SPEAKING FREELY Bank of England misses the point
By Peter Morici
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The Bank of England (BoE) announcement of a 50 billion pound(US$99 billion)
lending facility for British banks and building societies (mortgage providers)
will do little to open up lending and help the United Kingdom to avoid a
recession.
The facility will permit British banks and building societies to borrow against
mortgage-backed and other securities for terms of up to one year, and renewable
by the BoE for up to three years.
The market for mortgage-backed securities and other collateralized debt
obligations (CDOs) has essentially closed,
making the extension of new mortgages and credit by banks to worthy homebuyers
and businesses in the United States and Britain very difficult.
Unfortunately, the BoE action will, like similar special lending facilities
created by the US Federal Reserve in recent months, have limited impact on the
present banking crisis.
Over the past two decades, banks have moved from a "deposits into loans model"
to a "loans into bonds model". The shift is a good thing because it eliminates
the kind of risks banks bear when they borrow short and lend long, which
mightily contributed to the US Savings and Loan Crisis of the 1980s and 1990s.
Properly done, the loans to bonds model permits banks to greatly expand their
lending capacity.
However, in recent years, banks have created increasingly complex and difficult
to understand securities. Banks sold, bought and resold securities, and engaged
in credit-default swaps that did not lay off risk in the manner advertised.
Insurance companies, pension funds and fixed income investors, having been
stuck with risky securities, are no longer willing to finance bank loans in
this manner. Banks can no longer sell CDOs to these investors.
These practices did permit banks to earn outsized profits on transactions fees
and pay executives much better than in comparable non-financial firms. However,
it is simply impossible to borrow at 5% and lend at 7%, the essence of
traditional banking, and skim off the kinds of profits and executive bonuses
bankers now expect and still provide for loan servicing, insurance and the
other costs involved in lending and securitization.
Unfortunately, bankers are not much interested in returning to traditional
lending practices and are looking to other lines of business within their
larger financial services firms for opportunities that may permit continued
outsized incomes.
Central banks, by taking mortgage-backed securities and other CDOs off the
books of banks, may temporarily relieve liquidity pressures, but such measures
do not resolve fundamental structural problems within contemporary financial
conglomerates.
The Bank of England and Federal Reserve would do better to bring banks and
fixed income investors together to define the kinds of simple mortgage- and
other loan-backed securities that insurance companies, pension funds and the
like would accept, and condition access to the discount window on banks making
and securitizing loans in such a rebuilt market for collateralized debt
obligations.
Peter Moriciis a professor at the University of
Maryland School of Business and former Chief Economist at the US International
Trade Commission.
(Copyright Peter Morici 2008.)
Speaking Freely is an Asia Times Online feature that allows guest writers to
have their say.
Please click hereif you are interested in contributing.
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