Banks release billions over credit crunch

Last Modified: 12 Dec 2007
By: Faisal Islam

The Bank of England has joined Central Banks from around the world in releasing billions from reserves to try to stop the credit crunch.

An unprecedented financial crisis - was today met with an equally unprecedented exercise in global financial fire fighting.

For three months international money markets have dried up, starving big banks of easy access to money, as the financial system feared which bank was sitting on billions of pounds of losses in low quality American mortgages.

Today five of the world's biggest central banks - the US Federal Reserve, the Bank of Canada, the European Central Bank, the Swiss and the Bank of England ripped up the rulebook to announce coordinated injections spraying billions of extra dollars, euros and pounds into the banking system in coming weeks.

The Bank of England in particular announced a relaxation of its tough stance - in exchange for the money injection, Mervyn King will now accept high quality credit card debt from Britain's banks as collateral, and unlike Northern rock, big bank borrowers may not even face a penal rate of interest.

The Credit Crunch

The core of the problem is what is known as the graph of fear. It represents the ordinary close relationship between the Bank of England base rate, and the market interest rates which determine key mortgage rates - known as 'three month bba libor'.

Everything pretty normal till July. The Bank of England controls the economy. Then the relationship breaks down as the credit crunch bit in September. The Bank of England losing control of the economy if you like, by the equivalent of four standard interest rate rises.

Then normality returned, but it was brief - as credit crunch mark 2 began to bite a month ago.

The net result is that when the Bank of England cut rates to 5.5 per cent last week, the market rates did not even follow them down. A situation with echoes in Europe and the US.

The question is whether today's action will it close the gap? We'll know tomorrow.

Even this afternoon, traders celebrated the intervention by piling money into highly risky trades which borrowed cash from Japan to invest around the world.

The real problem is that the original source of the fire - losses on US mortgages - is still burning. And with many in the City not believing even the multibillion write-offs already made by some of the world's biggest banks-- our multinational fire fighting force cant actually get to the original source of the inflammation.