Global financial crisis Mervyn King, the Bank of England governor, on Monday implicitly asserted copyright over the Treasury-bills-for-mortgage-backed-securities scheme. At a press conference he revealed that he had personally tapped out the guts of the scheme on his home computer about a week before Easter.
The Bank, he made clear, had decided in March that action must be taken. Rumours that HBOS was on the brink of collapse and the Bear Stearns crisis underlined that any bank, whether solvent or not, could fall victim to a wholesale run and the refusal by others to lend it money.
The Bank thought something fundamental had to be done to ensure that a liquidity shortage could not bring banks down in future.
After discussing the plan with British commercial banks just before Easter, Mr King travelled to meet his counterparts at the Group of Seven gathering in Washington 10 days ago with the details all but finalised. At that stage the Bank was known to believe that it would be problematic for a small country to undertake a big new central banking operation on its own. But in the past week that all appears to have changed.
At the press conference on Monday, Mr King was at pains to ensure the scheme was not painted as a bail-out of the banks. “It is not available for failing institutions,” he sternly told journalists, insisting it would not address the solvency of banks.
Fed watches and waits
The US Federal Reserve is watching the British plan with interest and could consider implementing a similar long-term securities swap programme in the US if it proves successful in easing financial market strains, write Krishna Guha and Ralph Atkins.
Fed officials think of the Bank of England plan as building on the Fed’s new securities lending facility, which allows US primary dealers to swap top-rated mortgage securities for Treasuries, but for a period of only one month.
But they are open to the possibility that it might be helpful if the Fed, too, offered a longer-term swap facility like the new Bank scheme and intend to see if the plan is effective.
However, Fed officials note that, in principle, the UK plan leaves the mortgage credit risk with the banks, so while it may help with liquidity problems it will not do much to help solvency concerns.
The European Central Bank, meanwhile, has accepted mortgage-backed securities as collateral in liquidity-boosting money market operations.
Instead, he wanted to eradicate any shred of doubt that a solvent British bank would in future be able to settle its debts. “Now is the time to take the liquidity issue off the table in a decisive way,” he added.
By dint of the very unilateral action that it was initially keen to avoid, the Bank – the slowest to react to the initial credit crisis – has gone much further than the Federal Reserve or the European Central Bank. It is offering close to limitless liquid assets in return for high quality assets for a period of at least a year, renewable for a further two years. The Fed, by contrast offers a similar liquidity support scheme, but for a period of only 28 days.
The Bank has acted to address a problem particular to the UK and the rest of Europe – the lack of liquidity and trust between banks. Across the Atlantic the concerns are different: serious losses from defaults on home loans and US mortgage-backed securities.
The Bank scheme is designed to keep credit risk securely with the banks. If mortgage-backed assets become impaired, banks must replace them in the swap arrangement with pristine triple-A rated assets or hand the Treasury bills back.
The only way the taxpayer could lose money would be if a bank went bust and the value of the bank’s assets held by the Bank had fallen by more than the “haircut” it imposed on the banks when offering the swap arrangement.
Nor, Mr King insisted, did it breach his strongly held stance against encouraging moral hazard. The stiff conditions attached to the liquidity scheme, particularly the haircuts, ensured banks would not profit from what he regards as the reckless lending of recent years.
In helping banks with their liquidity, he has ensured that banks will have greater funds available to lend, if they choose to do so. But Mr King insisted the scheme offered no subsidy to new mortgage lending, since the bank would not refinance mortgage lending after December 31 2007.
One message was sent out loud and clear on Monday. The days when banks were an endless fount of cheap borrowing are over. As Mr King put it, the scheme “is designed to increase liquidity in the banking system and it is not designed to send the mortgage market back to the rather wild lending before the turmoil began last summer.”
