One bloke borrows money from another. He promises to pay it back with interest. He then lends that money to several other blokes, who each promise to pay it back with interest. They then lend it to more blokes, who each also promise to pay it back with interest. Bloke number one then asks for repayment of his loan. Bloke number two says he has to find out who has the money so that he can get it back and repay Bloke number one. Blokes three, four and five say they have to find out who has the money so that they can repay Bloke number two so that he can repay Bloke number one.
And so on . . .
This recently happened in the "good ole US of A" - that bastion of capitalist society. The lending had got so out of hand that nobody knew who owed whom and how much it was. The situation led to several financial institutions going broke because they couldn't find their money!
This led to a financial crisis in the US which had repercussions worldwide.
In the UK we used to have wonderful institutions called mutual building societies. They were originally started by groups of people who invested money and became equal shareholders in the society. They lent money to other people for the express purpose of buying their homes. The borrowers also became shareholders on account of the property they were buying belonged to the building society until the loan was fully paid. The people who invested money did so for the purpose of saving and as such they were paid a rate of interest. The people who borrowed were able, in the long term, to own their own homes. They paid a slightly higher rate of interest. The difference in the rates of interest paid for the administration of the society.
Through most of the 20th century this system worked well. You went to a building society when you needed to buy a house and they advanced you a loan called a mortgage. You could have as much as thirty years to pay the loan at a rate of interest much lower than bank loan interest rates.
Then the big banks got interested in widening their business. They started issuing mortgages. They also thought it would be a good idea to buy up building societies. Many of the shareholders of these building societies - both borrowers and investors - saw a quick buck and sold their shares.
Some of the bigger building societies then realised that they could break into the banking world and reverse the trend. So they decided to cease to be mutual societies and become public limited companies. Members would become shareholders not only in name but also in the eyes of the Stock Market. Or they could just take the value of the shares to which they were entitled and run - which many did. Most of these companies then expanded into banking, insurance and many other financial areas.
Now there are only a few mutual societies left.
Northern Rock was a building society based originally in the north of England. Although it gave up its mutual status it still based its business mainly on the lending of money for the purchase of homes.
But the scenario recited at the beginning of this post doesn't just happen in the US. It has spread worldwide. Northern Rock got caught up in this web. It realised that it had lost track of some of its investments and may not be able to meet the demand should its customers decide to withdraw money. So - with a good track record - it went to the grand old lady of Threadneedle Street (The Bank of England) and asked for financial backing. The Old Lady said yes and everything should have been fine. But Mr Average Northern Rock Investor got wind of this and decided that it would be better to invest elsewhere - just in case.
We now have the scene of hundreds of people queueing up outside Northern Rock branches to take out their money in case the bank goes under. More than one financial pundit has said words to the effect that in Britain this has not happened in living memory. Shares in Northern Rock have plummeted to below the level when the institution was first floated on the Stock Exchange.
Most of this is attributable to the fall in confidence in financial institutions brought about by the stupid US capitalist system of borrowing other peoples' borrowings.
People in this country - ordinary savers and borrowers - are losing confidence in their banks and want to see their cash in their hands rather than as a number on a bank statement.
Since the Bank of England has backed Northern Rock perhaps now would be a good time for the Chairman of the Grand Old Lady of Threadneedle Street to be seen going into a branch of Northern Rock with a large wad of cash and opening an account to show his confidence in the organisation. Perhaps he, or the Chancellor of the Exchequer, should even buy shares - or is there some rule against it?
If only we could keep it simple like it used to be . . .
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