Bank Bailout, is this how it works if it goes wrong?

Benefits_Blagger

I've benn following the banks bailout story and while I understand what is happening,I have been unsure of the mechanics of how it will affect us. However I think I have got my head around it now, let me know if my understanding is corrrect or incorrect.

but basically what is happening is that bank mortgage securities are bad, goverments bonds are good. the goverment are swapping these so the banks can raise finance on the goverment bonds.

this bit i understand, but it's the mechanics of how it will affect us if it goes wrong that I am unsure of.

but if the plan works, the goverment will pay income on the bonds using the money from the mortgage securities. however if the mortgages fail, the goverment will have to make up the shortfall on the bonds it has issued and is forced with 2 choices, raise tax or print more money. with the most likely solution being to print more money, which is inflationary as it devalues the money in our pocket.

is trhis correct ?

I understand that the goverment scheme is bad, i.e. swap good debt for bad debt, it's just the mechanics of how it will be bad if it goes wrong I don't understand.

hgllgh

"however if the mortgages fail, the goverment will have to make up the shortfall on the bonds it has issued and is forced with 2 choices, raise tax or print more money. with the most likely solution being to print more money, which is inflationary as it devalues the money in our pocket"

so effectively the BofE is transferring the mortgage risk on to the taxpayer because either way you get higher taxes or inflation.:mad:. And the problem will be down to mortgage defaults which now look increasingly likely do they not?

PasturesNew

Well, to pay the money back they'll have to stop all benefits payments and send everybody back to work to try to rebuild the country.

neas

Stoppign Benefits would probably save 50 billion... ;P Easily.

ianmr65

Benefits_Blagger wrote: »

but basically what is happening is that bank mortgage securities are bad, goverments bonds are good. the goverment are swapping these so the banks can raise finance on the goverment bonds.

Sort of. The on going asset value, and returns of a proportion mortage backed securities, are probably pretty good. Prime UK/ US, LOW LTV ect. The value of others are likely to be very bad and likely to plummet in value as the markets colapse, due to repos ect. sub prime us, and uk BTL for example.
As these securities have been chopped up and sold on many times no one is sure what they will end up being worth. So other banks have been reluctant to take them as collateral against loans.
The bond swap, is a short term lease/ loam arrange ment where the goverment will hand over bonds at about 85% of the current market value of the securities, for a fee, will enable the banks to borrow against gilt edge goverment bonds, are a lot more likely to hold there value.

Benefits_Blagger wrote: »

but if the plan works, the goverment will pay income on the bonds using the money from the mortgage securities.
is trhis correct ?

No. The bonds will be used as collateral and the banks will pay the BoE a fee for using them.

Benefits_Blagger wrote: »

however if the mortgages fail, the goverment will have to make up the shortfall on the bonds it has issued and is forced with 2 choices, raise tax or print more money. with the most likely solution being to print more money, which is inflationary as it devalues the money in our pocket.

is trhis correct ?

Not quite. The bonds are being rented, against the mortgae securities, for a maximum period of three years. They will only be cashed in, by whoever is holding them if the bank in question fails. Once the banks no longer need the bonds they will be returned, or payed back.
Howver should the bank in question fail, the goverment is going to be left holding what could be pretty useless mortage back securities.

At that point the tax payer makes up the shortfall. Eithr by getting further in to debt, or by printing money.

The reality is that this offer is not going to do a great deal, long term, as it is not going to solve the problem of the dissapearance in value in these mortgage backed assets.
Just inject some slightly cheaper cash in the system.

ianmr65

neas wrote: »

Stoppign Benefits would probably save 50 billion... ;P Easily.

yeah, but only if the claiments stopped were Old Age Pensioners, who make up about 80% of the benefits, and health care pot of £250bn.

Bring back the work house, or leave em to rot: thats what i say.

WTF?_2

hgllgh wrote: »

"however if the mortgages fail, the goverment will have to make up the shortfall on the bonds it has issued and is forced with 2 choices, raise tax or print more money. with the most likely solution being to print more money, which is inflationary as it devalues the money in our pocket"

so effectively the BofE is transferring the mortgage risk on to the taxpayer because either way you get higher taxes or inflation.:mad:. And the problem will be down to mortgage defaults which now look increasingly likely do they not?

Theoretically the risk lies still with the bank because they have to buy back the asset at a given price, somewhere down the line. So they ultimately have to make good the losses.

That is of course, assuming the bank doesn't default - or go bust. Probably the same thing actually.

As many have pointed out, this new money is unlikely to find its way into cheaper mortgages. The banks know which way the property market is going and won't want to waste their windfall. It'll most likely go into areas of investment currently showing good returns. ie. Soft commodities (food) and energy (oil, gas). This is the classic response to an inflated money supply - asset bubble inflation. The last time around the cash went into housing but once pricked, bubbles don't reflate until people forget about past losses.

We've had the era of ever more expensive houses, now say hello to ever more expensive food, petrol and home heating. That'll help those struggling with their monster mortgages to repay them, won't it Gordon?

Don't worry everyone else; As the pound continues it's downward trend making everything imported cost more, I'm sure our wages will rise handsomely to compensate us. :rolleyes:

danm

a couple of things to pick up on here.

the haircuts the BOE are enforcing are upto 22%.

Essentially this means that for every £1 in mortgage securities, the BOE will only give 78p worth of government bonds. Essentially, this protects the government against the first 22% of losses on these bonds if the banks fail....and they are AAA, which means there may be a portion of junior debt to absorb some more of the losses. I think the BOE is in a pretty safe position here.

The value of these securities are linked to Libor. Where they can't be valued in the secondary securities market, they are valued using a banks internal model. Variables that go into these model include Libor and secondary market spreads. If libor and spread reduce, the BOE will effectively be advancing more cash against the same security as they are now 'worth' more. This is not so effective IMO as the very outcome the bank are looking for perpetuates their involvement.

Benefits_Blagger

PasturesNew wrote: »

Well, to pay the money back they'll have to stop all benefits payments and send everybody back to work to try to rebuild the country.

thats why I'm $hitting myself!!!!!

alan99_2

The government is suddenly putting up 50 Billion of taxpayers money. So what if houseprices fall. People , especially FTBs could have had a chance of buying a home. Not any more.
People sell for less and buy for less. Less mortgages/credit more cash purchases/deposits is good for everyone.

The only people to benefit are the taxman. More stamp duty, more CGT on second home sales, more VAT on HIPS, EA, solicitors etc.

Pity the government can't find a couple billion or so ,if that to stop the lowest income people see their tax band increase from 10% to 20%.

Alan

Benefits_Blagger

ianmr65 wrote: »

No. The bonds will be used as collateral and the banks will pay the BoE a fee for using them.

Not quite. The bonds are being rented, against the mortgae securities, for a maximum period of three years. They will only be cashed in, by whoever is holding them if the bank in question fails. Once the banks no longer need the bonds they will be returned, or payed back.
.

Ok, think I'm getting the jist of what's happening now, so is it like a bank goes and gets a £10 billion bond off the BoE, which instead of being a dividend paying traditonal gilt is essentially a £10 billion banknote. which the bank then uses as collateral, so if the bank fails, whoever has lent it money then gets the £10 billion note which it then takes back to the BoE and then cashes in ?