Bank of England pumps £5bn into frozen money markets

Mar 18 2008 by Iain Laing, The Journal

THE Bank of England moved to pump £5bn into frozen money markets yesterday as London’s leading shares tumbled on the latest impact of the credit crunch.

Policymakers made the move to ease overnight lending rates between banks spooked by the bail-out and the cut-price sale of troubled investment bank Bear Stearns.

London’s FTSE 100 Index fell more than 2.5% as leading banks such as Halifax Bank of Scotland and Barclays bore the brunt of the sell-off.

The Bank of England’s intervention is its first such move in six months since the height of the credit crunch. The £5bn was only about a fifth of what banks had called for.

Last week, Bank policymakers also unveiled £10bn in loans in an attempt to bring down the rates at which banks lend to each other for three months, which have also soared.

Banks, fearful of losses, are hoarding cash to bolster their balance sheets, and yesterday pushed the three-month interbank lending rate to its highest point this year. It currently stands at 5.96% – well above the official 5.25% base rate.

The Bear Stearns crisis, which raised the spectre of Northern Rock, led to heavy losses on Asian stock markets, with Wall Street expected to open sharply lower later today as the sell-off spreads wider.

Prime Minister Gordon Brown’s spokesman said the Bank of England, the Treasury and the Financial Services Authority had been monitoring developments here and in the US.

He said: “The tripartite authorities here in the UK have been in close contact with their US counterparts over the weekend and are continuing to closely monitor developments in the markets.”

The investment bank became the latest victim of the turbulence after being forced to seek emergency funding on Friday. It was bought by rival JP Morgan Chase for a cut-price £116.4m on Sunday.

The US Federal Reserve, in a rare Sunday meeting, cut its lending rate to banks to 3.25% from 3.5% and created another short-term loan facility for big investment banks in an attempt to ease the pressure.

Panmure Gordon banking analyst Sandy Chen said: “We interpret this as a clear indicator that other firms may be vulnerable.”

Meanwhile, oil prices soared to record levels near $112 a barrel as fears over the US economy grew and the dollar weakened to a record low against the euro.

The Fed is likely to cut interest rates again at its meeting tomorrow to spur on the world’s largest economy, which is teetering on the brink of recession.

Bear Stearns – bought for just $2 a share by its rival – was heavily exposed to the mortgage-backed investments hit by the credit crunch.

Two of its hedge funds collapsed in July last year in one of the early signs of the approaching crisis.

Last week rumours of problems at the business swept the market, leading to a cash crunch for the firm. The bank looks after millions of dollars for hedge funds, which began demanding their money back as the rumours grew and the company had no deposit base to fall back on.

The Prime Minister, in a statement to MPs on last week’s European Council in Brussels, promised to take “whatever action is necessary” to maintain economic stability.

The crisis at US investment bank Bear Stearns will add to the funding pressure on UK banks and a squeeze on borrowers despite falling interest rates, experts have warned.

The rescue and cut-price sale of the 85-year-old Wall Street firm to rival JP Morgan Chase will make banks even more fearful of lending to each other in the credit crunch, stockbroker Panmure Gordon says.

Analyst Sandy Chen is also expecting a raft of further losses among the UK’s major banks on the mortgage-backed investments hit by the crunch, which have plummeted in value. He said: “Banks themselves must be tightening their credit and risk models even further, leading to even greater pressure despite any further rate cuts.

“Recent events lead us to expect higher impairment charges, lower margins and concerns about capital cushions.”

This could lead to even more expensive mortgages for hard-pressed homeowners as banks look to rebuild their balance sheets – despite two rate cuts in December and February from the Bank of England and more expected later this year.

The UK’s five biggest banks wrote off almost £5.7bn in total from the value of investments hit by the credit crunch in 2007 amid spiralling defaults among higher-risk homeowners in the US.

These losses could widen further this year following the events at Bear Stearns, the latest victim of the freeze in money markets which claimed mortgage lender Northern Rock.

The US bank’s high exposure to the risky investments meant the other banks were more reluctant to lend against its assets.

The problems at Bear Stearns also show that the crisis in the US housing market is such that concerns are going beyond the “sub-prime” backed bonds originally at the root of the problem.

The US bank also held billions of pounds worth of so-called Alt-A investments, based on loans rated more highly than sub-prime mortgages but not strong enough to be classed as low-risk.

Halifax Bank of Scotland, whose annual results last month showed exposure of more than £7bn to these type of investments, has been one of the biggest stock market casualties of Bear Stearns’ woes, with shares down more than 12% yesterday.

The Fed, meanwhile, is expected to lower its main interest rate, the federal funds rate, by up to 1% today in an attempt to spur on the US economy and bring some life to the stagnant housing market.

A cut to 2% would mean US interest rates have fallen by more than half since the beginning of 2008.