Bank of England's Move: Finally, Addressing Confidence

by: Prince of Wall Street

Finally, a constructive move by a central bank to actually address the real problem in the credit crisis, confidence. Lowering rates is not going to fix this problem. Every financial institution must be confident that its trading counterparties are on financially secure footing before banks begin to lend to each other again. This commentary by the Prince on the Bank of England’s plans may be premature since the official plan has not been released yet. However, the Bank of England appears to be on the eve of doing something that the Federal Reserve would never consider, take on the securities of struggling banks. The WSJ is reporting that the BOE plans to quickly take on banks’ securities in a £50 billion ($100 billion) plan. The central-bank plan is expected to be up and running by the end of the week. U.K. banks are expected to raise tens of billions of pounds in capital and also increase write-downs in coming weeks as a result of the plan. RBS is expected to raise £10 billion in a stock issuance to investors and write down £7 in debt.

Amazingly, the goal of both the government and banks is to jump-start corporate lending and funding for consumers. If that was the aim of Federal Reserve they sure have been pursuing the wrong policies recently. The Federal Reserve has a similar program but the British approach would allow banks to park mortgage loans with the central bank for an entire year, or possibly more. The Fed’s effort allows banks to exchange mortgages for government bonds for 28 days with additional restrictions. The European Central Bank recently began lending against mortgages for periods as long as six months.

Under the terms of the pact with the banks, the Bank of England will swap as much as £50 billion in government bonds for securities backed by mortgages and some credit-card debt. It is rather surprising to the Prince that in a small country where the public is very watchful of government spending the BOE is able to take such actions. Taking these rotten assets into the public’s ownership amounts to just handing cash out to banks. Although I am sure the calls for similar program will soon mount in the U.S. The Prince seriously doubts that such a massive swap of rotten assets for good assets would ever get past U.S. politicians or be cheap enough to bring to fruition. From the scare details out at this point it seems clear that the BOE’s asset swap plan will cost taxpayers millions if not billions, it just won’t be apparent to the public for a few years. However, if the medicine works, and it might work despite the doubter, the United Kingdom’s taxpayers will be getting a good deal given their high level of consumer indebtedness. (According to the WSJ total household mortgage debt in Britain at the end of 2007 stood at about £1.19 trillion — or about 84% of the country’s gross domestic product, compared with 75% of GDP in the U.S. British banks also got a big chunk of the money they needed to make those mortgage loans from financial markets, rather than customer deposits: As of mid-2007, they counted on markets for nearly half their funding.)

The United Kingdom is taking drastic measures to get credit flowing to businesses and consumers again. The Prince is not holding his breath.

Treasury Chief Alistair Darling plans to make an announcement on the plan Monday, the Prince will check back in on this one then.