Just hours before TARP passed by 71 to 64 votes in the US Congress, the FT reported breathlessly, "The central bank announced a dramatic increase in its three-month lending to British banks, saying it was willing to offer cash against an even wider range of collateral!" and the The Chancellor states this as evidence of government doing all it can, all that is necessary...etc. But, all the bank is doing is expanding "eligible collateral... to include AAA rated asset-backed securities of some corporate and consumer loans; and approved highly-rated, asset-backed commercial paper programmes, where the underlying assets would be eligible if securitised".
This is only even a slight shift down in acceptable risk grades. In recent three-month auctions earlier this week, the Bank also accepted other countries’ government bonds, debt of US government-sponsored enterprises such as Fannie Mae and Freddie Mac, and AAA-rated tranches of prime European mortgages. That is not very wide - at worst the prices in the market are less than 10% down and this may be reflected in the bank's pricing? As of today (only until Nov. 18 subject to review on Oct.14) the class (but not the quality) of collateral is widened to include AAA-rated US securities backed by student, consumer and auto loans, senior tranches of US commercial mortgage-backed securities, US covered bonds, AAA-rated tranches of corporate bonds, and a wide range of other asset-backed commercial paper. Securitised student loans already carry a government underwriting guarantee. The others are all AAA too, although "a wide range of other CP" might include softer qualities, but generally the SLS (Special Liquidity Scheme) only seems to accept the highest rated paper. Yet, this dispensation carries a charge. "Given the further broadening of collateral, there will be a minimum bid rate of 50 basis points above the relevant overnight index swap (OIS) rate." An Overnight Index Swap (OIS) is an interest rate swap agreement where a fixed rate is swapped against a pre-determined published index of a daily overnight reference rate eg. SONIA (GBP) or EONIA (euro) for an agreed period. It is currently about 290 basis points, giving a price of 340bp not far off the very high TED spread of 380bp though slightly below 3 month dollar LIBOR at 433bp (and even higher in Europe at 533bp!), which represents a profound breakdown in interbank lending! Bankers are complaining that the billions of dollars of liquidity provided by central banks are not filtering into the loan market, which is paying punitive rates for euros, sterling and dollars in the overnight interbank market. What they are saying is that the Bank of England and others are not being as helpful as claimed. Mervyn King - Governor of the Bank of England - said today, "In these extraordinary market conditions, the Bank of England will take all actions necessary to ensure that the banking system has access to sufficient liquidity". Yes, liquidity, but not at rates that might help ease the liquidity squeeze. To ensure that it does not lend too cheaply, BoE insists that any bank willing to post some of the wider collateral may face a higher minimum bid in the auction (higher than those posting normal collateral). The minimum bid will be the three-month risk-free rate of interest as determined by the overnight index swap market. But for those posting weaker collateral the minimum bid is raised by 50 basis points, but not just that; BoE also insists on steep haircuts for "weaker collateral" (weaker than AAA-grade?) by offering as little as 60p in the pound for some foreign currency denominated CMBS. 60% puts this collateral firmnly in the sub-investment junk category? Hypo-Real might take that, but it's just not British.