The FT and Guardian yesterday finally caught up with the huge bill the taxpayer faces to indemnify Bank of England for losses on Covid-linked pandemic debt. Well, only five months late to wake up to ‘The Worst Blunder in UK Financial History’. And only three months after the Daily Telegraph discovered the problem.
And even then, I expect none of them have actually got the story quite right, almost certainly because the officials who they’ve been talking to have been slightly economical with the truth.
This was a problem earlier with the Telegraph story back in end-April, which implied this these losses were merely a ‘paper problem’, when in fact during the first four months of the year, Britain’s public sector net borrowing cam to £48.4bn, and the indemnity alone accounted for £19bn of that - ie, 39% of the deficit.
The issue with yesterday;s story was different. Some of you may be wondering why the losses were revised 'up' £50bn to £150bn only, when previously, the Bank of England had estimated the losses of up to £200bn?
What happened to the other £100bn, seemingly missing from the calculations? Was the initial Bank of England estimate, which I picked up on back in March, wrong? Or was yesterday's news story wrong?
The most likely explanation for the missing c£100bn in losses is that the c£150bn expected losses are 'mark to market' losses on the £824bn in government bonds BoE holds in its Asset Purchase Facility. Since they were mostly bought between 2Q20 and 4Q21, we can make a guess that they carrying coupon of around 0.5%, whilst current 10yr yields have risen to 4.25%. I can certainly imagine £150bn in ‘paper losses’ in market value on those bonds.
But what that ‘losses’ calculation does not include are the funding costs of holding the position. That bond portfolio, after all, has to be funded somehow, and the way it is funded is not primarily through issuing banknotes (£86bn only in circulation), but rather by the £874bn of reserves deposited by Britain's commercial banks in Bank of England. If those reserves fled, Bank of England’s balance sheet would be a smoking nuclear ruin.
So how much does BoE pay on those reserves balances? It pays Bank Rate, which currently stands at 5%. So roughly speaking, over the year, they'll be paying out around £44bn on reserves balances to fund a £824bn stack of government bonds from which they received around £4bn in interest. So there's a loss on interest earnings, and my guess is this runs to around £40bn a year. Every time Bank Rate goes up, so does the funding loss. Two and a half years of funding losses at that rate restores the 'missing' £100bn in losses the taxpayer has to fund.
So most probably, the full loss both on market value and negative interest income has probably risen to around . . . . well, the calculations are not difficult. Paying those losses, though, is: they are a massive albatross around the neck of Britain’s finances.
With luck they won’t be quite big enough to establish a doom loop in which the deterioration in Britain’s finances is driven by the need to pay the losses, which in turn forces up interest rates, which generates even bigger losses. . . .
Fingers crossed.
I read once that £$many trillions lie offshore lacking the incentive to launder for a good return.
Talk of £400 billion for Covid. A lot was peed against the wall at lockdown BBQs and must represent a lot of tax income. People shopped in supermarkets and online. Most of that circulated, paying van drivers and the delivery system, never mind the VAT returns.
My question is, if you make people rich they must spend it somewhere. Make investment attractive and the flow reverses, the jobs accrue and tax and VAT income goes up. If only we had governments who realise such basic economics.