FYI | Apr 29 2008
By Greg Peel
If there is one economy in the world that is feeling a direct fallout from what began as the US subprime crisis, it’s the United Kingdom. Back in 2007, long before Bear Stearns hit the wall, the most immediate potentially terminal victim of the subprime credit crunch was Countrywide – America’s biggest issuer of low grade mortgages. As the world focused on the US in general and Countrywide in particular, suddenly there was a run on the UK’s Northern Rock – a regional lender not dissimilar to Countrywide.
While Bank of America stepped in early to prop up Countrywide (a costly move so early in the credit crunch), no one was prepared to save Northern Rock for any reasonable price. It is now history that the government overrode the Bank of England and declared all British deposits at all banks guaranteed. It was then forced to later nationalise Northern Rock.
BoE governor Merv King’s initial response to the credit crunch was a laissez faire one – he saw no reason to evoke moral hazard and bail out a system which had dug its own hole. Thus while Uncle Ben Bernanke was busy immediately slashing rates and pumping in liquidity, the BoE did nothing – at least nothing until Northern Rock hit the wall. The central bank has since made rate cuts and pumped in liquidity as well.
But whereas the UK financial system was initially hit by the securitisation market fallout, itself a result of the US housing slump, the problem has now exacerbated as Britain, too, begins to see a downturn in house prices. The problem is no longer simply a US one. The UK mortgage market is under fire from both without and within.
The other piece of history created recently was the Fed’s “rescue” of Bear Stearns the subsequent opening of the discount window to previously barred investment banks. This has gone a long way to stabilising the global financial system, and may yet prove the move that established the bottom of the bear market. The significance of the discount window is that troubled investment banks could approach the Fed and exchange their frozen mortgage paper for US Treasuries, at least for the time being.
Prior to expanding the windows candidates the Fed had also lowered the premium applied to cost of funds from the window from 1% to 0.5%. As approaches to the window are made public, the stigma attached to requiring emergency funds can be more destructive to a troubled bank than the emergency funds will themselves alleviate. Hence the “discount” window became really a premium window, the implication being that if a bank is prepared to pay up for some temporary assistance, things can’t yet be catastrophic.
As the UK financial market has been in danger of crumbling as well, and throwing up its own Bear Stearns, the Bank of England has decided to take a leaf out of Uncle Ben’s book. It is making 50 billion pounds in Treasury bills available to be exchanged for mortgages and credit card debt. However, unlike the Fed’s system, any approach to the BoE for assistance will be kept secret – for eternity.
The BoE has been spooked by activity currently under investigation which involved hedge funds going short on banks and then spreading negative rumours. The Halifax Bank of Scotland (HBOS) was one victim of such attempts, and we will probably never know whether such a scam also played some part in Bear Stearn’s ultimate demise. While cowboy traders will probably now not be foolish enough to try such scams again under the spotlight of the regulator’s glare, the same destructive rumours could nevertheless spread legitimately – albeit Chinese whisper style – and start a slippery slope for a bank who deigned to access the BoE’s emergency funding. There has already been a bit of this going on throughout the credit crunch period.
Thus the BoE has taken extraordinary measures to make sure approaches remain entirely anonymous.
Any BoE employee spilling the beans will be sent to the Tower. The total amount of funds accessed will not even be revealed until October. And the Freedom of Information Act will be overridden, such that anyone trying to write a book about the episode in 30 years time will still come up empty handed.
Nevertheless, the banks themselves are permitted to make their own revelations if they want. Both Barclays and HBOS have candidly declared they will use the facility. This smacks of goodwill gesture, not dissimilar to a similar show of faith from the large US commercial banks when the Fed first started offering large extraordinary facilities. However, there is more general fear that if too many banks join the chorus the implication will be that the UK banking system is in worse shape than already assumed.
The amount is also a revelation. The 50bn pounds compares to a total of only 17.6bn pounds of Treasury bills currently on issue.
