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Sunday, September 23, 2007

Pascal's Wager and Northern Rock

Or, Who trusts a politician?

Pascal's Wager (see below) can be applied to many situations where a decision has to be made by taking into account the risks involved and the likely consequences of acting or not.

A highly publicised example occurred in Britain recently when there was some uncertainty about the reliability of the Northern Rock Bank/Building Society. Due to financial chaos over mortgage debts in the USA there were "knock-on" consequences for banks elsewhere which affected their liquidity (cash flow) rather than their actual security.

In the case of Northern Rock, the Bank of England promised to support the bank through its "temporary" crisis when other banks would (or could) not. Even though the bank's directors and Government Ministers give multitudinous assurances that Northern Rock was profitable and that depositor's savings were absolutely safe, there was a run on the bank with ugly scenes of depositors (savers) queuing outside local branches to withdraw their savings "just in case".

It is obvious that most of the depositors were subconsciously applying Pascal's Wager in their decision making.

In this case the four possible situations are:

Situation 1. Northern Rock is failing and savings are withdrawn.
Situation 2. Northern Rock is failing and savings are NOT withdrawn.
Situation 3. Northern Rock is SECURE and savings are withdrawn.
Situation 4. Northern Rock is SECURE and savings are NOT withdrawn.

Let us examine the possible consequences of each situation:

Situation 1. Northern Rock is failing and savings are withdrawn.
Consequence: You have done the right thing. You can go to the jeweller and buy up some gold.

Situation 2. Northern Rock is failing and savings are NOT withdrawn.
Consequence: You stand to lose your life savings.

Situation 3. Northern Rock is SECURE and savings are withdrawn
Consequence: Very little. You may incur some penalties for withdrawing some funds early, or loss of interest while the money is not in the bank

Situation 4. Northern Rock is SECURE and savings are NOT withdrawn.
Consequence: You have done the right thing, your savings are safe and accrue interest whilst others lose theirs.

In situations 1, 3 and 4, nothing much happens to your wealth and if Situation 1 prevails you may even congratulate yourself on your astute judgement on fiscal policies, and/or your scepticism in the assurances of politicians.

However, if Situation 2 prevails, you are stuffed, rooted, destitute and may be pension-less.

It is clearly this situation which many depositors feared and which caused the queues at the banks.

It boils down to a matter of judgement of the risk, and your trust in the assurances of politicians.

As we all know with hindsight, Northern Rock did NOT fail, depositors savings WERE safe and those who stood in queues and withdrew their cash suffered minor losses. What is clear is that Northern Rock was never going to be allowed to fail.

So, who trusts a politician these days? It is clear that we should have trusted them in this instance!

Here endeth the trilogy about Pascal's Wager.

13 Comments:

Anonymous Ellee said...

Maalie, you are quite a philosopher. Just remember that politicians are human beings too, and we have to place our trust in those. It's distinguishing between the honourable and dishonourable that is the difficulty.

10:57 am  
Blogger Shrink Wrapped Scream said...

Yes, there was quite a hoo-ha over all that business, wasn't there? I DO trust politicians (some, at least), although most I meet are the most boring folk on the face of the earth.. Since moving to the Isle of Man, (pop. 70,000) which has it's own government, currency and laws, I have been pleasantly surprised at how accessible and accountable our politicians are. Oh, we still have the odd scandle or two, but speaking as the average "man in the street", I do feel I have a voice in how our island is run. I felt the very opposite was true when I lived in London - even when I did finally track down my local MP, pinning him down to give a clear, straight answer was nigh on impossible!

11:08 am  
Blogger Maalie said...

Yes, Ellee and Scream, my point was that in this case we ought to have trusted the politicians! They were right!

Scream, I can see the I.o.M today - nice and clear between the showers!

11:26 am  
Blogger simon said...

love it!

12:30 pm  
Blogger Shrink Wrapped Scream said...

I forgot, you are just a mere hop away, aren't you? I'm hoping to dodge those showers when I take the mutt on his trot along the beach - wish me luck!

2:10 pm  
Blogger simon said...

SWS- I sang with a soprano who was from the Isle of Man. She was flown to Australia especially to perform at ST Andrews Cathedral (the Messiah)

There's a link!

11:49 pm  
Anonymous Ellee said...

I know, you made your point well and very astutely.

6:51 pm  
Anonymous Ellee said...

Simon, that's impressive!

7:43 pm  
Blogger Elizabeth said...

Hello, just discovered your blog; thoroughly enjoyed reading your posts.
A rare day when we should trust the Politicians, oh that it was the first of many!

10:18 pm  
Blogger lorenzothellama said...

What are you talking about Maalie?
Have I really missed so much in the last couple of weeks? Are my premium bonds safe and what about my Post Office Savings Book?
Lorenzo the Sunburnt Llama.

8:54 am  
Blogger Kiwi Nomad 2006 said...

maalie.... I think you forgot an important weighting in your scenarios... if all the sunburnt llamas in England are actually overseas in warmer climes.... and don't even know about the 'crisis', then of course there isn't one ;-)

4:51 am  
Blogger Val Travers said...

I've heard it's a good time to take out a fixed term invesment policy (not with NR). Really good rate on offer at the mo. The other building societies are desperate for your moolah

9:40 pm  
Blogger TCA said...

keep it under the mattress, thats my advice.

B.B

7:56 am  

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