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Mervyn King Bows To Fed-style Rescue Deal

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From The Sunday Times

March 23, 2008

Mervyn King bows to Fed-style rescue deal

David Smith, Economics Editor

BRITAIN’s banks believe they have secured a deal under which the Bank of England will provide the kind of support America’s Federal Reserve has given to its beleaguered financial institutions in recent months.

Though no precise commitments were given when senior bank executives met Mervyn King, the Bank’s governor, last week, it is understood that there was tacit agreement that the central bank would step in to provide bigger injections of liquidity into the markets when needed, and accept a wider range of collateral against such support.

The Bank also promised to try to limit any stigma attached to such assistance, though officials concede this will be difficult.

King fell short of meeting all the bank chiefs’ demands, including requests for an overhaul of the entire system under which emergency funding is provided. The Bank’s new money-market arrangements only came into effect last year. The new help will be given on an ad hoc basis.

The governor is also said to have made clear that while he had an obligation to protect the financial system, his remit did not stretch to propping up the banks’ profitability, a sign that not all the rancour that characterised the relationship between King and the banks last summer has disappeared.

One senior banker said: “The governor doesn’t realise that bank profitability and stability of the system go hand in hand. The banks’ reserves have been eroded. They will not be able to lend freely until their capital is built up again. If he cut rates at the front end of the curve, as the Fed has done, then banks would be able to very gradually restabilise over the next two to three years, which would give them much more confidence to continue lending.”

Bankers say, however, that there is a new determination on the part of both King and the banks to work together to get through the crisis following the scare generated by the slump in the share price of Halifax Bank of Scotland (HBOS) last week. The test will come with what happens to money-market interest rates in the coming days, with three-month Libor currently near 6%.

“Banks are not worried that other banks will go bust,” said one senior banker. “It’s just that they think they will need all their money for themselves, to meet customers’ demands. Why lend money when you think you will need it all yourself?”

Senior bankers have been openly critical of the Bank governor, though a truce has been agreed. They believe that while America’s banks have made all the mistakes, British banks are being penalised for the huge financial losses that have been racked up on Wall Street.

“It may have escaped King’s attention that the big retail banks made huge profits in the reporting season that has just ended, said one. “This should be a time when we are taking advantage of the opportunity, but the Bank of England does not seem to understand that. It is essential that we are given an equal footing to that enjoyed by American banks and by continental banks that have been supported by the European Central Bank.”

Bankers at Barclays, Royal Bank of Scotland and HSBC have also been impressed by the way that Hank Paulson, the US Treasury secretary, has been in contact to gauge their opinion and pledge that the Fed will do anything in its power to keep the financial system afloat.

Last week’s events and a relatively dovish set of minutes from the meeting of the Bank of England’s monetary policy committee (MPC) earlier this month have shortened the odds on a cut in interest rates next month, analysts say.

A survey by Ideaglobal.com, the financial research company, shows that analysts put a 40% probability on a reduction from 5.25% to 5% coming next month, though a May cut is marginally favoured.

The median expectation for the low point in America’s Fed Funds rate is 1.75%, from 2.25% now.

Despite a relatively upbeat picture from manufacturers, the CBI is expected to revise down its growth forecasts this week.

With both the International Monetary Fund and the Paris-based OECD saying the US economy is either in or close to recession, the next big policy focus for the credit crisis will come with the IMF’s spring meetings in Washington on April 12-13.

There, G7 finance ministers and central bankers, including chancellor Alistair Darling, King, Paulson and Fed chief Ben Bernanke, will discuss further action to limit the economic damage from the crisis.

The chancellor will be pushing efforts to step up cross-border surveillance. It has also emerged that central banks in America and Europe, including the Bank of England, are studying the possibility of bulk purchases of mortgage-backed securities. This would be a dramatic move to ease the credit crisis, but the talks are at a very preliminary stage.

Financial markets continue to be stunned by the number of big banks in America and Europe that are still owning up to problems, seven months after the crisis first started. Last week Credit Suisse, the Swiss banking giant, warned that it could suffer a first-quarter loss due to its exposure to America’s sub-prime crisis.

The bank also admitted some of its losses were caused by traders hiding figures to protect bonuses. The Financial Services Authority has now launched an investigation into the bank’s internal reporting controls.

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Complete insanity. The bail-out continues. Remember - nothing will be allowed to fail. They will monetize eveything. Loans will roll over indefinately into the next life-time with interest waived.

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