat more worrying than a bank that has equity in its assets, but no cashflow. Now that would probably be called a catastrophe. This was where the danger sign was and I think this is why the government both held off warning them and then stepped in to stop it happening.

Those guys are probably the reason this mess started with the sub-prime market in the first place (just speculation here really of course as I don’t know this). Well that and the Fed raising rates in a knee-jerk way similar to the BOE. Actually they are worse than the BOE. I saw on a chart today that at one point they raised rates by ¾% in a day and then within six months there were two more raises, one at ¼% and one at ½%. Did they really think that this wouldn’t cause a problem like this?

The way they raised the rates will have caused this, they kept rates too low for too long and then over corrected just as the BOE have done for the last two rate rises at least (probably three). Funny thing is it’s almost exactly two years since the Fed made that very poor Robert Mugabe like financial decision and I say that it takes two years to see the entire roll out of effects from a rate rise. Coincidence? So once again they are forced to over correct, as will be the BOE.

I continually say this, but the BOE do not wait long enough to see the result of what a ¼% rise will do. They are too quick to follow it up if they do not see any change. The economy doesn’t move like that, it is much more like a big oil tanker. You HAVE to think where you want to be a long way in advance, historical information is only a guide and if you have not got people who can see what the effects are going to be steering the ship, then you will have continual over-corrections going on.

Don’t get me wrong, things are much better today than they have been for years, indeed things are a lot better managed and I do get the feeling that they are getting better in this area. But they should be able to keep the country on a great track without ever going below 4.5% or going above 5.25%. The fact that they can’t, says to me that they do not look ahead far enough and that they are looking at the wrong indicators to keep the country on track. It also says that there isn’t anyone on the committee with a pair of binoculars!

I now know that for a fact! How do I know that? Well none of them voted for a rate reduction last month! All nine voted to keep the rates the same and these so called and well paid experts are guiding our economy.

The last two rate rises I have said they should not have happened and the one before that I said was too soon. A poor quality pilot continually has to overcorrect to keep on course. Whereas a pilot who knows how to read the weather forecast can dead reckon his way through with ease.

I had a meeting with someone the other day who has read my book but wanted to offer me help in an area of business in return for me guiding him through a minefield. I don’t usually do this sort of thing, but he wrote a damn good email that sucked me in.

When he was here he said to me that I must get very frustrated that there are people with far less knowledge guiding the country than I have. I think he said they were far less financially literate. This was a very nice compliment to which I replied, I was not that literate and that they can wrap me up in clever terms in no time at all. He said, that’s not what I mean, you fully understand what’s happening, they don’t and that must be very frustrating. I said, “it’s just I seem to be able to read what’s really happening whereas they seem to be continuously reaching the wrong conclusions. Not only that, they still think if we’ve always done it that way then we should continue, whereas I always try to question accepted practices”.

OK enough of the boring stuff, now comes the bit why some of you pay to be here.

So what does this crisis mean for us and how can we use it to make money?!!

Firstly this will have put an end to the banks upward price cycle for interest rates, well at least for now. I was worried that they were going to give us another increase just to be sure they’d done the right thing before Christmas, but that now won’t be happening.

Who knows where their 2% inflation target will take them in the future! The problem is that I find interest rates quite difficult to predict as I’m dealing with decision makers who do not see the economy as clearly as I seem to. So predicting where they are going to go is somewhat tricky. Just as I start to get a feel for them, they change people on the committee, which is probably why they do that.

This should mean that rates will fall by ¼% next month or at the latest, the month after that. They won’t cut rates by a ½% as we are British and we react somewhat more refined than the Americans. I would hope that they cut rates again the following month and then do nothing for the four months following that.

Then they will be just about going into spring, the economy should be buoyant but not too buoyant and we should all be getting along. After that I have not looked into where the bank will send them. However, I do know what they should do and that would be reduce it by ¼% and then say that they are not going to look at them again for 3 months. They should change their policy and only look at the rates four times a year. But they won’t do that. And as I said, predicting people that don’t seem to see where the economy really is going is rather tricky and very irritating.

Next you have all of the confusion, because most property investors will be looking at what has just happened as a very bad thing, because they don’t understand what has happened. This is good news for us. Which should mean more landlords will be selling off their property, so you can buy at hopefully discounted rates. This coupled with the time of year means that there will be less competition from the first time buyer, and thanks to the ill conceived HIPS coming to 3 bed property’s and homeowners deciding to sit and wait rather than be among the first to learn, you should find the property market value wise, slows down for the autumn.

This is good for us, as it means we’ll have six months of a free range of buying, without the press saying ‘get on the ladder’, but with further speculation about the financial crisis and a house price crash, which will mean more landlords putting their properties on the market. Touch!

This also means as usual we can expect a reasonable lift in the property market next year of approx 12%. This crisis really has cleared the air for us and we can go out and buy with confidence, always protecting our cashflows of course and not over buying just because we are in a prime time. As we can see from events this week how not taking them seriously enough means that you can be in trouble.

If you want to stay ahead of other property investors though, I suggest you speak of all doom and gloom about the market and how you are only buying because you may as well put the money somewhere as you do not think it is safe in the banks. After all there’s no need to let all property investors know how good it’s going to be over the next six to nine months. Let the good times roll!

I couldn’t wait to see how this played out so that we could clearly have a direction to head in. I was so excited when it happened last Friday, as this is one of the reasons I set up the site, to be able to give clear direction to people right at the time when you can use it to make money. I thought it was going to kick off a few weeks earlier when Barclays went to the BOE, but unfortunately it didn’t, still the timing was made even better with the delay! Now just imagine if I had been running this site in 2002 when I found the market was undervalued by 30%! :-)

I knew it would work out best for us property investors. There is always a way to turn bad news and panic into profit. When these sorts of things happen in the future, there will be opportunities for making money, it just may mean changing the way we do something.

But there is no need to fear them, as having some clear thinking after one of these has happened is what makes being a member of this site really worthwhile. What is clarity worth to you now? And what will it be worth next time? ;-)

I had an email from a book buyer the other day saying ‘Sell me on why I should pay you £40/mth to be a member, as I already own 19 properties?’ I responded to him, ‘Well to someone like you this site is easily of value, as just one tip from me at the right time will enable you to make hundreds of thousands, so I think £40/mth is an investment waiting for that one tip, forget about everything else. But only you can decide if I’m right!’ He probably thought it was just a sales line.

Best Wishes


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Topics: Free Content, Government, Property, The Economy | Comments Off

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