Sunday, April 20, 2008

Bank of England Will Unveil Swap to Ease Loan Market (Update1)

By John Fraher and Brian Swint

April 20 (Bloomberg) -- The Bank of England will tomorrow announce a plan to swap about 50 billion pounds ($100 billion) of government bonds for mortgage-backed securities to ease credit costs, people familiar with the matter said.

The plan will ``unfreeze the situation we've got at the moment,'' Chancellor of the Exchequer Alistair Darling said in an interview with the BBC, without saying how much it would make available. ``What the Bank of England will do is in effect lend the banks that money. In the meantime, the Bank of England will take a security.''

Prime Minister Gordon Brown's government is trying to promote lending after a surge in borrowing costs prompted banks to pull back their best mortgages, threatening to exacerbate the worst housing downturn since 1992. The plan shows a change of approach after three interest-rate cuts since December by the Bank of England failed to stimulate loan provision.

``It's been a long time coming but what's important is that the bank is recognizing commercial banks' problems,'' said Philip Shaw, chief economist at Investec Securities in London. Success may depend on credit ratings of the securities that the Bank of England accepts and the duration of the plan, he said.

The swap is double the value of loans and guarantees Governor Mervyn King extended in September to prop up Northern Rock Plc. The government in February nationalized the mortgage lender, the first U.K. bank to fall victim to the credit freeze stemming from the collapse of the U.S. subprime market.

Statement to Lawmakers

Darling will speak in Parliament tomorrow around 3.30 p.m. and will also update lawmakers on the progress of the Bank Act, which would give British authorities power to seize control of failing banks.

The central bank announced its last measure to tackle the credit crisis at 9 a.m. on March 20, when it said it would extend additional emergency funds. The Bank of England wouldn't comment on the timing of the swap announcement or give further details of the plan.

Investec's Shaw said the central bank may provide the funds on a rolling basis as needed by financial institutions. The British Broadcasting Corporation reported on April 18 that the offer may total 50 billion pounds.

The central bank's move allows financial institutions to add government bonds to their inventory of liquid assets and make it easier for them to both raise cash and lend, especially to consumers seeking home loans. In return, the government will hold the riskier mortgage-backed assets as security.

`Essential' Step

``This is an essential initial step in trying to get the financial market stabilized and that in turn will help the mortgage market,'' Darling said. ``We can re-open the financial markets, because that is an essential pre-condition for the provision of mortgages.''

To date, the Bank of England has widened its collateral requirements just for three-month lending. It only accepts top- rated government securities at its weekly auctions.

The U.S. Federal Reserve last month made up to $200 billion available to banks in return for debt including mortgage-backed securities. The European Central Bank, the first central bank to react to the credit crisis in August, has extended the maturity of money auctions to help cash-strapped institutions.

Investec's Shaw says the term of the Bank of England's swaps may need to be longer than those under the terms of the Fed's program, maybe as long as a year. The U.S. central bank lends Treasuries for 28-day periods.

Collateral Rules

The Bank of England will accept only British and European mortgages and credit-card loans as collateral as part of the plan, the Sunday Telegraph reported today, citing unidentified people with knowledge of the program.

Former Bank of England policy maker Willem Buiter, now a London School of Economics professor, said on April 18 the plan's success ``all depends on the scale'' and the central bank could offer assistance on a rolling basis.

``In total, they would have to do -- not in one big go -- at least 100 billion for it to really actually make a difference to the liquidity position of banks, but also act as the catalyst for getting that market going again,'' he said.

The risk is that a slide in house prices worsens, undermining support for Brown's government. Mortgage lenders including HBOS Plc and Lloyds TSB Group Plc have raised the cost of loans, even after three quarter-point rate cuts by the Bank of England to 5 percent.

House prices dropped 2.5 percent in March from a month earlier, the biggest drop since 1992, HBOS, the country's largest mortgage lender, said April 8. Brown's approval rating dropped faster than for any U.K. leader on record as support for the opposition rose to the highest in 16 years, a poll published on April 13 showed.

Darling urged patience, saying the credit crunch partly needs time to work itself out. He said one analogy was to someone with a dose of food poisoning which ``just has to work its way through the system.''

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