The run on Northern Rock

This is where the run on Northern Rock came from. It had a unique business model in the UK where it had a relatively small deposit base (i.e. people like you and me depositing money in its vaults, which can they be used to underwrite mortgages), but a very high mortgage lending base. To fund the difference, it had to go out to the overnight market and borrow money from other banks. Contrast this to LloydsTSB, for example, where there is a strong deposit base compared to mortgage lending. Once the LIBOR rates shot up, that market disappeared, and it had to borrow money from the Bank of England - the UK's "Lender of Last Resort" (what a comforting phrase for customers of Northern Rock!) This action marked Northern Rock out as a wounded beast in the financial sector, and panic ensued. The repercussions of this are still being felt.

What is the outlook?

We've already seen a slew of "write-downs" from major banks around the world, in recent quarterly reports. Taking a handful of the major banks - Merrill Lynch, Bear Stearns, HSBC, Citigroup, UBS, Morgan Stanley and Bank of America - on their own these banks have recently written down a phenomenal $32.6bn. This is larger than the entire GDP of Serbia, Syria or Bulgaria.

But there's more to come. These write-downs are largely as a result of having to re-value the loans and other securities on their books. But these securities have largely not yet been sold. Further write-downs and write-offs must be expected once the market frees up and buying and selling can begin again in earnest.

As an illustration, imagine you have just purchased a piece of art by Picasso which is valued at '1m. Suddenly the market for Picasso falls through the floor and people stop buying Picasso altogether. "It's too boxy," they say, moving into the Impressionists. You cannot yet sell your Picasso because nobody's buying, but if someone asks, you say it's probably taken a hit and is now worth ??750k. The big question, though, is not what you think it's worth, but how much someone is prepared to pay for it once the market for Picasso warms up again. This could be as little as ??300k, or even less. In terms of the big banks, we'll have to wait until the next round of reporting, or even the next one, or the next, until the full impact of the subprime crisis is revealed.

Away from the world of high finance, other factors are developing. The US and UK housing markets are slowing down. Consumer confidence is still reasonable, but rising mortgage defaults and static or falling house prices will start to impact on this, thus having a knock-on effect on retail spending. Risks are apparent across most of the economy, and sentiment is starting to turn bearish.

What does it mean for me?

So, the development of securitisation and a mispricing of risk led to a subprime crisis, becoming a drama, played out on the streets in front of the local branch of Northern Rock. And it seems the situation may take a turn for the worse. That is all fine, but what does it mean for me? Well, quite a lot if you're Mervyn King, Alistair Darling, Stan O'Neal, Chuck Prince or any banker that's used to a decent annual bonus. However, it is also starting to affect most businesses, and has likely already started to affect your business, even if you don't yet realise it. Here are a few examples:

1. Have you wondered why customers who used to be reliable payers are now mysteriously misplacing the invoices you are sending them? It may be because, in anticipation of a slowdown, they are themselves trying to conserve cash in a tightening market.
2. Are you concerned that there is a lack of transparency in your business that might be masking a mispricing of risk, not just in the financial metrics, but across operations?
3. Are you concerned that your internal governance and compliance, ticks all the Sarbanes Oxley boxes, but actually just slows down your business without making it more effective?
4. Are you looking at your customers and wondering which of them are best equipped to cope with a slowdown, and which of them have the potential to start becoming unprofitable?
5. Is your planning and forecasting process sufficiently joined-up and fast enough to be able to adjust to changing market conditions as quickly as your competitors?
   
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