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When was the last time you saw a bank run? Unless you're old enough to remember the Great Depression, the answer is probably never. But a lot of worried savers in England got an up-close-and-personal look at a bank run last week.
Hundreds of panicky depositors lined up outside branches of British bank Northern Rock (NHRKF, news, msgs) last week to withdraw their money. Fearing that the subprime-mortgage mess was about to swallow their savings, over three days depositors pulled $6 billion -- about one-eighth of the total deposits -- out of the bank. The run started to taper off only after the British government stepped in to guarantee the safety of depositors' money.
How likely are we to see a bank run in this country? Let me give you my best shot at answering that question.
A problem bigger than borders
Northern Rock, based in Newcastle, England, might seem an unlikely victim of the meltdown in the subprime-mortgage market.Those of us who live in the United States are used to thinking of the rising default rates and the risky lending practices that have struck mortgage lenders such as Accredited Home Lenders (LEND, news, msgs), Countrywide Financial (CFC, news, msgs) and Novastar Financial (NFI, news, msgs) as "our" problem. But truth to tell, lenders in other hot real-estate markets, such as the United Kingdom's or Spain's, have been just as willing to lend money to all comers.
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For example, one of Northern Rock's most "innovative" mortgages combines a mortgage for 95% of the purchase price with an unsecured personal loan for as much as 30% more. It makes the U.S. practice of bundling together first and second mortgages to enable a purchaser to put zero down seem, well, conservative.
Mortgages for 100% of a home's value -- let alone 125% mortgages -- stand a good chance of going bad when home prices start to fall. And that's exactly what has happened in both the United States and the United Kingdom.
A deeper look at banks
But to find the real similarities between Northern Rock and U.S. mortgage lenders you have to look under the hood at how these institutions, be they named bank or mortgage company or savings and loan, raised the money that they lent out as mortgages.Video on MSN Money
Jubak's Journal: Best financial betsA rising tide lifts all boats, but a receding tide separates the well-run companies from the badly managed. With many financial institutions faltering during the recent turmoil, MSN Money's Jim Jubak picks the companies that he thinks will fare well over the coming months.
In the good old days, the days when Jimmy Stewart ran the Bailey Building & Loan Association in Bedford Falls, S&Ls and banks took in money from depositors and then lent out the cash from these savings accounts as mortgages. And, quaintly enough, the banks even held on to the mortgages, collecting monthly payments for 30 years before retiring the debts.
Writing new mortgages depended on money flowing in from new deposits, from monthly mortgage payments and from the occasional early payoff of a mortgage.
Continued: Lending faster and faster
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