Wednesday, 19 September 2007

The Bank between a Rock and a Hard Place

Today the Bank of England said it will lend £10B to commercial banks in an emergency three-month auction and widen the range of securities it accepts as collateral to include mortgage backed securities. That should bring the 3 month swap spread in. The question is, why have they caved in to the banks after holding the line admirably until now? Some possibilities, the first three none too savoury:

  • The political clamour over Northern Rock could not be ignored and the Bank was worried that someone like Alliance and Leicester or HBOS might be next.
  • The Bank knows that another player is in serious trouble.
  • The knock-on effects of the high cost of Libor-referenced funds in the real economy are becoming too large.
  • The rate the Bank is charging for this extra liquidity is sufficiently high that it provides appropriate liquidity yet makes anybody imprudent enough to need it pay through the nose. This wouldn't be too bad but one wonders why at least some of this £10B was not provided earlier.

I agree with Nils Pratley that this is not a resigning matter for Mervyn King - the Bank has played a reasonable hand. But we do need understand what their thinking is. The performance today will be interesting.

Update. King is blaming the Market Abuse Directive for preventing him lending to Northern Rock covertly, and the takeover code for stopping him organising a quick-but-effective sale. This is fascinating if it's true.

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