Would You Borrow $80bn From This Man ?


In the aftermath of the disastrous run on the Northern Rock Bank throughout September 2007, the Bank of England began to understand the enormity of the calamity which had unfolded.

Alternatively of pumping cash into the banking sector in order to avert the impending liquidity crisis, the Governor of the Bank of England signalled to the markets that banks which have turn out to be weakened by imprudent actions may possibly be permitted to fail.

When the run on Northern Rock was sooner or later halted by a government assure to all depositors, there was pressure on the Bank of England to act in order to ensure that no other bank would be at risk.

Mervyn King, the Governor of the Bank, announced on 19 September a series of auctions designed to give loan funds for a period of three months. The funds would be secured on a versatile package of collateral, including mortgages. The rate of interest would be 6.75%. US$ 20bn was on provide on each of the four auctions, during the period 26 September to 17 October, creating a total of US$ 80bn.

Monetary markets have been rife with rumours that numerous other UK banks are at threat. The most likely candidate seems to be Alliance and Leicester whose share price has fallen from GBP11 to GBP6 throughout 2007. The result in of the problem is the very same as Northern Rock, namely, it needs significant funds from the wholesale market in order to prime up money held from depositors. Nevertheless, there are persistent rumours that larger banks, such as Barclays, are in trouble.

If these banks are in such dire straits, it is outstanding that there had been no applications received by the Bank of England for the US$ 80bn of funds on offer.

Admittedly, the funds have been getting presented at around 6.75%. Compared to the bank price of five.75% and interbank prices of around 6.2%, the interest rate was not generous. However, if borrowing cash at six.75% for 3 months, and possibly longer, could guarantee the survival of a bank and permit the directors to sleep at evening, it is surprising that there was not a single applicant.

In a slightly various context, if home owners, who had defaulted on mortgage capital repayments, had been presented an interest only loan of 6.75% for 3 months, the supply would have been welcomed, and house repossessions would be lowered substantially.

The purpose why no-1 responded to Mervyn King’s provide is due to the collapse in self-confidence and credibility of the Bank of England.

Mervyn King justified the Bank of England’s lack of intervention with respect to Northern Rock by reference to ‘Moral Hazard’. By this the Governor meant that he did not want to send a signal to other banks and financial institutions that the Bank of England would bale them out should they experience troubles in the future due to poor policies or imprudent lending.

Even though it is valuable for the Governor to caution banks against the dangers of risky enterprise models and the dubious practice of creating loans to consumers with low credit status, it is singularly inappropriate for him to make such remarks for the duration of a banking crisis.

Prior to the crisis at Northern Rock becoming public, it is clear that Lloyds TSB wished to initiate buyout talks. It seems that they had been looking for a Bank of England loan of up to GBP20bn over 2 years. This sum was roundly rejected. With the benefit of hindsight, this was a reasonable offer you from Lloyds TSB as the Bank of England has subsequently handed Northern Rock some GBP28bn and the crisis remains far from more than.

Although Mervyn King was contemplating ‘Moral Hazard’, both the European Central Bank and the US Federal Reserve have been quietly rising liquidity in financial markets. Certainly on September 19th, the Federal Reserve reduce interest rates by .five% from 5.25 to 4.75. This was followed by another reduce at the end of October to four.five%.

In addition to the stupidity of the policy, speak of ‘Moral Hazard’ seems a small peculiar. If the Bank of England was organizing to open a massage parlour or lap dancing club in Threadneedle Street, then this may effectively constitute a moral hazard for Mr King and his colleagues at the Bank of England.

Mr King also produced numerous references to the desirably of ‘Covert Action’ in dealing with the Northern Rock crisis, but claimed that he was prevented from acting in this way by UK legislation. This was an odd claim as neither Mr King nor his colleagues are on record as pointing this out in the course of their 10 years of independence from the UK Treasury. Probably Mr King was slightly befuddled and was confusing his role with that of MI5 or the CIA.

Even so, the main impediment to any bank taking up the Governor’s supply was that the assure of confidentiality was not deemed to be worth the paper it was written on. Based on the culture of blame and leaks from the tripartite agencies of the Bank of England, the Economic Services Authority and the UK Treasury, no bank was ready to take the danger of borrowing a large sum from the Bank of England.

The essence of banking is self-assurance. Unless depositors think about their funds to be protected, there will be a run on any bank, no matter who it might be.

Must a bank’s require for money grow to be public, then the bank may possibly unwittingly invite a run on its funds. A leak from the Bank of England would transform a crisis into a disaster. The bank would become a second Northern Rock.

Leslie Hardy is a noted writer on North Cyprus House
and the UK Chairman of Wellington Estates Ltd. Read more on this subject at Northern Rock

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By robertschrader on 2012-09-05 07:41:29
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