Bank of England stripped of independence, ordered to gush cash


By Ambrose Evans-Pritchard and Philip Aldrick
The Telegraph, London
Thursday, September 20, 2007

The government has forced the Bank of England to relax lending standards in a dramatic U-turn, effectively stripping the institution of its independence for the first time since the new monetary regime was created in 1997.

In a bizarre move, the bank shifted tack abruptly yesterday by agreeing to flood the capital markets with L10 billion of three-month money and widen the asset classes it will accept as collateral against the loans.

The change in policy came despite vehement objections from top bank staff, including Governor Mervyn King, who said a week ago that lack of liquidity was not the root of the problem and that opening the short-term credit spigot "encourages excessive risk-taking and sows the seeds of a future financial crisis."

In a humiliating climbdown, the bank said it is now acting "to alleviate the strains in the longer-maturity money markets." Eligible collateral will now include mortgage debt.

The new measures had little impact on the British markets yesterday since optimism was returning worldwide as a result of the Federal Reserve's half-point rate cut on Tuesday. The FTSE 100 was up 176.7 points to 6460, moving in lockstep with Japan's Nikkei and European bourses.

Political sources told The Daily Telegraph that the pressure came directly from Chancellor Alistair Darling. Labour is furious that the crisis at Northern Rock was ever allowed to reach the point of mass panic by depositors, with contagion effects spreading on Monday to Alliance & Leicester and other lenders.

The decision to intervene in credit management has left the governor in an untenable position. It risks destroying, overnight, a decade-long experiment in monetary discipline that has won praise across the world.

"This is a 180-degree turn," said Danny Gabay, an ex-official at the bank and now with Fathom Financial Consulting. "I don't think this U-turn was of the bank's own volition. My feeling is this has the dead hand of the Treasury all over it."

Tory MP Peter Viggers, a member of the Treasury Committee, said Mr King had been right to resist calls for extra liquidity. "This places the bank in a most difficult position. Was the bank put under pressure and if so by whom?" he said. Mr Viggers and fellow Tories intend to probe the affair aggressively at a grilling of Mr King before the committee today.

Mr Darling believes the Northern Rock debacle could have been avoided if the bank had agreed to accept mortgage collateral at its lending window earlier, copying the Federal Reserve and European Central Bank. Bank officials insist that this would have made no difference to Northern Rock, which got into trouble through over-reliance on short-term funding from the capital markets.

Relaxing collateral rules merely loosens standards for the entire system, encouraging moral hazard. It is hard to see how it can be justified at this late stage, as the crisis abates.

The Financial Services Authority was more open to the idea of relaxing rules, though informed sources deny reports the FSA took a strong stand. Relations between the FSA and the Bank have now become poisonous.

Bernard Connolly, global strategist for Banque AIG, said the bank may have been slow in seeing the gravity of the crisis, and insisted that Labour is using the issue as a pretext to force a loosening in monetary policy: "The governor is being burned at the stake by the government. This dispute has macro-economic implications."

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