Remember when Mervyn King, Governor of the Bank of England, was all about applying ‘Moral Hazard’ to the banking system? You know, the idea that some banks had to fail to teach others not to make dodgy lending decisions? You can be sure King remembers making statements on risky lending like this:
“The provision of such liquidity support undermines the efficient pricing of risk by providing ex-post insurance for risky behavior. That encourages excessive risk-taking, and sows the seeds of a future financial crisis.”
Ah well, six months is a very long time in a credit crisis. One winter of discontent later, and Merv the Swerve has done a U-Turn, with the Bank announcing today its much-mooted Bring-and-Buy-a-Bond sale.
In attendance at this open-to-all Swap Shop will be all the major lenders, hawking mortgages they’d currently find impossible to shift on a quiet day on eBay. Manning the stalls will be the Bank of England, who’ll swap £50 billion of the high street bank and building society’s mortgage debt for gleaming UK government Gilts. Here’s the official notice:
The Bank of England is today launching a scheme to allow banks to swap temporarily their high quality mortgage-backed and other securities for UK Treasury Bills.
With markets for many securities currently closed, banks have on their balance sheets an ‘overhang’ of these assets, which they cannot sell or pledge as security to raise funds. Their financial position has been stretched by this overhang so banks have been reluctant to make new loans, even to each other.
Under the Scheme, banks can, for a period, swap illiquid assets of sufficiently high quality for Treasury Bills. Responsibility for losses on their loans, however, stays with the banks. By tackling decisively the overhang of assets in this way, the Scheme aims to improve the liquidity position of the banking system and increase confidence in financial markets.
This ‘Bank of England Special Liquidity Scheme‘ looks a decent compromise in the dire circumstances. Here’s some of the advantages:
- The banks are taking a haircut on their assets, so the Bank of England has some protection from further falls in house prices
- The risks largely (but NOT entirely) remain with the banks
- Only debts incurred before 2008 are swappable, so banks can’t write loads of new loans with this specific money (though that’s probably splitting hairs in practice)
- It is of fixed duration (a year initially, with the option to renew for up to three years)
There are risks, however. Firstly, it’s going to be percieved as a bailout, even if in reality we all need the banking system to get moving again for the good of the economy.
Also odd to my eyes is that credit card debt is included in the arrangement. (I thought the whole point of this crisis was it was engendered by the sup-prime fallout. Are we getting the full story?)
The Lib Dems Vince Cable has been impressively vigilent on the subject of banking bailouts, perhaps because he’s unencumbered by the risks of ever being in high office himself, saying things like:
“I am very concerned that in addition to all the costs associated with Northern Rock, the government is going down the disastrous road of bailing out the banks and leaving the taxpayer with the liabilities.”
The biggest risk to taxpayers – although now unlikely, given this new level of support – is if a bank goes the way of failed Northern Rock, as the BBC’s Robert Peston writes:
The Bank of England and taxpayers would emerge as losers if there were a collapse of a bank to which it had lent. […] Many bankers are convinced that if this scheme had been in place last August or in early September, Northern Rock would have been able to raise enough money to avoid the humiliating financial crisis that took it from run to nationalisation during an autumn and winter of very public mayhem.
The City watchdog, the Financial Services Authority, desperately wanted such a generous mortgages-for-loans swap scheme to be established months ago. So again Mervyn King needs to say why it was inappropriate in the early weeks of the credit crunch but is highly appropriate now.
There in lies the rub for Mr King. Does he dare admit that he needed to extract his (several billion) pound of flesh, in the form of the failure of Northern Rock and the embarrassing need for banks to ask shareholders for more money (RBS confirmed this morning a call on shareholders for £10 billion) as the price for his bailout?
In the longer-term, we need to realise that bank failures are not once-in-a-million year events. As I commented recently on MP John Redwood’s blog, banking shocks are more like once-a-decade affairs. Somehow banks need to stump up some insurance against this in advance.
Perhaps this is impossible in practice (since banks would soon incorporate that insurance into their models of risk) but it’s surely worth a try? The alternative is more regulation, which we’d all suffer from if it meant a return to credit rationing.
Finally, more individual bankers need to pay for the crisis with their jobs (and not the IT and support staff who’ve taken too many of the arrows so far). I’m sure in a couple of years the bankers will be picked up by the next bubble, but it’d be nice to see them forsake their ludicrously high salaries for a few months first, just to show willing.