£40bn injection risking 'chaos'?

Last Modified: 19 Sep 2007
By: Faisal Islam

A dramatic U-turn by the bank of England. But who's in charge, the governor? Or the politicians?

It's the crisis that's been the toughest challenge for the Bank of England since Black Wednesday.

And today its Governor Mervyn King performed the most remarkable of U-turns - promising to provide exactly the flood of money that only last week he said could "sow the seeds of a future financial crisis."

From the outset, King has taken a strict approach to pouring cash into banking markets that have completely dried up over fears about multibillion pound exposures to dodgy American mortgage debt. His fear was that it would be a bailout of reckless investors in complex debt instruments and penalise those who had sensibly held back.

'...encourages excessive risk-taking, and sows the seeds of a future financial crisis'
Bank of England Governer, Mervyn King

Had this move happened last week there could well have been no run on the Northern Rock bank, because we the public would never have been told about billions of pounds being lent against a troubled bank's un-tradeable mortgage assets.

How does it work?

This crisis goes to the heart of how the Bank of England supports the banking system. It lends money to British banks on an overnight basis to keep the cogs of the financial system turning. It also lends money over a three month period.

In recent weeks, its provided overnight lending.But it's specifically not provided help on the longer term front. Indeed the governor, Mervyn King, chose to make public in a letter to MPs just one week ago his views that:

"...the provision of such liquidity support undermines the efficient pricing of risk. That encourages excessive risk-taking, and sows the seeds of a future financial crisis."

Now today the Bank says it will offer £10bn pounds of precisely this liquidity. With possibly another £30bn to come.

Some big banks had publicly lobbied for this move - which has occurred in Europe and the US, and it's understood that the banking regulator the Financial Services Authority was sympathetic too.

But senior sources close to the bank have told Channel 4 News that Mervyn King met with the heads of the major banks yesterday evening. He stuck to his long held position then. But just hours later announced the move they had been calling for.

So did the treasury put political pressure on the Bank of England to open the floodgates for the banking industry?

For ten years now the independence of the "old lady of Threadneedle Street" has been the bedrock of Britain's macro-economic policy, the bedrock of ten years of uniterrpeupted growth.

The question tonight, whatever happens to Northern Rock or Mervyn King personally is the independence of the Bank of England up for negotiation?

We asked the treasury to respond, but was told no interview was possible. But they did say:

"This was a matter for the Bank. The Bank of England is independent. It has it's own powers and it's absolutely their decision"

The Bank of England has since told us the governor did discuss the idea of injecting money into the markets and said he was thinking of doing it in the next day or two. It's not true that he changed his mind today, they said.