Collateral Damage

The first bank run of the 2007 Credit Crisis is now in full swing, as hundreds line outside Britain's Northern Rock branches to withdraw their savings. Some had to wait for as long as 4-5 hours and the BBC reports that around $4 billion was withdrawn Friday and Saturday. The run continues today (Monday), despite BoE's offer of an unlimited line of credit.

If anyone had any remaining illusions as to the nature of the problem facing markets, these are now surely being swept away. The bank in question apparently had a very small exposure to sub-prime loans (though I understand it frequently made loans for up to 125% of house market value), yet it is facing a crisis because it relied on the interbank market for 70%+ of its funding, instead of traditional retail deposits. As the interbank market dried up, Northern Rock simply could not obtain the day to day funds needed to run its business.

And why did the interbank market dry up? Two reasons: (a) Lack of trust and (b) banks needed to keep the extra cash to plug their own holes, which opened up as SIV's imploded and hedge funds needed money for margin calls.

I spoke to a long-time associate in the interbank market in London and asked him for his gut feeling. His take was that we are currently in the eye of the storm - calm, but with more trouble to come. Interestingly, he was the second professional who described the situation in exactly the same way. Another thing he mentioned was that he never expected to see a bank run taking place on London's high street - Podunk, USA maybe... but not London. Ah, the deleterious effects of globalization....

I close with an observation of my own: some think that China and other emerging markets are immune from the Credit Crisis. I, however, view them as another domino which just happens to be standing a few places further down. Their turn will come, too.
_______________________________________________________________
Scary Update: The UK government promised to guarantee all Northern Rock deposits. To the depositors this may seem like a good idea. The scary part is that it may seem like a good idea to several less savory characters, too. Like, for instance, other bankers. Moral hazard, anyone?