Friday, 14 September 2007

Liquidity Risk is real

The BBC doth protest too much. First:

Shares in one of the UK's largest mortgage lenders, Northern Rock, have fallen 32% after it had to ask the Bank of England for emergency funding.

The next paragraph however:

But experts say it does not mean Northern Rock, which has £113bn in assets, is in danger of going bust.

Liquidity risk has nothing to do with solvency. You can go bust with £113B in assets and £1 in liabilities if you can't find the cash to pay the liability and it is due today. If you have to go to the Bank of England as Lender of Last Resort because, well, it is a last resort, then you are in danger. And it is no surprise that an institution whose business model was based on originating mortgages then securitising them has a funding crisis. What is more surprising is the number of Corporal Joneses going around crying 'don't panic'. Panic seems entirely appropriate. Unless you are naked long CDS protection on mortgage banks, of course, or long gamma on the stock...

Remember, if it looks like a duck, smells like a duck and quacks like a duck, it is probably a duck. Similarly if it looks like a liquidity crisis, smells like a liquidity crisis and the central bank acts like it is a liquidity crisis, then it's probably a liquidity crisis.

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