Plan to ease the credit crunch

The final stages of a plan to ease the credit crunch are being worked on by the Bank of England. The details will need to be backed by the treasury but it is believed that this will not be an issue.

The plan is to allow banks to swap their mortgage assets for government bonds for a period of time. This should give banks more confidence to lend to each other and in turn have more money to lend to consumers. The credit crunch has stemmed from the reluctance of banks to lend to each other as they are wary of each others financial position and exposure to sub prime losses in the US.

In the past mortgage assets were used as the security on an inter-bank loan but following the collapse of the US markets, banks do not trust these assets.

This has caused the inter-bank rate to rise to an unsustainable level and makes lending rates to high. This has led to mortgage products being withdrawn and rates rising.

The government plans to allow the Bank of England to issue bonds backed by it, in exchange for mortgage backed securities. The plan is expected to be only weeks away from launching and it is hoped that it will free up liquidity in the money markets.

This has drawn criticism from certain areas as it could be seen as allowing banks to privatise their profits and nationalise their losses. The mortgage backed securities will inevitably be of inferior quality and higher risk than the government bonds they are replacing and there is concern that it could be the taxpayer again taking risks.

The exchange needs to be at a discount so that the banks are still taking any potential losses and not the taxpayer.

It is believed that in exchange for the government bailing out the banks there will be an orderly programme for identifying losses, making sure those losses are covered and paying for those losses by stopping dividends and raising money through shareholders.

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