大象传媒

Bank primes money pump

• Robert Peston
• 5 Sep 07, 04:30 PM

The 鈥檚 stiff upper lip has relaxed just a fraction. For the first time since the global financial system seized up more than a month ago, it has taken what looks awfully like evasive action.

It is endeavouring to relieve the upward pressure on short-term interest rates that has been caused by the global squeeze on credit by doing two related things 鈥� whose combined effect represents a commitment to pump up to 拢5.4bn of short term loans into the banking system.

That said, the Bank is insistent that it is acting within published guidelines: it has not rewritten its own rules about its role in the money markets.

Or to put it another way, it is still drawing a distinction between its own behaviour and that of the US and Eurozone central banks 鈥� both of which have behaved in a more exceptional way.

For me, however, that is a nice distinction. What it has announced today is hardly trivial. It is probably more significant than tomorrow鈥檚 monthly statement by the Bank鈥檚 on the base lending rate.

Having injected liquidity into the system today, I would be staggered if the MPC did anything but keep the base rate on hold.

What exactly has the Bank done?

First, it has agreed that banks can deposit 拢17.6bn in the coming month at the Bank of England 鈥� a rise of 6 per cent or just under 拢1bn from the reserve target of the past month.

Banks can draw on these facilities as and when they need cash in the coming days.

That may not sound terribly significant, unless you are versed in the arcana of central banking. But the point is that the Bank of England actually provides these reserves to the banks via loans to them backed by gilts and other collateral.

An increase in the reserve requirement is in effect an increase in lending to banks at the base lending rate of 5.75 per cent.

It represents a significant increase in the liquidity of the banking system 鈥� and relieves pressure on the banks to borrow at the higher penalty rate of 6.75 per cent.

Second, if that isn鈥檛 enough to bring down overnight borrowing rates, the Bank will supply up to a further 25 per cent of the aggregate reserves target in its so-called open market operation next Thursday.

Or to put it another way, it is prepared to lend banks a further 拢4.4bn at the base lending rate.

In crude terms, the Bank is basically providing additional cheap finance to the banks to meet any short term requirements they might face.

The Bank鈥檚 explicit aim is to bring down the rates which banks charge each other for overnight borrowing to something closer to the bank base rate.

It insists its actions are not specifically aimed at bringing down the three-month rate for loans between banks, which has been at more than one percentage point above the base rate 鈥� much more than usual.

That said, any increase in liquidity in the banking system should 鈥� in theory 鈥� have some effect on longer term rates such as three-month Libor.

The market for three-month money is not totally discrete from the market for overnight money. So what the Bank has done may ameliorate the horrible conditions in money markets.

But it won鈥檛 bring the crisis to an end. On its own, these measures won鈥檛 suddenly persuade banks to start lending to each other and other financial institutions with the alacrity of yore.

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Banks鈥� pyramid scheme

• Robert Peston
• 5 Sep 07, 09:44 AM

Back to school today. But those noisy boys from private equity, who were hyperactive last term and should have been on Ritalin, are curiously subdued.

In all my many years as a journalist, I have never seen an industry suspend activities with the speed and scale of what has happened to private equity 鈥� except when there has been a strike or industrial action.

Actually, private equity is in a way the victim of a strike, a strike of lenders.

Financing for big takeovers by private equity firms has evaporated.

Why did it happen? Nothing terribly sinister or complicated. It is simply that private equity firms became too cocky and ambitious for their own good.

In the first half of this year, they transacted so many big deals requiring so much debt-finance that eventually 鈥� as June turned to July 鈥� the financial markets simply could not and would not absorb all the debt being issued.

Who is to blame? Partly the firms themselves 鈥� but also the big international banks, like Barclays Capital, Royal Bank of Scotland, Citigroup, JP Morgan, and Deutsche Bank.

These underwrote the debt, on the assumption that they could then sell it to investors via artificial financial constructs, the so-called structured credit vehicles (the collective noun for those collateralised loan and debt obligations I鈥檝e been banging on about).

But what they seem to have failed to notice was quite how much additional debt they were expecting these investors to buy. By the middle of the year, the big banks had agreed to provide somewhere between $300bn and $400bn of debt to new private-equity deals, which was six or seven times the amount of such debt placed in a typical year until very recently.

And then there was the banks鈥� second bizarre manifestation of short-sightedness.

Not only were they financing the private-equity takeovers, they were also financing (underwriting) the structured credit vehicles.

In other words, they were on both sides of equation: they were creating both the market for the private-equity debt via the structured credit vehicles and the debt itself.

Does that seem as bonkers to you as it does to me?

It looks a bit like a pyramid selling scheme 鈥� except for the surreal twist that one part of a big bank is selling to another bit of the same bank!

What went wrong (as if you had to be told) is that the banks suddenly took fright about their exposure to structured credit vehicles (because of contagion from sub-prime and all that). So they stopped financing these vehicles, which in turn had less money to buy the private-equity debt. The banks then couldn't sell the private-equity debt, because they had forced the buyers to shut up shop!

It is one of those occasions when it is quite impossible not to say "you couldn't make it up".

Who are the victims of this craziness? Well it looks like being the big banks and their shareholders (oh dear, that鈥檚 you and me if we鈥檙e saving for a pension).

The point is that they are stuck with between $300bn and $400bn of unplaced private equity debt, whose market value is considerably less than the price they paid for it.

And they still have considerable exposure to all those structured credit vehicles 鈥� whose true value is anyone鈥檚 guess.

Their theoretical losses on all of this 鈥� on a mark-to-market basis 鈥� would run to many tens of billions of dollars. Which would not be enough to break any big bank, but would be a bit of an embarrassment.

At the moment, Barclays, RBS and their ilk are insisting that their woes are simply the result of 鈥渁bnormal鈥� market conditions which 鈥� they hope and pray 鈥� can鈥檛 last more than a few weeks.

Theirs is the Micawberish 鈥渟omething-will-turn-up鈥� approach to banking.

But what if investors鈥� appetite for all this debt isn鈥檛 restored promptly?

Well then the banks have an uncomfortable choice.

They can hold the debt for months and even years, in the belief that the borrowers are fundamentally good credits. But in the meantime, their own capacity to underwrite new deals would be constrained 鈥� which would delay the recovery on which they (and we) all depend. Think about what happened to the Japanese economy in the 1990s when its banks refused to recognise the imprudence of their lending.

Or the banks could sell all that debt at below par 鈥� which would mean they would have to suffer the short sharp shock of realised losses.

The world鈥檚 most successful investment bank, Goldman Sachs, has made its bet about what the banks will do. It has recently raised a substantial sum from investors to buy this debt as and when banks flog it for 90 cents in the dollar.

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