As Cote d'Azur said, the problem with both Northern Rock and Bear Stearns were mis-matched assets and liabilties, or more simply, they got their funding on a short term basis but invested on a long term basis. They were/ are not alone in this, and many hedge funds have similar funding structures. What triggered the crisis in both institutions was not problems with non-performing loans (e.g. sub-prime mortgages) - the full effect of that is still to be felt - the problem was more simply that the people lending to NR and BS (their investors) thought there may be a problem with these institutions (not without a level of merit) and decided that they wanted their money back - now.
Now if someone's lending to you on a 30 day basis, and all your money's invested in multi-year investments, and the person lending you that money calls it in, the only way you can pay them back is by liquidating those investments - et voila, you have a perfect storm.
- investors become concerned about BS
- some investors demand their money back from BS
- BS is forced to sell liquid assets to repay investors
- market hears BS is selling and assumes concerns are justified
- investors become more concerned about BS
- more investors demand their money back etc
The real concern about the current crisis is not the underlying credit quality of these investments like sub-prime mortgages. Clearly that is a worry to some extent, what is an absolute concern is market sentiment and perception which is and will continue to damage perfectly healthy firms and funds - nobody is quite sure of any one firm/ fund's individual exposure and so is assuming the worst. As an example, the $2 billion Peloton fund, which was invested solely in high quality mortgages collapsed a couple of weeks ago, solely based on (unmerited) investor concern about the quality of these mortages, as in the cycle above. Once people act on fears, however unjustified, those fears become self-fulfilling.
The only way to resolve this crisis in the short term is for confidence to return to the market - the central banks are doing their best, witness the Fed's assisted bail-out of BS and Bank of England's £5bn capital injection this morning. Unfortunately, they're also caught in a vicious circle - the market lacks confidence and thinks the worst, central bank steps in to provide more money, market thinks "shit, it must bad if the central bank is stepping in", confidence worsens. Not sure how this gets sorted in the short term. Good results from the investment banks this week would help.
For home owners/ personal borrowers, my feel is that there's going to be a real divergence between poor quality credits and good quality credits. If you have a poor credit rating, unfortunately, it's going to be hard to get credit (be it mortgages or credit cards) on decent terms - lenders are pulling back from those markets and those that are staying in are pushing up their rates significantly. If you can get it, you'll be paying a lot more for it, Bleak, but sadly likely to be very true. If you've got a good credit rating, on the other hand, you may actually be in a better position. Firstly, it's likely we'll see interest rates come down over the next 6-12 months which will mean a lower cost of borrowing for, for example, variable rate mortgages. Secondly, these lenders still have to deploy capital - if they're not lending to people with lower credit ratings, they're going to be fighting over people with higher quality ratings. I'd imagine, if you have a good rating, that you may be able to get more attractive deals than previously.
I stand, of course, to be proven to be speaking absolutely bollocks, but that's how it seems to me....