In his latest attempt avert a banking crisis, stabilise the housing market, and save Gordon Brown’s now tarnished reputation for economic competence, Chancellor Alistair Darling today unveiled details of a Special Liquidity Scheme described by the BBC’s Robert Peston as a “banking market bailout of an ambition we haven’t seen in this country since the early 1970’s and possibly longer than that”.
The aim is to unblock the interbank lending market, where interest rates have remained stubbornly around 1% higher than the Bank of England base rate despite three recent rate cuts, and thereby reverse the rapid shrinkage in mortgage availability caused by the unwillingness of commercial banks to lend to each other, by lending central bank funds against a wide range of collateral supplied by those commercial banks.
The mechanics are reasonably straightforward – the Bank of England, mimicking the $200bn (about £100bn) Term Securities Lending Facility set up for US banks by the US Federal Reserve on 11th March, plans to allow banks to swap “high quality”, predominantly mortgage-backed bonds for government securities to a value initially estimated by Reuters at around £50bn, depending on take up. This facility will be available for a one-year period, renewable for a total of three.
In an attempt to avoid being seen to put taxpayers money at risk, should any of the securities bought by the Bank of England drop substantially in value thanks to rising mortgage defaults and repossessions, some special conditions will be attached described by the FT as, “more draconian than expected”.
These include a substantial “haircut” – a discount applied to the value of the assets put forward by the banks, meaning in effect they need to provide more than £1 of their own securities – as much as £1.22 according to the FT – to receive £1 of Treasury bills. There will also be a fee of at least 0.2% of the amount borrowed and perhaps significantly more should the wide gap between the interbank lending rate (LIBOR) and the three month Treasury Bill rate remain.
Lastly any assets bought by the Bank of England will be priced at relatively low, “observed market prices”, a measure designed to head off accusations that the Bank of England might otherwise create an artificial floor for mortgage backed assets at the taxpayers’ expense.
It remains to be seen whether these relatively stringent conditions deter would-be borrowers from approaching the Bank of England at all. But assuming an enthusiastic takeup, will it work? If success is defined as averting another Northern Rock-style banking collapse, then maybe – banks will now at least have a way to raise finance from somewhere other than their reluctant rivals, or from following RBS in going cap in hand to shareholders with a big rights issue (thought to be for around £12bn).
However, beyond that the impact is likely to be limited. As Roger Bootle at Capital Economics notes, the similar Fed TSLF already in place in the US, although only offering funds for 28 days, has, “so far failed to normalise US interbank rates”.
More importantly if the Bank of England is attempting to reverse banks refusing to lend – a natural and largely rational response to rapidly deflating UK house prices – it will fail. As such former MPC member Willem Buiter notes even an extra £100bn may not make much difference unless the housing market stabilises, which looks highly unlikely given the monthly drop of 2.5% recorded by HBOS in March was the biggest for 16 years.
So, whilst it’s unlikely we’ll see expect queues of anxious savers forming at branches of any other UK institution anytime soon, it’s equally sensible not to expect mortgage rates to drop or house price falls to level off for some time yet.