It is good news that the Bank of England is thinking about its role in modern markets, and that the US and UK authorities are to review how to handle banking liquidity and regulation in future.
This agenda should include:
1. Have the Basel regulatory arrangements encouraged too much off balance sheet lending?
2. How can a market in securitised good quality loans be restored? Should the authorities buy in or accept as collateral more of these loans, whilst protecting taxpayers against losses?
3. Has the UK Government burdened British markets with too much off balance sheet borrowing of its own? Can this be curbed?
4. Do the leading Central Banks have enough capital of their own to keep markets liquid enough?
5. Shouldn’t Central Banks try to keep market interest rates in line with their announced main interest rate by open market operations?
There is nothing wrong with the idea of banks bundling up loans and selling them to others in the market. That is healthy and helps the growth of the world economy. The danger arises if the banks themselves continue owning large quantities of corporate bonds or securitised papers in conditions where they find they cannot sell or value these assets at a realistic price. Market seizure for bonds or loan packages forces banks to cut their lending and to write down the value of these assets on their balance sheets in moves which can become a vicious circle.
The Central Banks need to find a way of keeping the high quality bond and securitised paper market in line with their chosen interest rate generally. That should be the main issue facing the US/UK Committee.
Meanwhile, the UK Government needs to ensure rapid and orderly repayment of the Northern Rock loans and needs to consider whether that is sufficient to give the Bank of England the financial firepower it needs. It also needs to cut its own appetite for borrowing, which is now in danger of crowding out other borrowers from the market. The Bank needs some of its old powers – and information – back from the FSA so it can understand banks’ positions more quickly and respond in money markets appropriately.