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September 18th, 2007

WARNING: This is not a recommendation to buy, sell or hold any financial instrument.

An overnight shift in policy from covering roughly £30,000 worth of deposits to 100% of deposits!?

Sterling holders, consider reducing or eliminating your exposure to GBP denominated assets immediately.

If a bank CEO tells me not to panic, I’d remove my funds from that bank as soon as posible. If a government changes the rules, in desperation, in the middle of a crisis, I don’t hold that country’s currency anymore. (Get back to me when, not if, this happens to New Zealand.)

The British government’s guarantee might seem like good news to the average Sterling holder, but think about how the government would guarantee those funds, in practice.

Printing presses.

What’s different about today vs. the past is that the mask is off this scam in the UK now and the government is struggling to obscure how ugly the monster really is. Maybe the PR campaign, which amounts to a Jedi mind trick, will work. Maybe not.

If the herd doesn’t buy it… I don’t know what will happen next. Banking holidays? Martial law provisions to govern GBP FOREX flows? Let’s not go there just yet, but for the handful of GBP holders who read Cryptogon, consider taking immediate defensive action. [Here’s a private email that I wrote to one of Cryptogon’s top contributors who was looking for ideas on asset preservation during financial emergencies. It might be useful for people affected by the UK crisis.]

P.S. If the smoke clears and the British people are holding Euros, ordo ab chao, my friend.

Via: Guardian:

Alistair Darling yesterday moved to take control of the biggest banking crisis in years with a full guarantee of deposits at Northern Rock that left the system for dealing with bank collapses in tatters.

After another day of turmoil on the high street which saw savers besieging Northern Rock branches across the UK, the chancellor threw out rules that had been in place since 2001 in an attempt to stem the worst banking crisis since the 1970s.

It was unclear whether the chancellor’s statement would lessen queues outside Northern Rock branches today, however, the chancellor’s decision was backed by the Treasury select committee chairman John McFall, who told the BBC’s Newsnight programme: “The Bank of England has done the right thing here.”

In full-page advertisements appearing in many national newspapers this morning, the Northern Rock’s chief executive Adam Applegarth said: “The simple fact now is that the chancellor has made it clear that all existing Northern Rock deposits are fully backed by the Bank of England and are totally secure during the current instability in the financial markets.

As Alliance & Leicester and Bradford & Bingley shares plunged by 31% and 15% respectively in late trading yesterday, Mr Darling was forced to add that if another bank was to arrange an emergency lending facility with the Bank of England and was declared solvent by the FSA, the government would be willing to extend its full deposit guarantee plan.

UPDATE #1: Independent: “Almost Too Shocking to Contemplate”:

Will last night’s further commitment from Alistair Darling, the Chancellor, to put in place arrangements that would guarantee all the existing deposits of Northern Rock over and above that already offered by the deposit protection scheme operated by the Financial Services Authority do the trick?

First, let’s examine the quite breathtaking implications of an announcement which on a quick ring round the City last night was widely thought to be without precedent. It is one thing to guarantee the Â£24bn of deposits held by Northern Rock in the hope that this might calm nerves and convince depositors that they don’t any longer need to queue round the block in the pouring rain to get their money out. The Government wouldn’t be doing it unless it thought Northern Rock essentially solvent and therefore ultimately of no risk to the taxpayer.

Yet if the authorities are to underwrite Northern Rock, the implication is that they stand behind the entire UK banking system. Any government that is prepared to guarantee the creditors of one bank must surely offer the same facility to everyone else?

In the event of a more generalised run on UK banks, it would be in no position to provide such support. The sums involved would overwhelm the ability of the tax system to pay, or indeed the money printing presses to cope. The Bank of England’s position as lender of last resort would be stretched to breaking point.

What at first, then, seems like no more than a neat trick to restore confidence in Northern Rock on reflection looks much more high-risk. Mr Darling had better hope it works. If it is Alliance & Leicester, or worse, one of the big high-street banks, which next comes calling, cap in hand, then it won’t be just his job that’s on the line â€“ the Government’s entire future would be at risk.

In order to implement his guarantee, Mr Darling would, in the event of a continued run on Northern Rock, in effect have to nationalise the mortgage bank by taking both its assets and its liabilities on to the Bank of England’s own books. What are the consequences for the public finances of that? Again, the implications are almost too shocking to contemplate. What if it doesn’t work? What if there are runs on other banks? Will the Government then nationalise Alliance & Leicester (A & L), Bradford & Bingley, and others too?

UPDATE #2: Telegraph: Darling’s Risky Plan Needs to Succeed:

By guaranteeing all the existing savings in Northern Rock accounts, he has left an indelible mark on Britain’s financial system â€” whether he succeeds or fails in stopping the run on the bank.

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Of course, everyone with an interest in Britain’s economic health should hope he does succeed.

If his message gets out, he has a good chance. The Chancellor has explicitly told savers at Northern Rock that their money is entirely safe left in their accounts.

The hope is that this brings to an end the scenes of the past few days, with thousands of account-holders queueing for hours to withdraw their savings.

This, in turn, will help arrest the dramatic decline in Northern Rock’s share price, which continued again yesterday with a 35 per cent plunge. A little period of calm will be enough to help Northern Rock to organise its sale to another bank â€” surely the best option available to the struggling institution. Things may eventually get back to normal, with the only side-effect for the economy being a period of slower growth.

However, even if this, the best of all outcomes, is the result, things have still changed forever.

Mr Darling may be saving the banking system as a whole from an even worse crisis in the coming weeks, preventing a swathe of lenders from going bust. But by laying down such a precedent, he also risks encouraging other banks to make precisely the mistakes made by Northern Rock.

The fuse for Northern Rock’s near-demise may have been lit by the credit crunch, which made it difficult for it to fund itself, but the company has no one but itself to blame for strapping the financial dynamite around its waist â€” gearing itself up with so much debt.

Mr Darling is effectively sending the message that other banks will be bailed out â€” and all their accounts protected â€” even if they take similar or greater risks with their customers’ and shareholders’ money.

…

What if the Chancellor’s plan fails? The mind boggles. If the queues outside Northern Rock continue the next risk is that other banks fall victim to the crisis. Alliance & Leicester, whose shares plummeted late yesterday, is thought to be particularly vulnerable to a run. And as the Government has already played its most powerful hand, it will be effectively powerless to stop the fear building.

The financial world is built on trust and confidence. If Mr Darling’s adrenaline injection doesn’t help revive these two factors, no one really knows what happens next.

The Chancellor’s plan is high-risk. By the end of today it will be clear whether it has succeeded.

UPDATE #3: Telegraph: Sterling Poised for Weakness as Northern Rock Crisis Deepens:

The crisis unfolding at Northern Rock pushed sterling lower today and analysts now expect the currency to face serious pressure in coming weeks.

Economy | Posted in Collapse Top Of Page