The central banks are at it again

Yes, yet another attempt to "stabilise financial markets" is under way. The world's central banks are again coordinating a another major liquidity injection; the third one since August.

These stabilisation efforts appear to be getting more desperate. Something is wrong with the our banks. Underneath those balance sheets there is something rotting and festering. Fear and panic has now gripped the world's central banks and cash is now flowing into the financial system in an effort to cover the putrid smell.

This is how the Bank of England announced today's efforts:

"Since the co-ordinated actions taken in December 2007, the G-10 central banks have continued to work together closely and to consult regularly on liquidity pressures in funding markets. Pressures in some of these markets have recently increased again. We all continue to work together and will take appropriate steps to address those liquidity pressures."

Over in the States, the Fed is thinking big. It announced a new lending facility:

"Under this new Term Securities Lending Facility (TSLF), the Federal Reserve will lend up to $200 billion of Treasury securities to primary dealers secured for a term of 28 days (rather than overnight, as in the existing program) by a pledge of other securities, including federal agency debt, federal agency residential-mortgage-backed securities (MBS), and non-agency AAA/Aaa-rated private-label residential MBS."

Similar announcements were made by the ECB and the Swiss central bank. However, the problem here is solvency not liquidity. Banks around the OECD have tangled themselves up an a massive housing bubble, and now it is all going south. Bank balance sheets are beginning to deteriorate.

There is a simple inescapable truth behind this crisis. If someone defaults on a loan, the loss must show up somewhere. At the moment, that "somewhere" is the balance sheets of commercial banks.

Over the last few months, banks, particularly the big ones on Wall Street, have begun telling central banks that these losses are becoming unbearable. So, the central banks are now moving those losses from the commercial banks and unto the government's balance sheet.

These liquidity injections are the mechanism by which these banking losses will be nationalized. Strip away the weird acronyms, and the operation amounts to a simple exchange. The central banks hand out cash and in return, it receives a rotten mortgage backed security. What is behind this MBS? Why, it is a bundle of bad housing loans, which are ultimately claims on borrowers houses.

There is a strange irony here. For years, successive governments in the US and UK pushed the idea of home ownership. Public policy aimed at building up home ownership at the expense other priorities. For example, in the US, mortgage interest is deductible, while income used to pay rent was fully taxable. The financial sectors in both countries were liberalized; thus setting off a chain of events that led directly to the crisis we see today.

The UK experience is particularly galling. During the Thatcher years, billions of pounds of public assets - council houses - were privatized on the cheap. Tax payers money build those houses, and when they were sold, there was a massive transfer of wealth from the state to private individuals. Then the banking system financed a massive bubble; it is now collapsing and the state is stepping in and buying up claims on houses. With Northern Rock alone, the state pumped in £30 billion and guaranteed a further £70 billion.

So public ownership of housing is back, proving my dear old grandma right once again. As she always says: "What goes around, comes around".