Insuring Risky Investments – Central Bank Style

If you’ve thought that the recent decisions by central banks to bail out investors who gambled and lost on sub-prime mortgages was odd, you’re not alone. If you thought that the bailout flies in the face of all you’ve been taught about the power and sanctity of the market, you’ve got company. And that company is none other than Mervyn King, governor of the Bank of England – the same bank which was born around the time when wealthy Scots seeking greater engagement in the Trans-Atlantic Slave Trade and a toe hold in Panama lost their loot behind the Darien Scheme of William Paterson, and born again when gold was discovered in Africa in the 1880’s.

The Darien Scheme was authored by the same person who decided to loan the English government $1.2 million pounds in exchange for the “title” The Governor and Company of the Bank of England and the right to print and issue bank notes. Things have changed since then. Mervyn King does not preside over the printing of money. That function has been outsourced. He’s a monetary policy man and today, he is concerned about insurance. He is concerned about the kind of insurance which can only be issued after a risky investment has gone bad. He is concerned that the sanctity of the market (if it ever existed) will be overthrown by a regime of intervention.

From the morning’s New York Times:In an unusual public display of discord, the British central bank criticized other central banks yesterday for injecting cash into the financial system to help stabilize credit markets, saying that such a policy amounted to a bailout of investors who made bad decisions.

Mervyn King, the governor of the Bank of England, also hinted that the credit crisis could make further interest rate increases unnecessary — if the recent sharp increase in borrowing costs ended up hurting consumer demand. That, he said, would reduce the prospects of inflation, despite the run-up in the prices of a wide variety of commodities, including crude oil and wheat.

The main thrust of his written testimony to Parliament, however, was a sharp warning about “moral hazard” — a term used to describe the downside of policies that effectively rescue investors when their bets turn out wrong.

clipped from
The European Central Bank, which initiated the effort on Aug. 9, has added 250 billion euros ($348 billion) to the market, and yesterday it continued its effort by lending 75 billion euros ($104 billion) for three months. The Federal Reserve and the Japanese central bank have also added liquidity, and on Aug. 17 the Fed cut the rate at which it lends money directly to banks by a half-point.But the Bank of England has taken only a modest part in this effort, injecting �4.4 billion ($8.9 billion) into the system since the crisis began a month ago. Instead, it has reminded banks that they can always borrow at a “penalty rate” of one percentage point above a benchmark rate that is now 5.25 percent — a pointed message that those who speculate and lose have to pay some price.
Over the last month, as investors refused to buy securities backed by potentially shaky American mortgages, the world’s central banks have stepped in to provide short-term lending capability to the financial system.

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