Northern Rock - An Argument for Gold?
The fears and furore over Northern Rock, and the first 'run' on a British bank for 140 years, serves to highlight the defensive strengths of gold compared with money in the bank.
Sub Prime Mortgage Backwash
Northern Rock appear to have been caught out by the ripples of the U.S. sub-prime mortgage and lending fiasco.
The only real surprise is that anybody was surprised. We read the book "Wake Up" about two years ago, and recommend it to any potential investors. Much of what the authors predicted has already happened, and much more seems to be unfolding or about to happen.
Perhaps the investors in Northern Rock, and the directors should have read this excellent book.
Lending Long & Borrowing Short - A Classic Recipe for Disaster
We are not qualified bankers, but we know that building societies and banks used to suffer runs or collapse because they made long term loans which they financed with short term borrowing. This is highly risky. Not only are they at risk if interest rates rise, although some increase can be passed on to borrowers, but if short term credit tightens, they can be squeezed dry of liquidity. Even the fear of liquidity problems is enough to start a bank run. Fears over the American sub-prime market have been around for some time, and we find it incredible to hear that the directors of Northern Rock failed to protect their company and its shareholders from the risks of a credit squeeze.
Blame the Bank of England?
Directors of Northern Rock, and others, have criticised the Bank of England, mainly for not having acted earlier to support Northern Rock. We have noted the Bank's governor's comments about changes in legislation creating some doubts and difficulties, and believe these should have been clarified before they were needed, but we still think it is more than a little rich for the Northern Rock directors, who got the bank into its mess, to criticise the Bank of England for not getting them out of it quickly enough. Banks which act like gamblers should be punished for their reckless risk taking. So should their directors.
Several German banks have collapsed. There have been rumours about other British banks, some major ones, Barclay's for example. Most financial institutions with high exposure, direct or indirect, to sub-prime loans, will be reluctant to publicise or admit their positions, in case it further weakens their share prices or credit ratings. There may yet be many more nasty surprises waiting in the woodshed.
What About Gold?
It should be obvious that a holding of physical gold is very secure. It's value does depend on opinion, therefore its price could become fairly volatile, but never to the extent that can occur with paper investments. Sub prime loans were collateralised as CDOs, (Collateralised Debt Obligations), given investment grade credit ratings by all the major credit rating agencies, before being sold to other banks, hedge funds, pension funds, and other investors. The value of such investments depends ultimately on the value and strength of their underlying assets, but these are obscured by layers of paper, contracts, and opinions. Whenever the real intrinsic value of an investment is obscured, there is a very real risk that its market value can change rapidly with market sentiment.
Gold remains the ultimate secure currency.
Queues Outside Northern Rock