Second credit crunch on the cards

Sarah Davidson

November 3, 2010

Danny Gabay, former Bank economist and now director of Fathom Consulting, said the UK’s banks should be forced to sell their mortgage assets at a discount of more than 20% to market value to the Bank of England to free up liquidity and help them lend more.

This would be a direct departure from the current programme of quantitative easing which allows the Bank to create new money to purchase gilts from financial institutions, thereby creating better credit conditions and improving liquidity.

But Fathom argues its plan would be a more direct approach to freeing up liquidity on banks’ balance sheets. It said improved lending would help secure a wider economic recovery, without which continued problems in the property market could force a second credit crunch.

Gabay said: “You have to fix the banks or we’re not going anywhere. The bottom line is that the economy is carrying too much debt, and while the government has taken the first steps towards dealing with its balance sheet, the household sector has barely begun.

“More QE is needed, but we need a fresh approach that acknowledges the source of the problem and we need urgent action to address that problem. Our plan, in our view, offers a way forward.”

But mortgage servicer HomeFunding’s chief executive, Tony Ward, said this plan won’t have the desired effect.

He said: “Forcing banks to sell at this much of a discount would be a bad thing. That would write 20% off against banks’ tier one core capital, which would give them liquidity but it correspondingly restricts the amount banks can lend against because their capital takes a hit.

“More sensible would be for the Bank to buy mortgage portfolios at par or to buy mortgage backed securities or covered bonds instead of gilts.

“If they did that it would achieve two objectives: one, it would put liquidity into banking markets without a write down against capital; and two, the fact that the Bank was prepared to purchase MBS would be a positive thing for investor confidence worldwide. That would impact considerably on the secondary markets.”

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