Boe Announce Conditions Of Their £50bl Special Liquidity Scheme

[ParticleMan]

Well done to HPC for figuring out what the true nature of this action would be, well in advance. Go on, give yourselves all a collective pat on the back, you've earned it. And from a quick skim, this looks just like what the doctor ordered - a death sentence for leverage levels in mortgage-backed lending (and hence the entire asset class), without creating any additional risks (well immediate-to-me-visible ones anyway) (and without allowing any of the present-day risks new room to manifest).

Speaking of pats...

Am I the only one confused? This is what the BoE say:

:

The swaps are available only for assets existing at the end of 2007 and cannot be used to finance new lending

:

Pat (et all). Forget lending. This is all about (bank) borrowing. The banks need to liquify their balance sheets and will only be able to do this by pledging the BOE-supplied gilts as collatoral (for new on-market loans).

Retail lending (if you must go there, and please don't, it's boring!) is only going one way from here. Higher quality collatoral (visibly less leverage, shorter terms and/ or lower capital sums at the riskier end), and at higher yields (the lender will need to claw back the BoE's discounting from somewhere as well as repay their own new borrowing).

... one more...

erm...he's taken mortgage assets that the market doesn't want at up to 70% of their 'mark to model' value when in truth they're only worth 16% of 'mark to market' (at worse), hardly call that a result for: the BoE, Merv, or UK plc

CL - daily revaluation (of the pledged collatoral, with the haircut applied afterward), and margin calls. The BoE isn't anyone's bitch just yet.

Edited April 21, 2008 by ParticleMan

[PatientlyWaiting]

So is it fair to conclude that these "hair-cuts" (new term on me - bear with I am enjoying this learning experience ...) represent the BOE's estimates of house price falls - and if so, over what period ? I'm assuming the 3 year max of the scheme. If so, I'd say the blue touch paper has been truly lit now ... let the panic begin - (sad because I can see where this is heading and it ain't pretty)

Just re-read, these hair-cuts are on the prevailing current price - holy hell.

Edited April 21, 2008 by PatientlyWaiting

[DabHand]

BOE is allowing bank to temporarily convert some of their tier3 (marked to internal pricing model with no oversight, i.e. fantasy) capital into tier1 (marked to market) capital. This will allow the banks more freedom to borrow and lend against these tier1 assets, make a profit and recapitalise to meet capital adequacy. All this before they have to end off balance sheet practices (e.g. SIVs), and meet stingent new guidelines on what constitutes lending capital.

The shorter term goals are to prevent fire sale price collapses of various financial instruments, avoid bankruptcy of one or more banking entities and to normalise the credit markets.

MBs/CDO's are having trouble finding a market and therefore a known price? l feel this is a cynical ploy by the banks, who would rather pretend not to know how much they are worth than actually scrutinise them and calculate the value to them given x repossession rates for subprime/alt-a etc, and y decline in house prices. I think the banks know that if they did analyse these assets properly they would find their tranches underwater (i.e. total loss) and would thus become known to be entirely worthless adding no value to the banks capital adequacy and most likely count as a loss or liability.

If you look at the proportion of tier 3 assets banks are now carrying around, they are often multiples of their entire company's capital worth. If they truthfully wrote down the losses for these they would be wiped out, so they place them into tier 3, mutter something about the difficulties of valuation...and the 'regulators' as useless as they might be, can still recognise a clusterf#ck when they see one, decide to look the other way for a bit and hope when they look back again they aren't staring at a BIG PROBLEM.

I expect many banks are now underwater, and l mean even by their own rules..forget the fractional lending debate for a second. The central banks, governments and regulators are allowing the banks time to get themselves out of the situation. Its a bit like a bank not foreclosing and giving you another 1 to 3 years to make that business profitable, or get a better job to pay off your accrued loan defaults.

The banks have no substantial capital to continue crazy lending due to the losses so far and likely future losses they KNOW they are going to have to eat. For me its a given that many banks will use rights issues as part of the general effort to rebuild. They will not use any capital or lending opportunities to continue to maintain a bubble asset. They will pick and choose who they can lend too and will become highly risk averse. We could still see mortgage waiting lists, it might get that tight.

As many posters have already said, its all about saving the banks and the powers that be will be delighted if they manage even half a job on that. They aren't going to undermine that effort by diverting good money after bad and try and save proles from their own mania. i.e. houseprices are still toast. Just means we wont get to see a general collapse of the global financial system. Would have been one to tell the grandkids eh?

[patprimer74]

Pat (et all). Forget lending. This is all about (bank) borrowing.

So, when the BoE says in it's notes "...and cannot be used to finance new lending", what they mean is "...and cannot be used to finance new borrowing"?

Thanks for making that so clear to us, PM! Now, have another go at explaining it to us - this time, in English layman terms.

p

[Biriani]

Just re-read, these hair-cuts are on the prevailing current price - holy hell.

Yep, and if there isn't a prevailing current price because nobody wants to buy the things, the BoE gets to make their own estimate of fair value, and then apply an EXTRA BIG haircut on top!

[Converted Lurker]

So is it fair to conclude that these "hair-cuts" (new term on me - bear with I am enjoying this learning experience ...) represent the BOE's estimates of house price falls - and if so, over what period ? I'm assuming the 3 year max of the scheme. If so, I'd say the blue touch paper has been truly lit now ... let the panic begin - (sad because I can see where this is heading and it ain't pretty)

Just re-read, these hair-cuts are on the prevailing current price - holy hell.

only other time I hear "haircut" used in any other context is in relation to car dealers (in days gone past) when they used to rewind mileage on speedos. Irony?

[ParticleMan]

So is it fair to conclude that these "hair-cuts" (new term on me - bear with I am enjoying this learning experience ...) represent the BOE's estimates of house price falls

If I had to take an entirely instinctive, gut-level-reaction view on anything I'd say the haircut was a nearer fit for estimated losses-at-default risk than anything to do with likely asset pricing action.

But I doubt it tightly correlates with either.

The BoE's inflation target is what it is. Might be an idea to fit HPI indicies to it, if you want an idea about where the overshoot is likely to fall to.

[ParticleMan]

Thanks for making that so clear to us, PM! Now, have another go at explaining it to us - this time, in English layman terms.

Without putting too fine a point on it, this English layman picked it up just fine from forum posts going back to August last year.

If you're looking for a snappy one-liner that the press office can use to reassure sheep worried about getting shorn, you're asking the wrong guy. It'll be a long long walk in the wilderness, I'm afraid. Better go buy some good boots now (before your Chinese Price Index makes a mockery of those, too).

[ParticleMan]

If you look at the proportion of tier 3 assets banks are now carrying around, they are often multiples of their entire company's capital worth. If they truthfully wrote down the losses for these they would be wiped out, so they place them into tier 3, mutter something about the difficulties of valuation...and the 'regulators' as useless as they might be, can still recognise a clusterf#ck when they see one, decide to look the other way for a bit and hope when they look back again they aren't staring at a BIG PROBLEM.

Some good stuff in there (still reading it but wanted to add my 2 yuan to this bit.

You've just built a pretty good tendril between this observation and hotairmail's one way back when - regarding the impact on total (balance sheet) lending capacity in the event of defaults.

:

Under the Basel II rules....capital to be provide at 8% of risk weighted asssets.

Mortgages for home occupation risk weighted by 50%

So for a mortgage of £100 the bank has to have capital of £4. Or in other words, the bank can lend 25 times the value of its capital.

So if $ 1 trillion of defaults wipes out $1 trillion of capital, this would constrain lending by $25 trillion?

And this would have to come off the existing stock of lending - not from new lending.

:

Soon (very soon I feel), the wider (non-Housing) asset markets will have to WAKE UP.

Edited April 21, 2008 by ParticleMan

[RobK]

It looks on face value as though the BoE and the taxpayer manage to steer clear of most of the risk under this scheme.

However, I think the actual risk arises in cases of a rapid deterioration in the value or credit rating of the collateral (such as might be created by a large house price crash and spike in foreclosures?)

Spot on. The BoE and the Treasury have probably managed to convince each other by reading the agreement(s) that there is no risk to the taxpayer. But politically could you ever make a margin call on a big bank that would make them insolvent?

A slide aside - not that I expect they will get much sympathy on here(!), but you would be a bit annoyed if you were an NR shareholder, wouldn't you? NR just had the misfortune to be first...

[lets get it right]

If I were Alistair Darling, I would be doing a bit of expectation management now.

'This is not going to allow the banks to indulge in some of the riskier practices evident in recent years. House prices went up because the economy was well managed and, due to low inflation and low interest rates, people could afford to pay more for their houses. (Nothing here, of course, about why they should.) It is clear that house prices are now too high in relation to income, particularly for younger people, and a slight correction is now occurring that will address the affordability constraints.'

For years they have spun everything. Wonder why they are not spinning this?

[ParticleMan]

Spot on. The BoE and the Treasury have probably managed to convince each other by reading the agreement(s) that there is no risk to the taxpayer. But politically could you ever make a margin call on a big bank that would make them insolvent?

The BoE's action will serve to smooth volatility in quotes on prices for this kind of debt (incidentally, it also addresses the feedback loop between market illiquidity and rapidly declining (and accelerating?) offered prices for these assets). All banks have equal access to the facility, and the BoE is revaluing daily, not trade by trade, and not three-monthly (which is effectively what the market has been doing 'till now). Note - I am not for a second suggesting this will shore up prices at their current levels (I would see it as inevitable that the prices decline class by class until the yield spreads make economic sense). But it will likely create a more regular pricing dynamic, one not dominated by three-monthly LIBOR spikes (I'm still a little concerned about the beating that might happen between the LIBOR rollovers and the nine-monthly BoE terms...)

From this - if a Bank is this near the edge solvency-wise that an orderly unwind in prices tips it over the edge - it would be highly-predicted, and not a systemic shock. To ram this point home - by the time a bank found itself on the wrong end of a BoE margin call - the market would have already priced its departure.

Edited April 21, 2008 by ParticleMan

[ParticleMan]

For years they have spun everything. Wonder why they are not spinning this?

We're at the stage where complexity in maintaining all the little lies that form the one big lie now requires energy in excess of the system's total.

They're screwed.

Edited April 21, 2008 by ParticleMan

[ReggiePerrin]

This may be the dumbest thing I've ever posted but if you want to understand what the man on the street really knows or doesn't know, then you can't do better than me

As I understand this

I as a bank have £100 worth of existing mortgages papers, an asset, which I would normally use as security to borrow money from another bank. The problem is other banks think my mortgage paper is rubbish and won't lend to me any money. I as a bank can now go to the BOE with my £100 of mortgage paper and get a bill for £85 (after the haircut thing), which I can use as collateral or as a security to borrow money from another bank. e.g. I can borrow £85 from someone else but if I fail to pay it back I have to hand over my BOE bill to the bank I borrowed from.

Is this right so far?

My problem is. As far as I can tell the bill has to be given back to the BOE after 9months, they will then re-issue it to me for another 9 months if I want. If I default on the money I've borrowed using this bill as collateral then the other bank will end up with my bill, they take it back to the BOE and they, I assume, hand me the mortgage paper that was used to get the bill in the first place. The bank with the bill can't spend it, they have to at some point give it back to the BOE?

1. So whats the point of the bills, if I lend money to someone, default, the lender still ends up with the rubbish mortgage debt anyway?

2. Plus I have to pay interest not only to the BOE but also to the person I borrow from.. Isn't that going to be very expensive?

Thanks for your time in advance for reading my verbal diarrhea

[gravity]

Just said this on another thread, but it pretty much follows what everyone on here already realises:

Robert Peston has just been on the BBC lunchtime news very doubtful if the bailout will mean lower mortgages. As he said, the banks realise that the housing market is overvalued so wont be rushing to expose themselves again.

Hope this gets repeated on the 6 and 10 oclock news !

[ParticleMan]

If I default on the money I've borrowed using this bill as collateral then the other bank will end up with my bill, they take it back to the BOE and they, I assume, hand me the mortgage paper that was used to get the bill in the first place. The bank with the bill can't spend it, they have to at some point give it back to the BOE?

I would assume that if the BoE were willing to repurchase the gilt on presentation (prior to its due date), they would hand over cash. Otherwise, it would be up to that bank to borrow money on-market, pledging the gilt once again as collatoral.

Either way, your bank would now have its previous liquidity problem once more (this is why you raised capital via the new BoE facility in the first instance) and a brand new solvency problem (you now have a liability to the BoE which you may or may not be able to repay in a timely fashion). If the solvency problem is severe, the regulatory regime will ensure that your bank is now wound up. If it is not severe, you will now need to pledge additional capital to the BoE for additional gilts and then raise additional cash on the open market (at your now newly-sodomising "hey I've just defaulted" actual market rate). Or sell assets on the open market (at their brand new "hey it's a firesale over at Joe's" prices).

This is why banks will be in no hurry to use this new capital in risky ventures (ie, such as highly leveraged lending into an asset market likely to suffer price falls - or in short, to UK Residential Housing PLC).

Edited April 21, 2008 by ParticleMan

[ParticleMan]

Robert Peston has just been on the BBC lunchtime news very doubtful if the bailout will mean lower mortgages. As he said, the banks realise that the housing market is overvalued so wont be rushing to expose themselves again.

For the record, I'd be comfortable with suggesting that retail rates are going to completely decouple from LIBOR - and that prime mortgage lending rates will be over 12% (for remortgage and new origination) within the next year.

[ReggiePerrin]

I would assume that if the BoE were willing to repurchase the gilt on presentation (prior to its due date), they would hand over cash. Otherwise, it would be up to that bank to borrow money on-market, pledging the gilt once again as collatoral.

Either way, your bank would now have its previous liquidity problem once more (this is why you raised capital via the new BoE facility in the first instance) and a brand new solvency problem (you now have a liability to the BoE which you may or may not be able to repay in a timely fashion). If the solvency problem is severe, the regulatory regime will ensure that your bank is now wound up. If it is not severe, you will now need to pledge additional capital to the BoE for additional gilts and then raise additional cash on the open market (at your now newly-sodomising "hey I've just defaulted" actual market rate). Or sell assets on the open market (at their brand new "hey it's a firesale over at Joe's" prices).

This is why banks will be in no hurry to use this new capital in risky ventures (ie, such as highly leveraged lending into an asset market likely to suffer price falls - or in short, to UK Residential Housing PLC).

Thanks ParticleMan

Cool, so any VI who thinks this is going to re-ignite the housing madness is in for a nasty shock

Listening to BBCnew24 in the background, Declan is giving the BBA man a bit of a hard time, the BBA man dodged the questions about their irresposible actions in the past causing this mayhem.

[Blue Peter]

For the record, I'd be comfortable with suggesting that retail rates are going to completely decouple from LIBOR - and that prime mortgage lending rates will be over 12% (for remortgage and new origination) within the next year.

That's a very bold prediction. Surely that would well and truly cattle truck the housing market (and all the RMBSs lodged with Her Maj's finest),

Peter.

[the_duke_of_hazzard]

For the record, I'd be comfortable with suggesting that retail rates are going to completely decouple from LIBOR - and that prime mortgage lending rates will be over 12% (for remortgage and new origination) within the next year.

If that happens then I'll eat Kirsty's hat for her - gladly!

[RobK]

The BoE's action will serve to smooth volatility in quotes on prices for this kind of debt (incidentally, it also addresses the feedback loop between market illiquidity and rapidly declining (and accelerating?) offered prices for these assets). All banks have equal access to the facility, and the BoE is revaluing daily, not trade by trade, and not three-monthly (which is effectively what the market has been doing 'till now). Note - I am not for a second suggesting this will shore up prices at their current levels (I would see it as inevitable that the prices decline class by class until the yield spreads make economic sense). But it will likely create a more regular pricing dynamic, one not dominated by three-monthly LIBOR spikes (I'm still a little concerned about the beating that might happen between the LIBOR rollovers and the nine-monthly BoE terms...)

From this - if a Bank is this near the edge solvency-wise that an orderly unwind in prices tips it over the edge - it would be highly-predicted, and not a systemic shock. To ram this point home - by the time a bank found itself on the wrong end of a BoE margin call - the market would have already priced its departure.

And what about an dis-orderly unwind in prices? The "market" cannot price in unexpected events, as shareholders in NR and Bear Stearns discovered at their cost.

My point was that the taxpayer is taking some risk. I have read your post carefully, but I don't think you are dis-agreeing with this?

I love the phrase "highly-predicted" by the way - you are not a risk analyst, are you?

[Reiver]

Having read this thread from the beginning for some reason I get the feeling that the Banks came out of the meeting with Mervyn thinking that they had gotten what they wanted.

Only to find that they hadn't read the small print and in fact he doesn't trust them any more than they trust each other.

Edited April 21, 2008 by Reiver

[CharlieChuck]

For the record, I'd be comfortable with suggesting that retail rates are going to completely decouple from LIBOR - and that prime mortgage lending rates will be over 12% (for remortgage and new origination) within the next year.

How do you come to this sort of level? that would be a huge risk premium, assuming libor stays roughly at its current level. Do you expect interest paid on savings to get to a similar level?

[lets get it right]

We're at the stage where complexity in maintaining all the little lies that form the one big lie now requires energy in excess of the system's total.

They're screwed.

I like that image. Darling, Brown and countless advisors all running from room to room with bits of paper 'this is our message - what's your message - no, you'll have to change your message a bit to fit with our message - what's he saying - damn, that's not quite what we're saying, get him to say this, no wait, we'll say that instead, but hold on, that won't sit true with what they're saying ... let's get everyone together and get our hymn sheets in order.

We must be clear. We must have a vision. We must be passionate. We must change. Let the process of change begin.

Brown undergoes metamorphosis and turns into a giant slug.

[moonriver]

Robert Peston has just been on the BBC lunchtime news very doubtful if the bailout will mean lower mortgages. As he said, the banks realise that the housing market is overvalued so wont be rushing to expose themselves again.

Hope this gets repeated on the 6 and 10 oclock news !

If anyone missed this and wants to see Robert Peston talking about it, he was also on "Working Lunch" today, and it should be shown on the "Watch Again" link here later today.

http://news.bbc.co.uk/1/hi/programmes/work...nch/5170354.stm

I ddn't realise Peston was the one who got the scoop on Northern Rock.

Wilkpedia says

"In 2007, Peston's scoop on Northern Rock seeking emergency financial help from the Bank of England won the Royal Television Society's Television Journalism Award for Scoop of the Year".