Friday, September 14, 2007

Paper covers Rock, but Rock wins

Now we know a bit more about the terms on which Northern Rock can access the financial resources of the Bank of England. In a statement dated September 14, Northern Rock says:
"...Northern Rock has agreed with the Bank of England that it can raise such amounts of liquidity as may be necessary by either borrowing on a secured basis from the Bank of England or entering into repurchase facilities with the Bank of England. Such repurchase facilities would include securities that have prime residential mortgage assets as underlying collateral. The collateral that can be used under this "Repo" facility is similar in nature to the collateral currently utilised by many Eurozone banks with the ECB."
As I suspected, Northern Rock was unable to access the Bank of England's Standing (collateralised) lending facility or participate in normal liquidity enhancing Repo operations, because these require collateral of a kind Northern Rock was unwilling or unable to offer - sterling and euro-denominated instruments issued by UK and other European Economic Area central governments, central banks and major international institutions rated at least Aa3 and, exceptionally, US Treasury bonds. Instead they are allowed to offer as collateral asset-backed securities, specifically, prime residential mortgage backed securities. Anne Sibert and I have recommended extending the menu of assets eligible for discounting at the Bank's Standing lending facility and for normal repo operations (see (1), and (2)) and it is good to see that a small step has been taken on the road to the Bank of England functioning as Market Maker of Last Resort. Unfortunately, the widening of the set of eligible collateral is so far only for exceptional and one-off bail outs like the Northern Rock credit line. It is, however, scandalous that so little is known about this facility. It is tax payers' money that is put at risk. It is also essential that the level playing field among competitors in the financial markets be distorted as little as possible. The following information should therefore be put in the public domain:
  1. The terms and conditions of the credit facility, including the interest rate charged on any use of the credit line, the fee charged for making the credit line available, the amount of the credit line, the period for which it will be available and any other relevant characteristics.
  2. The exact nature of the collateral that can be offered, its valuation and the haircuts imposed.
  3. Equivalent information as regards any repurchase agreements with the Bank of England.
Keeping this information confidential and secret destroys the accountability of the Bank, the FSA and the Treasury for the public resources put at risk. It is a distortion of the competitive level playing field of our financial institutions. It is also completely unnecessary for the effective implementation of the bail out. The same unnecessary secrecy surrounds borrowing at the Standing collateralised lending facility of the Bank of England, the choice of target reserves at the Bank of England by individual banks, and the use of these reserve facilities. Information on the use by individual, named institutions of any of these resources/facilities, and on the terms attached to this use, should be in the public domain. The current lack of transparency is both economically and politically damaging.


stevescot said...

I agree with a lot of your this.

When the Bank of england backs this debt though - is it with 'new money' created by the government - (in which case it's more a tax on savers than on tax payers - as the value of their money would decrease with the newly created money now diluting it.)

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Anonymous said...

Publishing the valuation of the collateral would no doubt be extremely difficult if they are offering Mortgage-backed securities. Banks and hedge funds are complaining that these assets are illiquid and that their value cannot be properly assessed. I think that in fact there are likely to be speculative pools of capital bidding on these securities, but currently at prices too low to be acceptable by the sellers. This is NOT an illiquid market just one which has unwilling sellers... who don't want to sell at the highest bid.

Anonymous said...

Ironic, Willem, that when I checked your Northern Rock posting for the third time today, Google popped up an add for UK Self Cert Mortgages: 'No broker fees, full market access, instant decisions, no income proof'. The forth time I read it up popped another one, this time for Guaranteed 110% mortgages; 'no credit scoring, same-day decision, if we can't help you, nobody can'.

Kinda describes Northern Rock and the Bank of England, doesn't it?

No doubt regulators will be hoping to tease out a buyer for Northern rock before the weekend is over, otherwise it's Defcon 5 next week in the City.

Christopher Glendinning Miller said...

I am not sure that there is any visibility as to the extent of this crisis. On Wednesday 19th September 2007 Barnard Marcus are to hold an auction of properties and I have identified about 17 that will cause a potential loss to the mortgage lender of £0.75 million. In July 2007 there was the publicized sale of six properties at Henry laver Court in Colchester which potentially caused a single mortgage lender a loss of £0.35 million. It may be that these figures all represent unique circumstances and maybe not reflective as a whole. If these figures all come about as a result of unique circumstances, there is probably little to worry about.

However, if they are reflective of the picture as a whole, there are almost certainly more serious problems afoot. The solution is not to simply put up interest rates. The outcome of this strategy will be almost certainty to achieve a recession or potential depression of the scale seen during the 30’s in America.

I believe that the only way forward to prevent the recession or potential depression is to allow inflation to run for a period of three years at rates above 30%. I accept that this is far from a palliative outcome. However, anyone opposing it really ought to go and watch ‘Grapes of Wrath’ or read the book to understand the extent of the true misery cause by a depression.

Tim Young said...

Despite the government's self-congratulation about economic stability since 1997, this is looking like the first real test of BoE independence. At the same time as financial risks are being realised, inflation pressure seems to be building as commodity prices and probably other import prices rise. The response of our politicians and central bankers is going to reveal whether their principles are real or just puffery.

Anonymous said...

Reading what you have said, does someone need to make a freedom
of information request to see whether the BofE has acted prematurely or is doing this to fraudulently prefer one group of potential creditors over another? It's not just about regulation it's about law.
If NRock can stand, it can stand. If it falls, it can fall and be
bought up with the correct people loosing the correct beneits, i.e.
shareholders their stake, directors their jobs and I'm sorry to say,
NRock staff too, but that is the price for working for an organization
and not questioning it's practices.

Carlomagno said...

Explain this to me: one day you're slamming the Bank of England and the next you write that "it is good to see that a small step has been taken on the road to the Bank of England functioning as Market Maker of Last Resort."

What gives?

DorsetDipper said...

On the subject of Moral Hazard, aren't depositors in Northern Rock victims of Moral Hazard generated by the regulation of financial insitution through the BofE?

You walk into a bank and before you deposit your life's savings you are told one of the following:

1. "We may go bust and you may lose most or all of your deposit"

2. "We are regulated by the BofE"

- which one are you told? And which one is true? And would your behaviour change depending on what you are told?

Anonymous said...

Really the whole episode needs a good investigation because all sorts of contradictory information is floating around on whether funds were needed or not how much etc. Have they really only mortgages as collateral? Have they sought outside buyers/investors? What courses were considered before going to BOE? What funding have they tried to raise? Did they/why did they fail to do so? If its CP what are the maturity schedules amounts etc.