How the Bank of England made £62bn 'disappear'

How easy is it to hide £62 billion? That is the question that has been flummoxing the City today. For it transpires that last autumn, to the almost complete ignorance of most of the City (and, I admit, most of the journalists who, like myself, keep a pretty close eye on the UK economy), the Bank of England lent a staggering amount of cash to Royal Bank of Scotland and HBOS.

I was dumbfounded when I found out. Not because there was any surprise about RBS or HBOS needing the cash – we know now from the fact that they had to be semi-nationalised. In the event, as Paul Tucker admitted at the Treasury Select Committee, the £61.6bn (it was actually a moving sum, and peaked at this level around 17 October) was only good to buy them time, in HBOS’s case for a snap merger, in RBS’s for nationalisation. We knew that they and most of the other British banks were in dire straits.

No, the reason I was surprised is that it ought not to be so easy to hide such an enormous loan from the general public. This was not merely my conclusion: the Northern Rock episode (with the details of its emergency loan being leaked to the BBC) had convinced some in authority, and some in the Bank, that it was nigh on impossible to get away with a properly covert lender of last resort operation in the modern world, with 24 hour news, markets that are extremely sophisticated and a democracy that demands instant disclosure. How wrong we all were.

This is an important issue for all of us. For a period of time in late ‘08 and early ‘09, British taxpayers’ cash was at a significant risk (although the money lent out by the Bank was not backed up by its own debt so this was rather more like quantitative easing than Government debt). But hardly anyone in Government, Parliament, the City or the general public had a clue. For the conspiracy theorists out there this information will prove extremely worrying (or exciting, depending on whether these things make you tick).

But none of this answers the question of how the Bank managed to keep the details a secret. Although those I have spoken to about it today are painfully tight-lipped about the whole thing (as one would expect), I have a few hunches about where they squirrelled away these numbers.

The first thing to remember that in the wake of the Northern Rock fiasco the Government enacted a number of laws which allowed the Bank to withhold certain information about the constitutent parts of its balance sheet if it judged that this would help it improve financial stability. This meant that it could legally be rather more discrete about where in the balance sheet these sums would show up. However, as it pointed out in its Annual Report last year, it is still obliged to disclose the overall picture of its balance sheet, and this would not be complete without including the £61.6bn of cash it lent to these two banks. The money could not simply disappear into a black hole of its own making.The first thing to remember that in the wake of the Northern Rock fiasco the Government enacted a number of laws

The likelihood instead is that it was helped in its effort to disguise the cash by the fact that there was an awful lot else going on with its balance sheet at that particular time. Whereas Northern Rock occurred before the crisis had reached a fever pitch, these loans happened when central banks around the world were doing everything they could to stem the pain in financial markets. Among those measures were special currency swap operations in which the Bank swapped cash with the Federal Reserve and the European Central Bank. These operations helped swell the Bank’s balance sheet.

In order to hide the emergency loan, all it had to do was, when printing the details of its balance sheet, to plop the loans in the same category as these currency swaps. Voila, no-one could be sure that all that fizzing in the Bank’s accounts wasn’t just due to those volatile currency swaps.

You can see the results in these graphs, which show the make-up of the balance sheet in recent years.

I’ve used my elementary Photoshop skills to add those blue lines that mark where the emergency loans for the banks began and ended. Look at the right hand graph – the assets side of the balance sheet – and in particular the purple bit that denotes “other assets”. That includes the currency swaps and, according to Simon Ward of Henderson (the City’s big expert on these complex central bank balance sheets), most likely the emergency loans as well. And, indeed, note how there is a pretty big bulge between October 08 and late January 09 – the precise period when the loans were being issued.

So the answer is that hiding this much money is actually pretty damn easy when there’s all manner of financial chaos going on. It is a finding that will definitely cheer the Bank of England, which rather likes the idea that it can step in and save a bank without anyone finding out and causing another Northern Rock. Not that RBS or HBOS ended up in a much better state in the end, but that’s another story.

Incidentally, as a footnote I should add that this deduction is the author’s own and not from the Bank of England themselves: they have been as evasive as possible when it comes to this, which given the circumstances is pretty understandable.