Paper Covers Rock, But Rock Wins

By Willem Buiter

Published September 14, 2007; Republished By SSE September 26, 2022

Now we know a bit more about the terms on which Northern Rock can access the financial resources of the Bank of England. In a statement dated September 14, Northern Rock says:

...Northern Rock has agreed with the Bank of England that it can raise such amounts of liquidity as may be necessary by either borrowing on a secured basis from the Bank of England or entering into repurchase facilities with the Bank of England. Such repurchase facilities would include securities that have prime residential mortgage assets as underlying collateral. The collateral that can be used under this "Repo" facility is similar in nature to the collateral currently utilised by many Eurozone banks with the ECB.

As I suspected, Northern Rock was unable to access the Bank of England's Standing (collateralised) lending facility or participate in normal liquidity enhancing Repo operations, because these require collateral of a kind Northern Rock was unwilling or unable to offer - sterling and euro-denominated instruments issued by UK and other European Economic Area central governments, central banks and major international institutions rated at least Aa3 and, exceptionally, US Treasury bonds. Instead they are allowed to offer as collateral asset-backed securities, specifically, prime residential mortgage backed securities. Anne Sibert and I have recommended extending the menu of assets eligible for discounting at the Bank's Standing lending facility and for normal repo operations (see (1), and (2)) and it is good to see that a small step has been taken on the road to the Bank of England functioning as Market Maker of Last Resort. Unfortunately, the widening of the set of eligible collateral is so far only for exceptional and one-off bail outs like the Northern Rock credit line. It is, however, scandalous that so little is known about this facility. It is tax payers' money that is put at risk. It is also essential that the level playing field among competitors in the financial markets be distorted as little as possible. The following information should therefore be put in the public domain:

  1. The terms and conditions of the credit facility, including the interest rate charged on any use of the credit line, the fee charged for making the credit line available, the amount of the credit line, the period for which it will be available and any other relevant characteristics.

  2. The exact nature of the collateral that can be offered, its valuation and the haircuts imposed.

  3. Equivalent information as regards any repurchase agreements with the Bank of England.

Keeping this information confidential and secret destroys the accountability of the Bank, the FSA and the Treasury for the public resources put at risk. It is a distortion of the competitive level playing field of our financial institutions. It is also completely unnecessary for the effective implementation of the bail out. The same unnecessary secrecy surrounds borrowing at the Standing collateralised lending facility of the Bank of England, the choice of target reserves at the Bank of England by individual banks, and the use of these reserve facilities. Information on the use by individual, named institutions of any of these resources/facilities, and on the terms attached to this use, should be in the public domain. The current lack of transparency is both economically and politically damaging.