Bank of England: Credit Crisis 'Exaggerated'

MoneyNews
Friday, May 2, 2008

Credit markets will gradually recover in coming months amid an eventual realization that financial risks from the subprime crisis have been exaggerated, the Bank of England said Thursday — even as more data emerged confirming a slowdown in Britain's economic activity.
The Bank of England has tried to restore normalcy by offering to swap up to $100 billion in Treasury notes.

The Bank's Financial Stability Report says some market players will eventually recognize that some assets are cheap relative to fundamentals, and this will stimulate recovery.

The Bank's major effort to restore normalcy in the credit markets has been its offer to swap up to £50 billion ($100 billion, €64 billion) in Treasury notes for mortgage-backed assets held by banks.

"The unavoidable correction after the credit boom is proving protracted and difficult," Deputy Governor John Gieve says in the report.

"However the pricing of risk in credit markets seems to have swung from being unsustainably low last summer to being temporarily too high relative to fundamentals. So, while there remain downside risks, the most likely path ahead is that confidence and risk appetite will return gradually in the coming months."

Gieve's remarks came as another report from the government showed a softening in the construction industry, with orders for new construction down 8 percent in the first quarter compared to the same period a year earlier.

Orders for private housing were down 13 percent in the year ending March 31 compared to the previous year, the Office for National Statistics said, while the drop in the first quarter was 29 percent compared to the first quarter of 2007.

The credit crisis was spawned by the softening of the U.S. housing market, which led to increasing arrears on sub-prime debt and a consequent reluctance by lenders to accept mortgage-backed securities as collateral.

"A correction in risk premia in credit markets to more sustainable levels was needed and was bound to be costly for some financial institutions and borrowers," the report said.

"But the adjustment is taking longer and proving more difficult than anticipated. Markets are struggling to establish prices that can clear a legacy of financial assets created during the credit market boom."

The report said buyers aren't willing to rely on rating agencies or the reputations of issuers in weighing the value of asset-backed securities and more complicated packages of debt.

The days of easy credit are unlikely to return, the report said, and that is likely to bring some increase in stress in the British economy.

The Bank said the most vulnerable are the individuals and companies who took on heavy debt.

"Many high-risk borrowers may find that they are unable to refinance expiring fixed-rate mortgage deals and will instead move onto the standard variable rate. This will result in a jump in their average effective mortgage rate of around 2.5 percentage points," the report said.

It noted that commercial property has also taken a hit, with U.K. prices down 16 percent in March compared to the peak in June 2007.

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