The Bank of England unveiled an ambitious plan on Monday to swap banks’ risky mortgage assets for at least £50 billion of government debt in the latest bid to spare Britain from the ravages of a global credit crunch.
Central banks everywhere have been desperately trying to get confidence back into markets, but despite eight months passing and billions spent, banks remain afraid to lend money because they don’t know each others’ exposure to bad US home loans.
In Britain, the credit crunch has already taken down Northern Rock bank and concern is building over the financial system and the wider economy as new buyers are shut out of the housing market as cash-strapped lenders restrict mortgages. Prime Minister Gordon Brown, whose popularity has slumped as voters lose faith in his handling of the economy, has made reviving the mortgage market a priority for his government as fears of a real estate crash have shot up in recent weeks. His finance minister Alistair Darling said he would meet lenders on Tuesday to get them to do their bit for the economy, by passing on interest rate cuts and doing more for people refinancing their mortgages.
Speaking to reporters after the plan was announced, BoE Governor Mervyn King said the Special Liquidity Scheme (SLS) would not make things better overnight but would at least give banks access to a greater pool of cash. The £50 billion was just a start and there was no arbitrary limit, he said. “What we have to do is to create an environment in which a bank knows that not only it, but other banks, can come to the Bank of England and exchange their illiquid assets for liquid assets,” he said. “It is restoring confidence in banks being able to deal with each other that is key in this.” Interbank lending rates fell modestly on Monday after the plan was announced, but are still some way higher than the BoE’s main lending rate.
Analysts remain skeptical about whether the scheme will be enough to prompt the economic rebound the government desperately needs. Bookmakers have now made the opposition Conservatives the hot favorite to win the next election, which must take place before May 2010. “We still have doubts over the extent to which the scheme can address the fundamental problems in the housing market and wider economy,” said Jonathan Loynes of Capital Economics.
Under the scheme, banks can get one-year government bills for highly rated mortgage debt which can then be rolled over the at the central bank’s discretion for up to 3 years. The six-month window for the plan opened on Monday. King, who has long taken a hard line on the dangers of moral hazard in bank rescues, said the facility was in no way a bailout of banks as any government securities they got would come at a hefty price or, in the jargon, haircut.
Banks will also have to pay an additional fee to make sure they pay a market rate for the government debt. “This is not a gift,” said King, who rejected the suggestion that the scheme required some quid pro quo from the banks. He welcomed, however, the moves by some banks to recapitalize themselves. Royal Bank of Scotland, Britain’s second largest bank, said on Monday it was considering a share issue and others in the sector are expected to follow. JPMorgan estimates the capital shortfall of the four large UK banks -- Royal Bank of Scotland, HBOS, Barclays and Lloyds TSB -- at nearly £37 billion. People familiar with the matter have told Reuters that RBS is seeking to raise over $20 billion.
Darling said in parliament that it was essential banks also start coming clean on their losses to get confidence back to markets. “This proposal has started across the world including here in Britain with banks disclosing their losses and making proposals to rebuild their capital position,” he said. (Reuters)