Last Wednesday, the Bank of England held the first of four auctions aimed at providing funds at three-month maturity. The auction was for GBP10 billion ($20.15 billion). Despite lingering questions about the bank's motivation, phone lines for bidders opened at 11 a.m. GMT sharp and closed promptly at 11:30.

Zero bidders came to the auction, the bank reported. However, it wasn't the range of product on offer that led to such an inauspicious start to the bank's emergency market relief; rather, it was the current unwillingness of lending institutions to be linked to the BoE.

In fact, banks and building societies that have reserve accounts or access to standing facilities at the BoE are permitted access to the funding. Also on offer was a wide range of collateral, including mortgage product and marketable debt securities, such as covered bonds and commercial paper.

"At this point, no lending facility wants to associate itself with a Bank of England auction," said one market source. "Even with the Bank of England's pledge to protect the privacy of bidders, it could prove detrimental if word got out that bidders were doing what is becoming seen as bailout business, under the current circumstances."

But perhaps even more telling were the rates set by the bank, which created somewhat of a paradox. On the one hand, the Bank of England has opened this unprecedented auction to alleviate liquidity constraints on the longer-maturity money markets, but the bank set its rate at 6.75% for the upcoming auctions, whereas before the announcement the market was trading at 6.55%.

"It seems as though the bank is moving towards the approach of the [Federal Reserve] and the [European Central Bank], but this floor on rates is confusing and does not at a first glance seem to provide a way to get three-month rates down," reported Brian Hilliard, an economist at Societe Generale. "In effect, the bank seems to be saying that it is making sure that funds are available at longer maturities but still wants to make it costly. It can then feel that it is still pursuing the line that moral hazard must have a cost."

Whatever the BoE tries to do seems to be generally criticized. Initially, the bank was branded by the British mainstream press as too slow to come to the market's aid. Now, its solutions are viewed as being too greedy in time of need.

The Bank of England expanded its list of eligible collateral for upcoming auctions to include: debt securities issued by Freddie Mac, Fannie Mae or the Federal Housing Authority; U.K. and European Economic Area (EEA) RMBS bonds rated double-A minus or higher; U.K. and EEA covered bonds rated triple-A; credit card-backed triple-A-rated tranches from the U.K., U.S. or EEA; single-name corporate commercial paper and senior corporate bonds rated single-A

or higher.

Even with the unfavorable rates, the repo arrangement is sure to stimulate bank buying for those looking to buying cheap ABS and MBS, but with only GBP10 billion available, there is not sufficient liquidity to curb some of the liquidations the market is seeing, said Royal Bank of Scotland analysts.

"With a GBP10 billion auction for three-month term, followed by three subsequent ones, this facility provides some expensive funding, but funding nonetheless, for banks potentially through to December," said analysts at the bank. "We expect that the facility could be extended if market conditions warrant, but nothing was mentioned in the release from the Bank of England."

Beyond the rate dispute, one other question lingering in the market is why the Bank of England took so long to throw the market its lifeline? Analysts suggest that if the bank had announced its repo auction even a week earlier, it would have curbed some of the problems that Northern Rock faced.

The bank could still revisit the question of rates. "Of course, one way to make this process achieve the objective of easing the strains or distortions at the longer maturities would be to cut the rate on the standing lending facility before the repos are held," said SocGen's Hilliard. "That would then reduce the floor rate on the repos and help to bring down three-month Libor."

On announcing its intentions to deliver the repo auction, traders reported a relief rally in the interbank and ABCP markets, with broader credit and equity indices also posting solid gains.

(c) 2007 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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