Page last updated at 20:46 GMT, Friday, 18 April 2008 21:46 UK

Bank 50bn mortgage rescue plan

Robert Peston
By Robert Peston
Business editor, BBC News


Bank of England
The Bank of England plan is similar to one seen in the US

The Bank of England will next week unveil a plan to swap 50bn of government bonds for British banks' mortgages, the BBC has learned.

The government bonds would have a maturity of up to a year, but would be rolled over for up to three years.

These would meet banks' demands for longer term loans, while escaping being accounted for in the national debt.

The Bank of England hopes the scheme will encourage banks to lend to each other again and also to homeowners.

The banks have been asking for longer term finance from the Bank of England to fill their funding gap following the collapse of the market for mortgage-backed securities last August.

The disappearance of this market deprived banks of tens of billions of pounds of finance for mortgage lending and is one of the main reasons why the cost of mortgages for many homeowners has been rising, even though the Bank of England has been cutting its base lending rate.

The Bank of England financing plan is expected to be announced towards the end of next week.

It will be the biggest ever special initiative by the British monetary authorities to supply liquidity to the British banking system.

Tensions

In the creation of this financing plan, there has been tension between the Bank of England, on the one side, and the Treasury and Financial Services Authority on the other.

The Treasury and the City watchdog have been frustrated at what they perceive to be the slowness of the Bank in launching what they regard as an initiative badly needed to prevent the crisis in the banking markets from turning the UK's economic slowdown into a recession.

Meanwhile, the lending programme could open up the Treasury to accusations of creative accounting by opposition parties by limiting the maturity of the bonds to one year, but allowing the lending facility to be in place for three years.

If the Treasury had chosen the simpler route of issuing bonds of two-year and three-year maturity, the new bonds would have been part of the national debt under accounting standards.

This would probably have led to a breach of the so-called fiscal rules put in place by Gordon Brown in 1997 to keep the public sector's balance sheet in reasonable shape.

Bonds with a maturity of less than one year, issued in what is known as a "repo" operation, do not count towards the national debt.

Shortage of cash

In the first half of 2007, British banks raised 60bn from the sale of mortgage-backed securities but next to nothing since then.

Britain's smaller building societies and banks are suffering worst from the general shortage of liquid funds.

Some have been forced to massively cut back on their provision of new mortgages, which is exacerbating a downturn in the housing market.

These smaller banks will be unable, under Bank of England rules, to directly benefit from the new financing plan. They are prohibited from participating in repos.

But the Bank of England hopes the bigger banks will swap their illiquid assets for the new government bonds and this will reduce the inter-bank lending rate or the market price of loans.

The Bank of England and the Financial Services Authority are also expected to put pressure on the bigger banks to lend at these keener rates to the smaller banks and building societies, thus turning on the funding tap.


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