While it has very much been in the news of late, the Bank of England has a history which is drenched in traditional and authority.  Located at the famous Threadneedle Street, London  the bank was founded by a Scotsman by the name of William Patterson as long ago as 1694.  In order to begin trading, Patterson arranged  a loan of some £1.2 million to the UK government, in exchange for the right to operate as the bank of the UK government - something which was set down via a Royal Charter in July 1694.

While the Royal Charter has been renewed and amended on a number of occasions since 1694, the Bank of England remains very much the mouth piece of the UK government in the financial markets.  Back in the early days when there was little regulation and no defined structure to government finances, the Bank of England took advantage of this and while entrenched in public and national debt services, they also took the first steps towards regulating the banking sector as a whole.

The first governor of the bank was Sir John Houblon, whose face still adorns the £50 note issued in 1990.  There have been numerous governors since then with one of the most recent being Eddie George, who was subsequently replaced by Mervyn King on his retirement.  While the bank were recently given a form of independence and the right to act on their own instructions, there is still a direct connection between the Bank of England and the UK government, something which has caused some controversy.

The recent Northern Rock debacle has opened up a number of old wounds, and we are yet again going through a phase of reviewing the regulations and rules relating to the financial markets.  Despite many attempts to undermine her, the “Old Lady of Threadneedle Street” (as the bank is fondly referred to) is still very much alive and kicking, with a reputation that many overseas authorities can only dream of.

For many years now we have been bombarded with the fact that the majority of us do not “pay” for our banking, and at some stage “free” banking is set to disappear.  Well, the truth is that there is no such thing as free banking, and all that will change is the fact that you will be charged more by the banks!

You Don’t Pay A Fee, So Its Free?

No.

When you deposit you money into your current account, you will receive interest which will be well below the base rate at the time, with some banks offering you only a tiny amount of interest - often just enough to say “we pay interest on our current accounts”. 

Charge one : the banks will either be lending your money out at higher interest rates, or placing it on the money markets over night and receiving a much better rate than they are giving you.

Many banks will now try to push you towards online banking, with a number of them introducing fees for paper statements.  This saves them money sending statements to you, and pushes you towards their websites where you will be able to sort out your own queries. 

Charge two : Paying for statements and logging on to the internet (a cost to you).

When you take out a mortgage or some kind of loan, many banks will charge a set-up fee.  This fee is just a bonus for the banks as there is no reason to charge this fee.  They are being paid for their time via the profit when you take out the mortgage or loan, and have the cheek to charge you on top.

Charge three : Set-up fees.

These are just a few of examples of where “free” banking is at the moment, and when you consider that they are looking to introduce monthly charges, you can maybe understand why the banks are making so much money!

If you have ever been in major debt, you will know the pressure which it can put upon your shoulders, the effect it can have on your life and your health.  Under this pressure, many sufferers are forced to take out loans to consolidate their debts and try to bring things a little more under control.  All ok so far, but…..

Under such pressure it is human nature to want to pay of your debts as quickly as possible, and this is a trap which many have fallen into.  Do not forget that you were in that situation because you were unable to handle your debts in the first place, and now you need a major restructuring, not just an amalgamation.  Do not fall into the trap of trying to pay off your debts as quickly as possible, you need to live, you may have other expenses in the future, but you can not afford to fall into the same trap again.  Why?

In simple terms, when you first fall into debt this can have an effect on your credit rating, which is why many people will not be able to obtain loans, etc from the normal sources.  However, those who are lucky enough to nip the problems in the bud before they grow, should also be very careful.  Many in such a position will be in the last chance saloon, and need to ensure that they take a structured and sensible approach to their debt solution.  As strange as it may sound, you are better off taking a loan over a longer period than you really need, in order to give yourself some breathing space.

If you take the consolidation loan over a short period, in the hope of rectifying your problems as soon as possible, you have a good chance of falling behind with payments at some stage and falling back into trouble.  Only this time, your credit rating will be lower and you may not have access to the relevant finances to refinance again.

When you are in trouble, you need to take a long term approach as this will give you some breathing space and also allow you to rebuild your credit rating.

Recent events in the money markets have shown that once you sign that mortgage / loan deal, do you really know what happens, and where your liability may end up? Unless you have done some major research into the sector, you will probably not be aware about what goes on behind the scenes.  Let us tell you what happens…….

Once you sign that mortgage or loan deal, there is every chance that your agreement could be split up into many pieces and sold to a number of financial companies around the world.  But how is this done?

Simple!

When you sign a financial agreement you will create two separate income streams, interest and capital, which will be stripped and bundled up with a variety of other financial elements.  By bundling many different qualities of income stream into a new financial instrument, it is possible to create a customised vehicle for any requirement.  Risks and the duration of the instrument can be varied simply by taking on different “strips” of any other agreement.

So in effect you take your mortgage out in the UK and within a matter of days your agreement could be scattered to all areas of the world.  This is part of the problem with the ongoing credit crunch in that nobody really knows who is at risk until the pack of cards start to fall, then A cannot pay B who cannot then pay C, and so on.  After a short period of time, liquidity dries up, finical institutions need to retain their funds, and the internal money market is dead.  Step forward Northern Rock for 75% of that last mortgage they agreed, in the form of a commercial loan, but the funding is not there!

While the above description may sound a little simplistic , it really is that simple.  A lack of confidence in the money markets can lead to banks withdrawing their finance from the markets, which results in other companies not being able to function normally, which results in Northern Rock like situations.

Northern rock is a little different than most banks as it borrows a large amount of mortgage funding from the market, rather than being in a position to use its own assets.  The likes of Barclays, Lloyds, etc are total different in that they are more likely to use their own asset to back 75% of a mortgage agreement, and borrow 25% from the money markets. 

Now that a degree of calm has returned to financial markets, we have the traditional witch hunt, looking for someone to blame for the whole situation.  In reality there is no one person or organisation to blame, but quite a few financial experts are pointing the finger at the regulators and the government.  The bottom line is, were the government right to effectively bail out Northern Rock with a loan, and guaranteeing customer deposits?

Apparently it has just come to light that the authorities were warned some 4 weeks ago that Northern Rock would struggle if the credit crunch hit the UK, and while plans were suggested to assist the company (and support the overall sector to some extent), the parties involved could not decide which route to take.  Did they bail out the company with an early crisis loan? Did they arrange a takeover by another UK financial bank? Or did they let market forces take their course?

In the end the authorities did nothing, until finally they were forced to come in and bail the company out, as well as guaranteeing customer deposits.  While there is major criticism of the regulator for the speed with which they acted, there is also great concern about the role of the government. Were they right to guarantee savers deposits? Does this not give the green light for others in the sector to instigate risky business models? Will the consumer now expect to be bailed out every time a bank is in trouble?

While it may well give the green light to other financial companies to instigate higher risk business strategies, it was also a necessity in order to steady the banking sector as a whole.  If Northern Rock had fallen, the knock on effect would have been like an earth quake in the sector. Speculators would have been looking for the next victim, and slowly but surely some of the smaller players would have been demolished by a wave of withdrawals, etc.

There is no right and wrong in these situations, as the landscape can change from day to day, but neither the government nor the regulators could ever be accused of acting on impulse!

While the announcement today that the UK Treasury will guarantee all Northern Rock customer deposits has been fairly well received - probably a case of better late than never - it does beg the question, why have the government changed their policy? Are they aware of more bad news in the sector?

Properties bought for cash

As we have mentioned on some of our earlier posts, the main component of any financial market is confidence. As we are seeing now, confidence is easy to smash but not so easy to build back up over a short space of time. The move by the Treasury today, which effectively guarantees that all Northern Rock customer deposits are safe, surprised many in the market due in the main to the historic role of the authorities not to become directly involved in free market business.

Many in the markets are asking why they performed such a major u-turn, after only hours early indicating that they were not prepared to step in above and beyond the current compensation arrangements available. Do they know something that will rock the sector again? Are they so desperate to restore confidence that this is the only action they can take?

We have regularly seen authorities in the US use such a tactic to try and soften the blow of future shocks and disappointments, but this is the first time we would have seen such action in the UK, if this is the case. No matter how hard the government try, they are not able to convince the financial markets that the worst is over. Such major changes in policy can also upset markets, with suspicion and a lack of direction being pushed to the forefront.

After a sustained period of rising interest rates to try and squeeze consumer demand, it looks as though the US Federal Reserve are about to back track on their recent strategy and introduce an interest rate cut to try and stimulate the economy and reduce the effects of the ongoing credit crunch. It is a major shift in policy but one which has been forced on them in reality.  So what next?

If the latest rumours are correct this will be the first reduction in US interest rates for over 12 months, and should mark the top of the interest rate cycle.  While a reduction in interest rates will assist the economy, there are also fears that it would introduce “cheap money” and feed the inflation monster again.  The authorities are in a very difficult situation because if they keep rates high for too long, the economy may stall and fall into recession.  However, if they reduce rates then they may well avert an imminent economic correction, but they would just be storing up problems for the future with a probable boom and bust scenario.

To be fair, the Federal Reserve have been fairly successful with their recent interest rate strategy, and had it not been for low grade mortgage sales by some of the sub prime mortgage providers, the economy would have been slowing at the moment, rather than having the potential to grind to a shuddering halt.

Will events in the US effect the direction of UK interest rates? Yes, so it is probably a good idea to keep an eye on developments in the US market over the days, weeks and months ahead.

After the events of recent days we have seen mortgage rates increase, without interest rate rises from the Bank of England - purely because of the credit crunch and the increase in the cost of borrowing.  So how will this effect the housing market and what assistance can the Bank of England give home owners?

We are in a fairly surreal situation at the moment, with the Bank of England keen to reduce interest rates, although their scope is limited due to the potential for inflation to move ahead again.  We have interest rates steady, but mortgage rates increasing across the board, with a high probability of more rises to come in the short term.  Confidence in the financial sector is draining quickly, although the homeowner is seeing no real deterioration as yet. So what really is going on?

The housing market is bound to be effected by recent events, not just because some banks and financial institutions are  unable to offer mortgage deals at the moment, but because their cost is rising. This confusion in the mortgage market is going to take some time to filter through the system, and there will be many mortgage applications put on ice or even refused.  When you consider that the housing market is purely based on supply and demand, the demand will start to slacken yet the supply is still increasing - a recipe for disaster?

There is no doubt that while the Bank of England will be doing what they can to see some of the struggling companies through the worst, we will need to endure a little more pain before the situation resolves itself.  Delays and increased borrowing costs will hit the housing market, effect the economy and generally depress the mood of the consumer.  What can we do?

At this moment in time there is very little that we can do, except hope that the situation does not deteriorate any more than it already has done.  Once we see confidence picking up again, then we will no doubt see lenders returning to the market and supply increasing again.  This may be some little time off at the moment, so brace yourself for a rocky ride!

As the UK banking turmoil continues, with rumours that more banks may be in trouble and mortgage rates are about to rise, many are asking the question. “Is our money really safe?”.  The short answer to that is yes!

While the recent turmoil has been brought about by events elsewhere in the world, which have had a knock on effect to confidence and the financial position of some UK banks, it is a situation which will not last for ever.  However, if one of the major UK banks were to close then this would send shock waves through the whole system, and have disastrous consequences for the sector.  This is something which neither the Bank of England nor the other major banks would allow to happen..

Some may remember Barings Bank and what happens there, but this is totally different as that was brought on by a rogue trader and slack financial controls.  Northern Rock, no matter what people may say, are actually a victim of circumstance, although it is highly unlikely that they will remain an independent company for much longer.

The financial system is all about confidence and this is something which will and does effect all in the sector.  The possibility of one of the major banks going out of business would push many customers to retain their savings “under the bed”, and a return to a fear of the sector - this will just not happen.  If the worst ever did happen then there are various compensation systems in place whereby victims would be covered for over 90% of their savings.

The Northern Rock saga is just the beginning of the situation and more banks will almost certainly get dragged into the situation.  While the Bank of England have taken the positive step of offering assistance to the Northern Rock, the market and the lack of confidence is a larger issue. The Bank of England can influence the markets in conjunction with there worldwide banking partners, but there will be a natural process of recovery as participants come to terms with what is happening, and confidence slowly begins to rise in due course.

The UK credit crunch has now taken hold of its first major UK causality, with Northern Rock forced to call on the Bank of England’s “lender of last resort” system, to bail out their business.  While the situation is only short term, it has caused major upset with the Bank’s customers with over £1 billion of deposits withdrawn over the last couple of days.  So how did Northern Rock get into this mess, and is it terminal?

The problem with the Northern Rock business model is the fact that they lend 75% of all mortgage amounts from the inter bank market - effectively borrowing money from their banking counter-parts.  This has left them more wide open than most to the recent disappearance of commercial lenders, in light of concerns within the US financial markets.  As lenders have disappeared from the market, Northern Rock have been pushed into a corner whereby they have had to call on the Bank of England to allow them to agree future mortgages.  So how much will this cost Northern Rock?

While the loan situation is purely a technical phase, the Bank are being charged an enormous 6.75% by the Bank of England, which will reduce their profit margin on future mortgages.  Last year the group made profits of some £500 million, so you can see from their history that they are not a small bank.  Unfortunately, while the turmoil continues and customers clamour to withdraw their funds from the bank, their reputation is being ruined and when the situation calms down they will almost certainly become part of a larger group, with the  likes of Lloyds TSB being mentioned as a possible suitor.

While many may not have been aware of the internal credit market before the recent downturn, it does demonstrate how events in another part of the world can result in the collapse of confidence, and even businesses, in another area of the world.   The financial markets around the world are so entwined that the knock on effects can last for some time, and have disastrous effects.

Northern Rock may be the first major UK bank to hit trouble, but there are rumours that a whole host of others are finding life tough.  This is not the last of the credit crunch problems in the UK, you can be sure of that!