Bank of England Contributing to Mistrust of LIBOR

The Bank of England Monday announced a plan to swap government bonds for mortgages held at its banks for a term of 1-3 years. Under the BOE plan this would give British banks some long term capital to continue lending, and similar to the plan in America, not add to the central banks' debt because they would eventually return them.

But banks in both the US and England have been hoarding cash even as their Central banks have lower interest rates. Banks, uncertain about the financial condition of one another, have not wanted to lend funds to other banks or to their own customers creating a credit freeze-up. The Auction Rate Securities market used by companies, schools, municipalities, and hospitals as a source of long term funds, but repriced every 7, 28 or 35 days, shut down over similar concerns of the credit worthiness of the issuers and the price of the underlying securities. Now financial institutions and money market funds which had lent to these issuers have found themselves holding ARS fixed income debt without a market and/or market price. US Security regulators have granted some short term relief in pricing these securities, but the end result has been to create an aversion to ARS and Preferred ARS securities further causing a giant quake-like disruption across all credit markets.

Recently concerns have now also arisen with regard to LIBOR--the London Interbank Offered Rate. The Bank of England prefers that the LIBOR be lower in yield to stimulate commerce and the Banks in England tend to report it lower to attest to their credit-worthiness. Because the LIBOR is set essentially by survey of bank costs, suspicions are rampant that the LIBOR is being mistated. Indeed the futures market indicates this may be so. This discrepency in price has further exacerbated the the crisis in confidence as many derivative contracts and mortgage rates are tied to LIBOR--further incentive to keep it low to avert triggers and further defaults?

So uncertainty in the credit markets has become amplified despite well-intentioned actions by Central banks. We have reached the point where banks are railing in losses depleting their capital reserves and now mutual objectives are making regulators and central banks partners with their constituent banks in contriving 'feel good' guarantees to remedy the mounting financial problem.

The trouble is that market participants are bit more savvy than that. Institutional investors know that there are losses yet to be realized. Time and off balance sheet incubation of devalued debt at Central banks will not allay this problem. Such actions only suffice to add to the uncertainty and mistrust in the financial system. Real estate mortgage losses have to be realized for demand to re-ignite to remove the excess housing inventories. Procrastinating so that banks don't fail is like hoping a declining trade will turnaround and bail you out. That is nonsense and so are the contrived policy actions of the Central banks.