Bank of England Will Unveil Bond Swap to Ease Mortgage Market

Bank of England Will Unveil Bond Swap to Ease Mortgage Market

By John Fraher and Gonzalo Vina

April 21 (Bloomberg) -- The Bank of England will today announce a plan to swap about 50 billion pounds ($100 billion) of government bonds for mortgage-backed securities to lower credit costs, people familiar with the matter said.

The plan will ``unfreeze the situation we've got at the moment,'' Chancellor of the Exchequer Alistair Darlingsaid yesterday in an interview with the BBC, without specifying how much would be made available. ``What the Bank of England will do is, in effect, lend the banks that money. In the meantime, the Bank of England will take a security.''

Prime Minister Gordon Brown's government is trying to encourage lending after a surge in borrowing costs prompted banks to withdraw their best mortgage offers, threatening to exacerbate the worst housing downturn since 1992. The plan is a change of approach by the Bank of England after three interest-rate cutssince December failed to ease the logjam.

``It's been a long time coming, but what's important is that the bank is recognizing commercial banks' problems,'' said Philip Shaw, chief economist at Investec Securities in London. Success may depend on the credit ratings of the securities the Bank of England accepts and the duration of the plan, he said.

The swap is double the value of loans and guarantees Governor Mervyn King extended in September to prop up Northern Rock Plc. The government in February nationalized the mortgage lender, the first U.K. bank to fall victim to the credit freeze stemming from the collapse of the U.S. subprime market.

Statement to Lawmakers

Darling will speak in Parliamentaround 3.30 p.m. and will also update lawmakers on the progress of the Bank Act, which would give British authorities power to seize control of failing banks.

The central bank announced its last measure to tackle the credit crisis at 9 a.m. on March 20, when it said it would extend additional emergency funds. The Bank of England wouldn't comment on the timing of the swap announcement or give further details of the plan.

Investec's Shaw said the central bank may provide the funds on a rolling basis as needed by financial institutions. The British Broadcasting Corporation was the first to report on April 18 that the offer may total 50 billion pounds.

The central bank's move allows financial institutions to add government bonds to their inventory of liquid assets and make it easier for them to both raise cash and lend, especially to consumers seeking home loans. In return, the government will hold the riskier mortgage-backed assets as security.

`Essential' Step

``This is an essential initial step in trying to get the financial market stabilized and that in turn will help the mortgage market,'' Darling said. ``We can re-open the financial markets because that is an essential pre-condition for the provision of mortgages.''

To date, the Bank of England has widened its collateral requirements just for three-month lending. It accepts only top- rated government securities at its weekly auctions.

The U.S. Federal Reserve last month made up to $200 billion available to banks in return for debt including mortgage-backed securities. The European Central Bank, the first central bank to react to the credit crisis in August, has extended the maturity of money auctions to help cash-strapped institutions.

Investec's Shaw says the term of the Bank of England's swaps may need to be longer than those under the terms of the Fed's program, maybe as long as a year. The U.S. central bank lends Treasuries for 28-day periods.

Size Matters

Former Bank of England policy maker Willem Buiter, now a London School of Economicsprofessor, said on April 18 the plan's success ``all depends on the scale.''

``In total, they would have to do -- not in one big go --at least 100 billion for it to really actually make a difference to the liquidity position of banks, but also act as the catalyst for getting that market going again,'' he said.

The risk is that a slide in house prices worsens, undermining support for Brown's government. Mortgage lenders including HBOS Plc and Lloyds TSB Group Plchave raised the cost of loans, even after three, quarter-point rate cuts by the Bank of England to 5 percent.

House prices dropped 2.5 percent in March from a month earlier, the biggest drop since 1992, HBOS, the country's largest mortgage lender, said April 8. Brown's approval rating dropped faster than for any U.K. leader on record as support for the opposition rose to the highest in 16 years, a poll published on April 13 showed.

Darling urged patience, saying the credit crunch partly needs time to work itself out. He said one analogy was to someone with a dose of food poisoning, which ``just has to work its way through the system.''

To contact the reporters on this story: John Fraher in London at jfraher@bloomberg.net; Gonzalo Vina in London at gvina@bloomberg.net.

Last Updated: April 20, 2008 19:02 EDT

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