There are those that blame the Bank of England for being slow to permit UK banks to use mortgages as collateral. This is a little unfair – UK mortgage markets have functioned well for some time without any central bank intervention. But for years, mortgage-backed bonds have been eligible for repo with the European Central Bank and the Federal Reserve followed suit recently.
Spanish banks in particular have done many mortgage-backed deals that have been used specifically for repo. The beauty of this is that Spanish banks were able to finance themselves without having to state that they used emergency funding channels. Northern Rock is eventually allowed to follow suit but on an emergency basis – instantly alarm bells go off. Confidence is a fragile and sometimes irrational thing.
Look how much change the UK central bank has undergone and undertaken in the past 10 years. It is no longer as close to the market as it once was. It no longer manages the UK government’s borrowing; gilt issue and cash management are the preserve of the Debt Management Office established in 1997.
It has also dramatically changed the way it manages the money market. In the past, there was a seemingly quaint system of discount houses whose job it was to act as intermediaries between the central bank and financial institutions. The bank used to buy and sell bills at a discount from these institutions when it wanted to add or withdraw overnight liquidity.
Unfortunately the discount houses were thinly capitalized, which explains why the Bank of England structured them out of existence. It is worth remembering, though, that they performed a useful job for many, many years.