Savers Beware! Confessions from the Leading Edge of the Financial Crisis

By: Ben_Traynor

Long, long ago, in a booming bank far from Cyprus...

"WE'RE TOP of the Best Buy table again," my manager said, "so we're expecting A LOT of business."

And so it proved. The bank I worked for at time saw millions pour through the door in deposits.

Our latest fixed-rate bond had just launched (we put out a new one every month or so). This was a fairly standard savings account that locked depositors in for a fixed period (from memory I recall the options were one year, two years or five years). Topping the Best Buy table meant our bonds were offering higher interest rates than any comparable product in the country.

We had been making something a habit of this, as well we might since it was official corporate policy to offer a better rate than anyone else. We were not a large bank by UK standards, but we had a growing national presence. The top brass weren't shy of sharing their plans for world domination; one initiative they launched was called 'The Great Leap Forward', which incorporated something called 'The Customer Service Revolution' (I am not joking). I suspect the 'Great Leap Forward' owed more to our corporate logo being a frog than to any admiration for Chairman Mao, though I was never entirely sure.

To cut a long story short, the bank I worked for succeeded in becoming a household name thanks to its aggressive strategy. Unfortunately for its employees, shareholders and customers, it was for all the wrong reasons. The bank in question was Northern Rock.

That job seems a lifetime ago now, and in many ways it was a different era. No one had heard the phrase 'subprime mortgage'. Few people thought a crisis was looming. I remember once attending a presentation for something called ShareSave, which offered me the glittering opportunity to put some of my salary towards buying shares in my employer (I declined, more through an inherent bias towards diversification than any particular concerns about the bank). ShareSave was run by another bank (I forget which), whose representative explained that this was "just in case Northern Rock goes bust". The notion was met with mild amusement.

Another thing people took for granted back then was being able to put money in the bank and earn a return on it, while expecting it to be there when you went to withdraw it (in truth most people still hold to the latter belief in practice, myself among them, despite recent lessons. I guess it's just convenience...). In October 2006 for example, a few months after I left, Northern Rock was still topping the Best Buy table for one-year fixed rate accounts, offering 5.5% to anyone prepared to tie up their cash until the following October.

Of course, by then they'd have witnessed the infamous 'Run on the Rock' in September 2007, and possibly queued up outside a branch themselves. Strictly speaking Northern Rock did not suffer a depositor run in the 'It's a Wonderful Life' sense – its funding base had already been hit by loss of access to the wholesale funding markets before the Great British public started banging on the window (for a good academic overview of what happened try this paper by Shin: 'Reflections on Northern Rock: The Bank Run that Heralded the Global Financial Crisis').

The collapse of Northern Rock took a lot of people by surprise, including the bank's management. But looking back, the monthly scramble to top the Best Buy tables was symptomatic of a seat-of-the-pants business model that ultimately came unstuck.

I am reminded of all this, more than half-a-decade later, by the closing of banks in Cyprus and these comments from an analyst at Italian bank UniCredit, in response to the news that the Cypriot parliament has rejected proposals to impose levies on depositors as part of a national bailout:

"As recently as in January, Cypriot banks offered 4.5% for a 1-year deposit while other peripheral countries, including Italy and Spain, offered about 2.5%, and Germany 0.9%. Since 2008, a depositor in Cyprus has earned 31% in yield (before tax), compared with 15%-18% in Italy and Spain and 8% in Germany. Now do your math on these numbers: A Cypriot (or foreigner) who placed €100,000 in deposit in Cyprus in 2008 would by now have earned just around €15,000 more than if he had placed that money in Italy or Spain (and some €23,000 more than if he had placed it in Germany.) Why does the Cypriot parliament (and many commentators) seem to suggest that a 15% tax on such deposits (which would cover the bill also for the sub-100,000 Euro deposits) would be unreasonable now the banks are in trouble, but that German, Italian and other Eurozone taxpayers should rather foot the bill? To me, the Cypriot position is simply un-sellable in the rest of the Eurozone."

Though I would never claim to have foreseen the downfall of Northern Rock, one of the early memories of my time there, and one that took on added significance later, was reading our quarterly report (placed on every staff member's desk and then directly into most people's waste paper bins) and seeing a pie chart showing where our funding came from. As I recall, only a third or so came from savings deposits. This struck me as being rather low when compared with the textbook model of banking I'd been taught at school and university, but at the time I put this down to ignorance on my part.

Looking back however, it seems that during the middle part of the last decade the race was on at Northern Rock to get as many savings deposits through the door as possible. Whether management were getting worried or whether it was just part of the general merry-go-round of lending, securitizing and selling on to hedge funds that was all the rage back then, I don't know. But hindsight tells us that those Best Buy rates should have been a warning.

The same can be said of the juicy rates offered to British savers by Icelandic banks until well after the credit crunch started, before those banks collapsed in 2008 – leaving UK taxpayers to foot the bill. It would also seem tempting rates were a flashing warning sign in the case of Cyprus too.

None of this is especially new or insightful. The adage 'if something seems too good to be true it probably is' is as old as it is trite, but it is a lesson as easily as it is frequently forgotten.

Cyprus offers us yet another reminder: if you are paid a return on your money, that's because you're being compensated for taking on some risk. And yes, that includes bank deposits.

By Ben Traynor
BullionVault.com

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Editor of Gold News, the analysis and investment research site from world-leading gold ownership service BullionVault, Ben Traynor was formerly editor of the Fleet Street Letter, the UK's longest-running investment letter. A Cambridge economics graduate, he is a professional writer and editor with a specialist interest in monetary economics.(c) BullionVault 2013

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