A View of the Credit Crisis from the UK

The following gives a good summary of what is on the minds of central bankers in the UK and the US. The real concern continues to be the effect of asset values (CDOs, SIVs, etc.) on the banks and the effect this will have on their ability to lend. This in turn effects consumers (the real issue.)Text in bold is my emphasis. From Bloomberg:

Bank of England Governor Mervyn King said there's a risk a further drop in asset prices will lead to more deterioration of credit conditions.

``Market fears about the possibility of further movements in asset prices might impair the balance sheets of the banking system in the U.S., which would lead to a classic credit squeeze,'' King told U.K. lawmakers today. ``This is a risk rather than something that's actually happened yet.''

The world's biggest banks have written down more than $50 billion on credit-related losses and UBS AG, Citigroup Inc. and Merrill Lynch & Co. fired their chief executives. The Bank of England today joined the European Central Bank and the Federal Reserve in moving to stem a renewed rise in lending rates, offering banks emergency funds with longer repayment terms.

Borrowing costs have soared as banks hoard cash before the end of the year on concern losses from the collapse of the U.S. subprime mortgage market will spread, keeping lenders from offering money to all but the safest borrowers.

``Continuing fragility in the banking system'' has increased the risk that money markets will ``tighten'' at year end, the bank said today. The cost of borrowing pounds for three months rose 3 basis points to 6.59 percent yesterday. That's 84 basis points more than the Bank of England's benchmark rate and the highest since Sept. 18.

Fed Deputy Governor Donald Kohn yesterday helped spark a stock-market rally when he said market ``turbulence'' may reduce credit to businesses and consumers, reinforcing investors' expectations the Fed will cut interest rates again next month.

While the Fed has reduced its key rate by 75 basis points to 4.5 percent, the ECB and the Bank of England have kept their benchmark rates unchanged since markets seized up in August.

King and other British policy makers said today a reduction in lending will eventually hurt investment and consumer spending in the U.K.

``The big area of concern in my mind is consumption,'' said Bank of England Deputy Governor Rachel Lomax. ``It's the most important component of demand and it's most likely to be hit by tighter credit conditions.'' King said corporate investment and commercial property are his biggest concerns.

The Bank of England is aiming to curb market lending rates and inflation at the same time. King said today that ``the near- term outlook for inflation and growth has become less benign'' and policy maker Timothy Besley said there's still ``a fair amount of inflationary pressure out there.''

King drew a distinction between the jump in credit costs in August and September, stemming from the plunge in the U.S. market for subprime mortgages, and the latest increase. King said the first round was driven by concerns about banks' liquidity and the latest by concerns about the health of their balance sheets.

``Although that fear has so far run well ahead of realized losses, it has the potential to lead to a further tightening in credit conditions,'' said King. ``The bank will continue to assess how these developments will impact on the outlook for inflation.''