17 September 2007

The first post-modern bank run

There is a reason why people do not paint landscapes in a hurricane. The next gust is too likely to change the scene. Also, one gets wet. For the same reason, there is little purpose in describing in detail the ongoing run on Northern Rock, the British bank suffering most from the great credit crunch of 2007.

Know this, and you know enough: when “the Rock” – now nicknamed “the Crock” by wags in Britain’s financial press – unveiled its deal last week with the Bank of England over access to emergency funds, it effectively announced its own demise.

Will anyone catch Britain’s fifth largest mortgage lender, currently in freefall? The Rock’s share price fell by more than 30% last Friday. As of this moment on Monday morning, fewer than three hours into trading, we already see an equivalent drop.

Depositors are lining up to withdraw funds from branches across the country, just as they did on Friday and Saturday. Invisibly, holders of “Internet savings accounts” are doing the same online, and confusing queues in cyberspace force frustrating waits there, too.

A secondary question is, if no one is prepared to catch this bank in free fall, what will the mess look like later, for whom? Watch the herd. Analysts have gone from describing this last week as a potential “one-bank-collapse” to describing it today as a “systemic threat”.

Efforts by executives and policymakers to renew confidence among depositors so far seem to be falling on deaf ears. This is the nature of any bank run, but we have some novel ingredients, too.

Alistair Darling, the Chancellor, went on BBC Radio 4 this morning to reassure depositors that, because of the Bank of England’s pledge of emergency funds, the Rock really did have enough money for them, and their deposits were secure. In theory, this kind of reassurance persuades depositors that they need not withdraw.

However, in practice, the reaction has so far been the exact opposite. The Bank of England’s pledge and Darling’s reassurances, as received by depositors in a highly competitive market, imply no reason not to withdraw.

Add to this the fact that online depositors, since their relationships with the bank exist solely in the “virtual” realm of cyberspace, evidently feel no customer loyalty whatsoever.

The crisis at Northern Rock is therefore neither merely a matter of one bank’s potential fall, nor merely a source of systemic risk. It is Britain’s first post-modern bank run, with individuals showing how very little interest they have in their relationships with institutions, public and private. Institutions therefore fail utterly to speak effectively to disinterested individuals.

So while many people now say that trust in the system is breaking, it would be more accurate to say that trust was already broken, over years, in advance of this crisis. An erosion of trust created the conditions for today’s scene. The risk was foreseeable but remained invisible as long as the financial markets’ liquidity boom continued.

By anchoring its operations in the fickle wholesale credit market, the Rock showed how shallow its commitments really were. Today, by withdrawing funds so rapidly even when the risk of non-collection is zero, depositors are showing equally shallow loyalty to the bank.

It shall be interesting to see where else, in the current credit squeeze, real market values get forced downward by the glaring commitment deficit in post-modern society’s moral balance sheet.

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