September 18, 2007
U.S. Banks Brace for Storm Surge as Dollar and Credit System Reel
By MIKE WHITNEY
By now, you’ve probably seen the photos of the angry customers queued up
outside of Northern Rock Bank waiting to withdraw their money. This is
the first big run on a British bank in over a century. It’s lost an
eighth of its deposits in three days. The pictures are headline news in
the U.K. but have been stuck on the back pages of U.S. newspapers. The
reason for this is obvious. The same Force 5 economic-hurricane that
just touched ground in Great Britain is headed for America and gaining
strength on the way.
On Monday night, desperately trying to stave off a wider panic, the
British government issued an emergency pledge to Northern Rock savers
that their money was safe. The government is trying to find a buyer for
Northern Rock.
This is what a good old fashioned bank run looks like. And, as in 1929,
the bank owners and the government are frantically trying to calm down
their customers by reassuring them that their money is safe. But human
nature being what it is, people are not so easily pacified when they
think their savings are at risk. The bottom line is this: The people
want their money, not excuses.
But Northern Rock doesn’t have their money and, surprisingly, it is not
because the bank was dabbling in risky subprime loans. Rather, NR had
unwisely adopted the model of “borrowing short to go long” in financing
their mortgages just like many of the major banks in the U.S. In other
words, they depended on wholesale financing of their mortgages from
eager investors in the market, instead of the traditional method of
maintaining sufficient capital to back up the loans on their books.
It seemed like a nifty idea at the time and most of the big banks in the
US were doing the same thing. It was a great way to avoid bothersome
reserve requirements and the loan origination fees were profitable as
well. Northern Rock’s business soared. Now they carry a mortgage book
totaling $200 billion dollars.
$200 billion! So why can’t they pay out a paltry $4 or $5 billion to
their customers without a government bailout?
It’s because they don’t have the reserves and because the bank’s
business model is hopelessly flawed and no longer viable. Their assets
are illiquid and (presumably) “marked to model”, which means they have
no discernible market value. They might as well have been “marked to
fantasy”,it amounts to the same thing. Investors don’t want them. So
Northern Rock is stuck with a $200 billion albatross that’s dragging
them under.
A more powerful tsunami is about to descend on the United States where
many of the banks have been engaged in the same practices and are using
the same business model as Northern Rock. Investors are no longer buying
CDOs, MBSs, or anything else related to real estate. No one wants them,
whether they’re subprime or not. That means that US banks will soon
undergo the same type of economic gale that is battering the U.K right
now. The only difference is that the U.S. economy is already listing
from the downturn in housing and an increasingly jittery stock market.
That’s why Treasury Secretary Henry Paulson rushed off to England
yesterday to see if he could figure out a way to keep the contagion from
spreading.
Good luck, Hank.
full: http://www.counterpunch.org/whitney09182007.html
