New bailout package for battered British finance

Bloomberg

Prime Minister Gordon Brown’s government tightened its grip on Britain’s financial system, guaranteeing toxic assets and giving the Bank of England unprecedented power to buy securities.

The plan will increase the cost of bailing out the nation’s banks by at least 100 billion pounds ($147 billion), the Treasury said in a statement yesterday. The government raised its stake in Royal Bank of Scotland Group to 70 percent and said it would use Northern Rock to spur mortgage lending.

"This is aiming to once and for all to underpin faith in the banking system," said Alan Clarke, an economist at BNP Paribas in London. "We’re breaking all conventions. The availability of credit is going down and the economic outlook is getting worse, so the government is having to throw more and more at it."

The new measures are the biggest steps by Brown to get banks lending again as Britain slides deeper into a recession that may be the worst since the aftermath of World War II. The government will require aid recipients to sign "specific and quantified" agreements to lend, reflecting Brown’s frustration at the failure of an October rescue to unlock credit markets.

"What I’m doing É is putting in place a range of measures that are all designed to get lending going again," Chancellor of the Exchequer Alistair Darling told Sky News.

Forecast of contraction
The British economy may contract 2.7 percent this year, the most since 1946, and house prices may plunge 22 percent in the next 18 months, the Ernst & Young Item Club said yesterday.

Under Darling’s unprecedented insurance plan, the government will charge a fee to guarantee about 90 percent of banks’ potential losses on assets that could further erode their capital. Concerns about these toxic holdings has crippled lending and helped trigger a drop in global stocks last week.

The Treasury is extending the 250 billion-pound Credit Guarantee Scheme it opened in October as part of the first round of the bailout. The program allows banks to issue bonds backed by the government and will now run until the end of this year instead of April 9 as originally planned.

Brown has criticized banks for failing to lend even after receiving the credit line and 37 billion pounds in new capital, steps that led to the takeover of RBS and a stake in Lloyds Banking Group, which took over HBOS. The main opposition Conservatives have doubled their lead over Brown’s Labour Party on concern the economy is worsening, a recent poll showed.

The demand that banks commit to lending targets means "this is basically making sure that the government gets something in return for all this money," said Vicky Redwood, an economist at Capital Economics in London. "It will be a commitment to increase lending by a certain percentage."

Financial institutions have refused to respond to Bank of England rate cuts by as much as the government wanted. While the central bank this month took its benchmark rate to 1.5 percent, the lowest since its foundation in 1694, U.K. banks and building societies approved the fewest new mortgages since at least 1999 in November, and lenders have told the central bank they will restrict lending further to companies and consumers.

No quantitative easing yet
As rates approach zero, the central bank will have the authority to channel liquidity to financial institutions by buying assets. The move won’t yet allow the Bank of England to increase the money supply, a tactic recently adopted by the U.S. Federal Reserve to fight the risk of deflation, because the purchases are financed by bond sales.

"This is not quantitative easing in the strictest sense," said Colin Ellis, an economist at Daiwa Securities SMBC Europe. "But that may come later."

The Bank of England will buy assets including corporate bonds, commercial paper and syndicated loans, a tactic than can be used should officials decide "that this would be a useful additional tool for meeting the inflation target," the Treasury said.

The government also said the central bank’s Special Liquidity Scheme, designed to give financial institutions access to credit, will be replaced by an Asset Protection Scheme.

The government will guarantee securities against future credit losses. Those securities include portfolios of residential and commercial property loans, corporate and leveraged loans and asset-backed securities.

The Royal Bank of Scotland said yesterday it may post a loss of as much as 28 billion pounds, the biggest ever reported by a U.K. company.