Monday, April 21, 2008

Bank of England unveils £50bn mortgage bailout

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By Miranda McLachlan

The Bank of England (BoE) launched an unprecedented £50 billion scheme today to bail out Britain’s ailing banking system and help to ease the tightening mortgage market.

The BoE confirmed this morning that it would allow lenders to swap assets for government-backed bonds in an attempt to restore confidence and ease the effects of the credit crunch.

Alistair Darling, the Chancellor, is set to provide further information to MPs at 3.30pm.

The BoE will allow banks principally to swap UK and European mortgage-backed assets for "safer" government bonds, which banks can then use to raise money.

Mervyn King, the Governor of the Bank, said today: “The Bank of England’s special liquidity scheme is designed to improve the liquidity position of the banking system and raise confidence in financial markets while ensuring that the risk of losses on the loans they have made remains with the banks.”

However, the City appeared to be underwhelmed by the terms of the bailout this morning.

David Buik of BGC Partners, the inter-dealer broker, said: "The initial reaction to the scheme has been rather luke-warm. It is early days but the cost of these facilities seems to be ... prohibitively expensive in current conditions."

Banks will be required to pay a fee based on the three-month London Interbank Offered Rate (Libor), the rate that banks charge to lend to one another, for the bonds.

The BoE will issue bonds valued at a 10 per cent to 30 per cent discount on the value of the banks' assets.

Richard McGuire, of the investment bank RGC Capital Markets, said that the scheme was "unlikely to do much to inject new life into the UK's troubled mortgage/housing markets ... given the costly nature of the exercise".

Mr McGuire described the discount applied by the BoE to the value of banks' assets as "sizeable".

Under the scheme, banks will need to provide assets of "significantly greater value" than the bonds they have received.

If the value of assets fall or they are downgraded by ratings agencies, they will have to provide more assets or return some of the bonds.

While the BoE said that the scheme was designed to minimise the risk to taxpayers, it confirmed that securities backed by unsecured credit card debt would also be eligible.

"The public sector would be exposed to a loss only in the very unlikely event that a participating bank defaulted and the value of assets it had placed as security with the Bank of England later proved inadequate," it said in a statement.

"Securities backed by credit card debt ... will be high quality."

It is hoped that the rate that banks charge each other will fall, and, as a consequence, homeowners and first-time buyers can secure better and cheaper mortgage deals.

However, there is also no guarantee that the bail-out will lead to cheaper mortgages.

The swaps are available only for assets existing at the end of 2007 and cannot be used to finance new lending.

Each swap is offered for a period of one year and may be renewed for a total of up to three years.

Banks will be able to enter into new asset swaps at any point during a six-month window, starting today.

Usage of the scheme will depend on market conditions. The initial offer is for £50 billion of bonds, but senior Treasury sources have told The Times that further cash injections up to a total of £100 billion were possible.

The scheme will be ring-fenced and independent of the Bank of England’s regular money market operations, so it will not interfere with the Bank’s ability to implement monetary policy.

British banks, uncertain which institution has lost what, have hoarded cash reserves to protect their own positions.

Mr Darling said yesterday that the latest move was intended to “ease” the market.

“We believe that this will be an essential step in trying to get the financial market stabilised. That in turn will help the mortgage market too,” the Chancellor said.

However, he gave warning that in return he expected that the banks would “begin now to disclose the extent of their losses and explain how they are going to rebuild their capital”.

Under the terms of today’s announcement, banks will be allowed to swap hard-to-trade mortgage-backed securities linked to their previous lending for specially issued Treasury bills.

Mr Darling is expected to press for mortgage lenders to ease lending conditions, especially for first-time buyers, when he meets them tomorrow.

“He’s not holding a pistol to their heads, but he wants to do everything he can to help people get on the property ladder,” a Treasury source said.

Vince Cable, the Liberal Democrats’ Treasury spokesman, said: “We cannot have a situation where the banks are able to privatise their profits and nationalise their losses.

"Since the mortgages from the banks are of inferior quality and higher risk than the government bonds which they are replacing, the implication must be that taxpayers are shouldering the risks and losses of the banks. This cannot be right.”

The British Bankers’ Association commented today: "The banks are participating in this arrangement and expect it to make a significant contribution to alleviating the pressures in the UK money markets.

"Restoring confidence in the wholesale funding market will strengthen the financial system and the stability of our economy."

A BBA spokeswoman denied that the banks were being bailed out. She said: "They are paying commercial rates for the loans offered by the Bank of England.”

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