ANALYSIS:MERVYN KING, the Bank of England governor, assumed full ownership of the idea behind the Special Liquidity Scheme yesterday, having tapped out the guts of the swap arrangement of UK Treasury bills for mortgage-backed securities on his home computer about a week before Easter, writes Chris Gilesin London.
The bank's view was that events in March, culminating with the rumours over HBOS and the Bear Stearns crisis, showed how any bank, solvent or not, could fall victim to a wholesale run and refusal by others to lend it money.
The bank thought something fundamental had to be done to ensure a liquidity shortage could not bring banks down in future.
The plan was discussed with British banks just before Easter, and King took the details when he went to meet his counterparts at the Group of Seven meeting in Washington 10 days ago.
At the time, the bank's view was that the crisis was too serious for any small country to go it alone with a big new central banking operation - but that view has changed in the past week.
King was at pains yesterday to make it clear he was not bailing out British banks. "It is not available for failing institutions," he told journalists, saying it was not an operation that would address the solvency of banks.
Instead, he wanted to ensure that no one need be in any doubt that a solvent British bank could settle its debts in future. "Now is the time to take the liquidity issue off the table in a decisive way," he said.
The bank, the slowest to react to the initial credit crisis, has now gone much further than the US Federal Reserve or the European Central Bank in its liquidity support operations.
It is offering close to limitless liquid assets in return for high-quality assets for a period of at least a year and renewable for a further two years. The Fed offers a similar liquidity support scheme but for a period of only 28 days.
The bank's action reflects the particular UK and European problem, which so far has been the lack of liquidity and trust between banks rather than serious losses from defaults on home loans and US mortgage-backed securities, which is a greater concern in the US.
The bank's scheme is designed to keep credit risk securely with the banks. If mortgage-backed assets become impaired, banks must replace them in the swap arrangement with pristine AAA-rated assets or hand the treasury bills back.
So the only way the British taxpayer could lose money would be if a bank went bust and the value of that bank's assets held by the Bank of England had fallen by more than the haircut that had been imposed on the banks when offering the swap arrangement.
- (Financial Times service)
