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Should Bank of England bend?

• Robert Peston
• 2 Apr 08, 10:58 AM

The stock markets appear to think it’s over. The banks, by their behaviour, seem to fear that it’s only just the beginning.

I’m talking about the poisonous impact of the credit crunch.

Yesterday the US stock market enjoyed its best start to the second trading quarter for 70 years – and the London market fared pretty well too.

But closer to many people’s lives, said it would while other banks have been hiking mortgage rates and insisting that borrowers put up larger deposits when buying a property.

So do these trends contradict each other, as they appear to do?

Not really.

Markets rose because of relief that (and , on a much smaller scale) had made a clean breast of its losses and the hope that other banks will do the same. The expectation would be that when the full damage has been exposed, the proper rebuilding can start.

And perhaps more important, the £10bn odd of new capital being raised by UBS and by shows that the material is available for that rebuilding: investors are supplying funds to strengthen banks’ battered balance sheets.

But many banks are still strapped for liquid funds and there are still strains on their capital.

Which is why First Direct has temporarily said no to new requests for home loans after being overwhelmed with applications in the wake of mortgage-rate rises imposed by its competitors.

And the funding drought also explains why almost all British banks are providing fewer and more expensive mortgages.

If this contraction of credit were to generate a further slowdown in the economy, that would generate new losses for banks - and would make the stock-market rally seem a bit premature.

But if the economic landing is soft, then stock markets renewed optimism may turn out to be appropriate.

are not desperately supportive of a very bullish case – new mortgage approvals in February were 38% lower than at the same time last year.

The interesting question for me is whether the symbolism of First Direct’s mortgage-lending strike will prompt the Bank of England to be more generous than it might otherwise have been in shaping a new lending facility for banks.

The Bank of England has become persuaded that the biggest constraint on British banks is their inability to raise liquid funds against great swathes of their balance sheets, notably US sub-prime investments, their holdings of regular US mortgages, their lending exposure to private equity and other highly leveraged corporate deals, and their UK mortgage loans.

What the banks would dearly love would be two or three year loans from the Bank of England, with those unsellable and unliquifiable assets pledged as collateral.

Would that represent a sensible refuelling of the financial economy by the Bank of England or a dangerous bailout of banks that only have themselves to blame for the mess they’re in?

Even if the banks are culpable, would we be cutting off our noses to spite our faces by depriving them of succour – in the sense that we suffer when the lending dries up.

What do you think?

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