Fed lessons for the BoE

The fire sale of Bear Stearns to JP Morgan has some clear implications for UK regulators and investors, most notably the value of acting fast and decisively in a crisis.

If a financial stalwart like Bear, despite the approximately $US15 billion cash on its books last week, can get caught in a liquidity trap so quickly, big London banks might not prove any less vulnerable.

That would test the mettle of the UK Treasury, the Bank of England, and the Financial Services Authority, and their revamped crisis-management procedures after the sluggish way they dealt with the crisis at Northern Rock last September that led to its nationalisation five months later. In contrast, the Federal Reserve wrapped up the sale of Bear over the weekend.

The UK banks in the spotlight now are the usual suspects, already subject to much rumour about their financial health during the credit crunch. Those worries are illustrated in the exaggerated fall of their share prices on Monday.

Alliance & Leicester underperformed the Euro Stoxx Banks index by 6.5 per cent during trading Monday, HBOS by 6 per cent, and Bradford & Bingley by 3 per cent. All three are relatively heavily exposed to mortgage lending and funding from the wholesale market.

But there's no reason to believe any these banks are in trouble. It's just that if investors' perception of Bear's lack of liquidity can become reality so quickly, it could happen elsewhere.

The Fed determined that a quick intervention was needed to preserve the stability of the financial system and pushed though the sale of Bear in days, something the Bank of England wanted to do at Northern Rock but couldn't pull off.

Another repercussion for the UK is the heightened nervousness of financial institutions which continue to prove so reluctant to do business with each other, despite the extra liquidity on offer from the Bank of England. Libor jumped to 5.6 per cent from 5.3 per cent on Friday, above the Bank of England's benchmark of 5.25 per cent. It's since settled back to 5.35 per cent as the central bank provided extra liquidity.

That's still not a good sign for anything but a slow return to more normal conditions in the interbank market and ominous for earnings in the financial sector.