As Lehman Brothers raced to find a buyer on Saturday, U.S. government officials and Wall Street chieftains mapped out options to prevent an abrupt collapse of the crippled bank and arrest the downward spiral threatening other financial companies.
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U.S. tries to contain Lehman crisis
By Vikas Bajaj
13 September 2008
As Lehman Brothers raced to find a buyer on Saturday, U.S. government officials and Wall Street chieftains mapped out options to prevent an abrupt collapse of the crippled bank and arrest the downward spiral threatening other financial companies.
Several possibilities began to emerge as top Wall Street executives met under the guidance of the Federal Reserve Board and Treasury Department. One would involve major banks and securities firms providing a financial backstop to facilitate a sale of Lehman. Another option would involve an agreement among Wall Street players to keep trading with Lehman as the bank seeks an orderly liquidation.
Those briefed on the talks said the situation was still fluid and other options could emerge.
Adding urgency to the discussions were growing concerns that other big financial institutions like the insurance giant American International Group and Merrill Lynch might face a similar crisis and also need billions of dollars in capital to strengthen their businesses.
The spreading troubles were the latest sign that even the government’s extraordinary interventions into private enterprise during the last year have not been enough to halt the unraveling of the financial system.
As the trading week ended, top officials from the Federal Reserve and the Treasury Department called an emergency meeting in New York with the heads of major Wall Street firms to insist that they find a way to rescue Lehman because their own companies might be next. The meetings, which involved top executives from Goldman Sachs, Morgan Stanley, JPMorgan Chase, Citigroup and other financial companies, continued on Saturday.
The group was working on two main contingency plans in case Lehman is unable to strike a deal to sell itself to one of several suitors — Bank of America or two British firms, Barclays and HSBC. Under one possibility being discussed, major financial firms would jointly inject new capital into Lehman, allowing it to spin off its portfolio of troubled securities into a separate company.
Under another option, Lehman would start an orderly liquidation of its assets on Monday. Its major competitors would agree to keep doing business and trading with Lehman as it unwound its business and portfolio.
The Fed’s call for Wall Street institutions to support one of their own comes at a time when many of them are also short on capital. And yet entities that do have cash ready to invest, namely private equity firms, are not at the table.
Regulators do not want those firms, which borrow money to buy companies, controlling major financial institutions that provide the financing for their acquisitions. Many foreign investors, for their part, are reluctant to buy after having seen earlier investments drop sharply in value.
For months, Lehman and other companies assured investors that they had a handle on troubled assets tied to real estate. But those assets turned out to be worth less than the firms had thought.
As a result, many investors are no longer sure what such financial companies are worth, and they do not want to invest in them until they do. Many hedge fund managers and other traders have profited handsomely from bets that these stocks would fall in value.
Companies that took the biggest risks and used debt aggressively to build their businesses stumbled first, and now healthier companies are coming under pressure. Loans that were considered far better than the subprime mortgages, which kicked off the panic, turned out to be only marginally safer.
“You have to think of this like there is an epidemic going on — an epidemic of capital destruction,” said James Melcher, president of the hedge fund Balestra Capital, who has been bearish on the stock market.
The U.S. government government has taken an unusually activist role in the crisis. This spring, the Federal Reserve arranged a hasty rescue for Bear Stearns, the wobbly investment bank. Then last week, U.S. government regulators took over the country’s two largest mortgage finance companies.
At every turn, officials hoped they had done what was needed to restore confidence in the markets, only to be greeted with another crisis.
Policy makers have signaled that they are not willing to provide financial support for a takeover of Lehman, as they did with Bear Stearns. Unlike Bear Stearns, which lost many clients and its access to money markets in just a few days, Lehman has been able to finance its business, especially after investment banks were allowed to borrow directly from the Fed. The problems that bedevil Lehman are more thorny questions about the quality of the securities it owns.
The decision by policy makers sets up a crucial test for the financial system: Can the market resolve the panic by pairing Lehman with a willing and strong suitor?
There is a growing consensus on Wall Street that the government may not be able to save every big firm whose failure would pose a risk to the system.
“The too-big-to-fail mantra or concept or government policy is in my opinion off the table and we have to deal with that,” said David Ellison, president and chief investment officer at the FBR Funds. “They are not going to save these companies.”
So far, the market has struggled to correct the excesses of the recent credit boom on its own.
Analysts say many financial companies, including the insurer AIG, need to raise capital. But every time their stock prices fall, raising capital becomes harder. And when that happens, bondholders and credit rating companies start worrying, too. Stock prices fall even further — and the whole cycle repeats again.
On Friday afternoon, for example, Standard & Poor’s warned that it might lower AIG’s credit rating because the drop in the company’s share price — 45.7 percent last week alone — could make it even harder for the company to raise capital.
That partly explains why markets in general, and financial shares in particular, are gyrating ever more. Even after the Bush administration took control of the mortgage finance giants Fannie Mae and Freddie Mac last week, a step many thought might calm investors, trading volatility kept rising.
“Investors are like hyperactive first graders playing musical chairs,” said Sam Stovall, chief investment strategist at Standard & Poor’s Equity Research.
The government, for all its activism, has been unable to stabilize the markets for long — though policy makers would argue that their interventions have prevented failures from cascading through the financial system.
After the Federal Reserve arranged the emergency sale of Bear Stearns to JPMorgan Chase in March, the stock market rallied and many strategists and executives on Wall Street declared that the deal was a turning point.
At the time, Richard Fuld Jr., the chairman and chief executive of Lehman Brothers, said that the Fed’s decision to lend directly to investment banks like his had eliminated the problems that felled Bear Stearns. Now, Fuld is expected to sell Lehman at a fire-sale price.
Stocks also rallied last Monday, after the Treasury Department and U.S. government regulators took over Fannie Mae and Freddie Mac, only to sink the next day as concern over Lehman, AIG and Washington Mutual spread.
At the end of the week, the broad stock market was up modestly, but financial shares closed down 2.5 percent.
Downturns are typically more volatile than the booms that precede them, strategists say. Investors try to anticipate the recovery, though the actual turning point is often visible only in hindsight. But after a lot of bad news, some investors usually dive in, believing that the markets have reached a cathartic moment.
“There are lots of investors that don’t want to miss the absolute bottom,” said Allen Sinai, a former chief economist at Lehman Brothers who now has his own research firm, Decision Economics. “Unless you are a professional trader, and even then, it’s a very dangerous philosophy.”
Many of the fundamental forces in the economy remain worrying. Home prices are still falling, though their rate of decline appears to have slowed in recent months. And defaults on all kinds of loans are rising. In the broader economy, the unemployment rate is rising and consumer spending has been faltering.
The losses created by rising defaults have impaired the ability and confidence of banks to lend to one another and to consumers. As financial institutions rein in risk-taking to protect themselves and preserve their dwindling capital, interest rates go up, lending standards tighten and credit lines are capped or severed.
“Every time there is another problem, it causes lenders to become that much more conservative, which then puts the squeeze on someone else,” said David Levy, the chairman of the Jerome Levy Forecasting Center, a research firm in Mount Kisco, New York
Many analysts believe that for the downward spiral to be broken, home prices must fall to a level that can be supported by factors like household income that have traditionally had a strong relationship to prices. Also, the government has to determine how it will restructure Fannie Mae and Freddie Mac, which own or guarantee half of the nation’s home loans, said Thomas Cooley dean of the Stern School of Business at New York University.
“We have to hit the bottom in housing prices,” he said, “and we have to just sort out how housing will be financed in future.”
EU bankers assess exposure to credit crisis
By Tony Barber in Brussels
September 14 2008
The world’s banks received a warning at the weekend that they would need to raise hundreds of billions of dollars more in fresh capital to cover losses from the global credit crisis.
Mario Draghi, governor of the Bank of Italy, said banks had raised $350bn since the turmoil on world financial markets erupted 13 months ago, and they would need to raise an equivalent amount in the future.
Mr Draghi is the head of the Financial Stability Forum, the group of major national financial authorities established in 1999 to strengthen financial markets supervision after the Asian and Russian crises of 1997-98.
Speaking at a meeting of European Union finance ministers and central bank governors, Mr Draghi said it appeared certain that the credit crisis would plunge more banks into difficulties, spurring a long process of consolidation in the banking sector.
”Various banks, within a sector that is basically well-capitalised overall, will be in difficulty,” Mr Draghi said. ”The conclusion is that there will be a series of consolidations in the world banking system. We have seen some already, but we are a long way from seeing the end of this.”
He estimated that banks across the world had already suffered losses and writedowns to the tune of almost $500bn as a result of the market turmoil.
EU-based banks account for about one-third of this sum, EU officials said.
EU central bankers were in touch with banks in their home countries at the weekend to assess their exposures to Lehman Brothers, the New York investment bank that fell into deep trouble last week, officials said.
Mr Draghi said banks in the 15-nation eurozone appeared to be at less risk than some rivals from the credit market turmoil, which EU policymakers blame largely on questionable lending practices in the US and some emerging markets.
”Within the euro area the situation in the banking system is different. It is not as stressed,” Mr Draghi told reporters. ”Our banks, the Italians, but the others as well in the eurozone, are banks that are not very exposed to these activities in some other parts of the world. They seem to be feeling the effects of this crisis to a lesser degree.”
Echoing a call from EU finance ministers, Mr Draghi said banks and other financial institutions must restore trust in each other by not concealing unpleasant facts about their condition.
”The less transparent the banking system, the more the market will require capital,” he said.
EU officials said the banking industry had made a useful start in July by publishing statistics on their involvement in the securitisation market.
By the end of October, banks are likely to adopt guidelines for issuing clear, comparable data when they publish their results for the first quarter of 2009.
”Transparency is improving,” Christine Lagarde, France’s finance minister, told reporters. ”It is vital to enhance work on the valuation of assets, in particular where the current market is illiquid.”
Is it all over for cut-price China?
Michael Sheridan in Hong Kong
September 14, 2008
THE huge container ships are still a fine sight as they weave through a maze of islands and head out to the South China Sea, but their cargoes are no longer made in the world’s bargain basement.
The fabled “China price” of cheap consumer goods has kept global inflation low, undercut workers in every industrialised nation and brought millions of Chinese peasants into a raw capitalist economy.
That phase of globalisation may now be coming to an end, economists say. The export machine that powered China’s spectacular growth is slowing as the cost of manufacturing in China and shipping goods to Britain goes up daily.
“We are starting to look elsewhere,” said a UK supermarket buyer, “to Israel, eastern Europe, Thailand, Vietnam and in many cases we are getting better prices than from China.”
It costs about £3,000 to ship a 40ft container stuffed with toys or shoes from Shanghai to Manchester, shipping firms said last week. That is more than double the amount charged in the early years when China was a paradise for outsourcing and oil traded at just over $20 a barrel.
Freight costs have pushed some American firms into “reverse globalisation”, moving their manufacturing operations in steel, furniture, electronics and textiles back to America and Mexico.
The harsh arithmetic of shipping is only part of the explanation. But it illustrates the pitfalls for any business model dependent on going halfway around the world in search of the cheapest labour. Even sweatshops, it turns out, have their bottom line.
The energy shock hit Chinese firms hard. Oil at more than $100 a barrel not only pushed up the cost of shipping, but fed through into raw-materials costs for plastics and led to higher electricity rates.
All of that, in turn, pushed up Chinese domestic inflation to nearly 10% and food prices for staples such as pork by 45%. Workers demanded wage increases. A labour law, enacted this year, gave them rights and made unions stronger.
As the labour market evolved and internet usage rose, literate young migrant workers learnt of opportunities elsewhere and voted with their feet against the worst-managed factories in southern China – often those owned and operated by companies from Hong Kong, Taiwan and South Korea. Last year there were labour shortages in the southern provinces for the first time.
Two more factors raised costs for Chinese firms. Determined to drive out bottom-end manufacturers and move production up the value chain, the Chinese government cut tax rebates that had amounted to a 13% export subsidy. It worked so well that some local authorities are having to step in to bail out big employers.
The biggest blow to exporters was the rise of the Chinese yuan against the US dollar and currencies of other trading partners. Not long ago, £1 bought more than 15 yuan. Today sterling trades at about 12 yuan and the differentials are widening.
“Now the pound is weakening against the dollar I’m in the same situation the Chinese have been crying to me about all year – currency,” said the British buyer, who asked not to be named.
“When they had this problem we helped them out. But now it’s reversed, will they help us? No chance. If this attitude prevails, at the low end at any rate, China may start to price itself out of our market.”
The Chinese have their own tale of woe to tell. “The situation here is very severe,” said Zhang Handong, director of Zhejiang province’s foreign trade research centre. “Last year was disastrous. I estimate Zhejiang exporting companies lost 36 billion yuan (£3 billion) in profits.”
Zhejiang’s provincial government stepped in to save its “big dragon” exporter, Feiyue Group, a company with 5,000 employees and reputed to make almost half the world’s specialised stitching machines.
Zhang said Feiyue’s exports fell 44% when tax rebates were cut, the yuan rose and energy prices soared. It owed more than £80m to its bankers. “Local government intervened by ordering the bank not to call in the loan and to continue to extend credit,” said Zhang.
For Qing Yuan, general manager of the Haoxing textile mill, the story is one of profit margins in remorseless decline. “A couple of years ago I could make money with my eyes closed,” he lamented.
Some small firms, like the Buruoyi garment maker in the port of Ningbo, are offering a preferential exchange rate to keep their customers. “If we don’t, foreigners won’t buy our products,” said Xu Zhaolong, a sales manager.
In the first seven months of this year, 3,600 toymakers shut up shop in Guangdong, the export industry hub. Official figures show 67,000 small and medium firms reported losses in the first half of this year.
Planners in Beijing believe that although exporters may be suffering, China needs to become a more balanced economy in which domestic demand drives growth – something that America and other trade partners have urged for years.
The government has also cut corporate income tax to 25% from 31% this year in a sign of its friendliness to business.
While the macroeconomic theory sounds fine, few Chinese exporters and perhaps even fewer foreign customers comprehended how painful the adjustment process would be.
Competitors in southeast Asia have been quick to step in. Vietnam is emerging as China’s main rival for budget manufacturing, although its own growth pains this year include a currency crisis, a property crash and 20% inflation.
Thailand, the Philippines, Malaysia and Indonesia have all seen their competitive edge improve.
Uncertainty has ruined investor sentiment and led the Chinese stock markets to their lowest levels in 21 months. The Shanghai Composite Index has lost 46% of its value since its record high last year.
China’s state media spoke last week of “renewed fears over slower economic growth”. Yet before gloom turns into a real depression it is worth recalling that China achieved growth of more than 10% in the second quarter of this year.
Export growth slowed last month even though the country achieved yet another monthly record trade surplus of more than £16 billion.
“Exports growth decelerated but imports posted a much bigger slowdown as commodities prices and shipping rates slumped,” a Ministry of Commerce official told Xinhua, the state news agency.
The unnamed official gave a hint of how the Chinese government intended to manage the volatility by holding the currency steady. “This can help exports while giving no further incentives to imports,” he said.
But the authorities in Beijing are likely to discover it is easier to navigate a giant container ship round the channels off Hong Kong than to turn round a giant economy at full steam.
Lehman sale talks falter
Bankruptcy fears grow
Reuters
15 September 2008
Talks to sell Lehman Brothers Holdings have faltered, triggering concerns that the investment bank may be heading into bankruptcy.
Barclays Plc, which had appeared to be frontrunner to take over Lehman – excluding its toxic mortgage-related assets – said it pulled out of the bidding, as top bankers and regulators met for a third day to try to resolve the crisis.
The British bank withdrew because the US government wouldn't provide financial guarantees, according to a person familiar with the matter.
US Treasury Secretary Henry Paulson remains strongly opposed to using government money in any deal aimed at resolving the Lehman crisis, a source familiar with his thinking reiterated on Sunday.
In a sign that bankers and regulators were preparing for the worst, an emergency session opened on Sunday afternoon between dealers with Lehman Brothers counterparty risk, the International Swaps and Derivatives Association said.
The session was to run from 2pm to 4pm in New York and will involve credit, equity, rates, foreign exchange and commodity derivatives, the ISDA said in a statement.
The aim is to reduce risk associated with a potential bankruptcy filing by Lehman Brothers.
"Trades are contingent on a bankruptcy filing at or before 11.59pm New York time Sunday," ISDA said the statement. "If there is no filing, the trades cease to exist."
Lehman has been collapsing under the weight of toxic assets, mainly related to real-estate, that are now worth only a fraction of their original prices because of the credit crisis triggered by America's housing bust.
BALANCING ACT
The crisis at Lehman presents a delicate balancing act for Paulson and the Federal Reserve, who have urged Wall Street chiefs to come up with their own solution.
So far this year, the government has sponsored rescues of Lehman rival Bear Stearns and mortgage lenders Freddie Mac and Fannie Mae.
The authorities don't want to be accused of encouraging excessive risk-taking by bailing out another yet another investment bank.
But they also cannot afford to let a blow-up of Lehman paralyze the financial system and deepen the credit crisis.
Investors have said that if nothing is done by Monday, global financial markets could plunge.
Other financial firms that are weighed down by poorly performing real estate assets are under particular pressure.
Shares of brokerage Merrill Lynch> tumbled 12 percent on Friday, while those of insurer American International Group Inc fell more than 30 percent.
Shares of Washington Mutual Inc, the largest US savings and loan, have declined 80 percent this year.
All three companies have varying degrees of exposure to the mortgages and other toxic assets that were Lehman's undoing.
"Anyone else who has these toxic assets, if they haven't made a full confession, they better do it now," said Matt McCormick, portfolio manager at Bahl & Gaynor Investment Counsel in Cincinnati, Ohio, which has US$2.9 billion of assets under management.
"These assets may be hard to unwind, but they can unwind your firm. Lehman tried to deny reality until the bitter end."
Bankruptcy would mark an ignominious end to a once-proud firm, founded by cotton-trading German immigrants 158 years ago. It would also badly tarnish the reputation of CEO Dick Fuld, who has insisted that his firm could work through its problems to survive as an independent entity.
"BAD BANK"
One solution that has been considered is a hiving-off of Lehman's bad assets into a "bad bank", in which rivals would take stakes, people briefed on the matter said.
It wasn't immediately clear whether such a plan could be part of a bankruptcy filing.
Former Federal Reserve Chairman Alan Greenspan said on Sunday he suspected "we will see other major financial firms fail," but added that this did not need to be a problem.
"It depends on how it is handled and how the liquidations take place," Greenspan told the ABC program "This Week."
"And indeed we shouldn't try to protect every single institution. The ordinary course of financial change has winners and losers."
At Lehman's headquarters in midtown Manhattan, employees were coming and going throughout the day.
Some entered with what looked like empty duffel bags and gym bags and emerged an hour or so later with full bags.
Few agreed to be interviewed.
"For some people it's business as usual, but other people are worried about liquidation and that they won't have jobs," commented a man who said he worked in the investment banking division.
"Some people are upstairs and working on their projects. Others are worried that they'll be out of work and are packing up," said the man, who declined to give his name.
Security outside the Fed building where talks between banks and regulators over the crisis were continuing was even tighter on Sunday than on Saturday, with nine dark-blue federal government vans blocking the area around the entrance and security guards preventing reporters from getting close.
At 7:30am three bags of Dunkin' Donuts products were delivered. A caterer smoking outside said she had worked 15 hours the previous day and expected the same on Sunday, with strong coffee one of the biggest demands from the power brokers. "'Coffee, coffee, coffee,' they say, 'the strong stuff,'" said the caterer, who declined to be identified.
Fed Chairman Ben Bernanke remained in Washington but was in close contact with officials in New York and briefed fellow central bankers on Saturday by telephone about the talks.
The US Securities and Exchange Commission and the Fed have had conference calls with Lehman's counterparties in major markets to discuss the implications of various scenarios for the firm, a source familiar with the situation said.
SYSTEMIC ISSUE?
Some analysts have downplayed the impact of Lehman's woes on broader markets, arguing that signs of the bank's trouble have been emerging for weeks and that clients, banks and other market players have had ample time to limit their exposure.
"Lehman can fail and it won't pose a systemic issue. Anyone who bet that Lehman would be bailed out by government made a silly bet," said William Smith, CEO of Smith Asset Management.
The meetings with the CEOs of Wall Street's top banks were reminiscent of the 1998 bailout of hedge fund Long-Term Capital Management, two sources familiar with the situation said.
With LTCM, major banks each contributed to a US$3.65 billion bailout of the hedge fund, allowing it to be wound down in an orderly way.
This time may be different. The capital of many top banks is already strained by the credit crisis, making them reluctant to fork over funds to help Lehman, whose problems are largely a result of bad bets on the US mortgage market.
Also, while LTCM was a client of most Wall Street firms, Lehman is a competitor.
Lehman has hired law firm Weil Gotshal & Manges to prepare a potential bankruptcy filing, the Wall Street Journal reported on Saturday, citing a person familiar with the matter.
RATINGS PRESSURE
Dealers said late last week they were continuing to trade with Lehman, which has about US$46 billion of commercial and residential real estate on its books.
Although Lehman has reduced its leverage, or debt relative to assets, it still has about US$600 billion of assets supported by some US$30 billion of equity, meaning the value of its assets need only decline by 5 percent to make the bank worthless.
One key source of pressure on Lehman is its debt ratings.
All three rating agencies said ratings cuts for Lehman were a possibility, as confidence in the firm erodes.
A ratings cut would make it difficult for Lehman to compete in businesses such as long-term interest-rate derivatives.
Ratings downgrades could force the firm to post billions of dollars of additional collateral with its trading partners, further straining the bank's balance sheet.
Merrill Said to Discuss Merger With Bank of America
By Jonathan Keehner and Bradley Keoun
Sept. 14 (Bloomberg) -- Merrill Lynch & Co. is in merger talks with Bank of America Corp. after shares of the third- biggest U.S. securities firm fell by more than 35 percent last week and smaller rival Lehman Brothers Holdings Inc. neared bankruptcy, people with knowledge of the negotiations said.
Discussions about a potential transaction were proceeding after Bank of America, the biggest U.S. consumer bank, and Barclays Plc, the U.K.'s third-largest lender, abandoned talks to buy Lehman earlier today.
Merrill's board was considering a $29 a share offer, the Wall Street Journal reported, 70 percent more than Merrill's closing price of $17.05 in New York trading on Sept. 12. Such a deal would value the firm at more than $40 billion. The New York Times reported that Bank of America was in advanced talks to buy Merrill, which employs the largest U.S. brokerage force, for between $25 and $30 a share, citing people briefed on the negotiations.
Bank of America, based in Charlotte, North Carolina, has maintained its AA credit rating as other U.S. financial institutions, including Merrill, faced downgrades. Merrill's stock plunged last week after Oppenheimer & Co. analyst Meredith Whitney predicted a $6.87 billion third-quarter loss and investors speculated that New York-based Merrill may sink along with Lehman.
``A merger between Merrill and Bank of America is a good idea,'' said Richard Bove, an analyst at Ladenberg Thalmann & Co. in Lutz, Florida. ``If Lehman fails, the next bank to be attacked would be Merrill. They are attempting to forestall that attack by linking with Bank of America.''
Thain, Paulson, Geithner
Merrill spokeswoman Jessica Oppenheim declined to comment. ``We don't comment on speculation,'' said Bank of America spokesman Bob Stickler.
Merrill Chief Executive Officer John Thain, 53, was among the Wall Street chiefs who gathered the past three days for a series of meetings at the Federal Reserve Bank of New York to discuss a resolution for Lehman. U.S. Treasury Secretary Henry Paulson and New York Fed President Timothy Geithner summoned the executives to the weekend meetings.
Bank of America representatives skipped the initial sessions because the bank was bidding for Lehman.
Bank of America has rallied 82 percent since reaching a low on July 15. On Sept. 12, the shares climbed 68 cents, or 2.1 percent, to $33.74 in New York Stock Exchange composite trading.
Merrill shares fell 12 percent on Sept. 12 to $17.05, the first close below $20 a share in a decade.
Mervyn King warns: I’ll quit over No 10’s mortgage scheme
Bank of England governor threatens to resign if Brown forces through state-backed mortgages
By James Cusick, Westminster Editor
13 September 2008
THE GOVERNOR of the Bank of England, Mervyn King, has privately warned Downing Street that he will resign if Gordon Brown directs the bank to become the key agency in a state-backed mortgage guarantee system.
Transferring the risk of investing in mortgage-backed bonds from investors to the Treasury, a move that would see the government "underwriting" mortgage deals, is understood to be one of the key recommendations contained in the final report from Sir James Crosby, the former head of HBoS. Crosby was commissioned to look at new ways of reviving the UK's ailing mortgage market.
Sources say the Prime Minister believes a temporary guarantee system, with the government refinancing bonds every two or three years, could be the magic bullet that revives the housing market and Labour's political fortunes.
Crosby's full report - expected to be published before Alistair Darling gives his autumn pre-Budget assessment on Britain's economy - is already with the Chancellor. Despite Crosby backing state "under-writing" of mortgages, but backing away from a full-blown introduction of a UK version of the US Fanny Mae/Freddie Mack model, Treasury economists privately attacked the proposal as "unworkable" and "liable to prolong" the credit crunch. Darling is understood to have told Number 10 that such mortgages would be a burden that the government should not bring upon itself.
King told the parliamentary Treasury select committee last week what he has repeatedly been telling financial institutions: that any attempt to artificially support the mortgage market by the government is something a central bank should not be doing.
In private, King has let Number 10 know that he believes risk and reward is part of the market and underwriting mortgages is not something in which the Bank of England should do.
With Darling opposed to the introduction of state-backed mortgage guarantees, with his stance backed by King and leading figures at the Bank of England, the replacement of Darling in the expected Cabinet reshuffle will set alarms bells off in Threadneedle Street.
One Bank of England source said: "The governor has made his position crystal clear. It is not the purpose, nor should it be, of central bank liquidity insurance to provide a source of long-term funding to the financial system." Asked whether or not Number 10 knew that King's opposition amounts to a serious resignation threat, the source said: "Yes, they know and understand that."
Given the pressure that the Prime Minister is under to show his party and the country that he has a solution to get Britain out of the economic downturn, the resignation of King would be, according to one Treasury aide, "an economic catastrophe". He added: "The government's credibility would be shattered, leaving Brown and perhaps the new Chancellor in an economic no- man's land."
Equally worrying for Brown is that political dithering over the Crosby recommendations will not be welcomed by agencies at the centre of the housing crisis, such as the Home Builders' Federation (HBF).
The HBF says that the housing crisis is well advanced and that if there is no urgent action by the Treasury to improve market conditions then further damage to the economy can be expected.
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