A scheme to ring-fence toxic assets on individual banks’ balance sheets and insure them against default looks set to be the centrepiece of the latest bank bailout - which could be announced as early as tomorrow*. Read more about it here.

This has the advantage that bad loans would not have to be marked to market. That would not have been the case under the more generic “bad bank” idea, which would have meant all banks tipping their toxic debt into a single which the government would then have to value.

But wouldn’t this undermine Gordon Brown’s claim - in an interview with the FT on Friday - that banks must admit how many “toxic assets” they have on their balance sheets?

Mr Brown said the banks had to “come clean” about these bad debts:

“One of the necessary elements for the next stage is for people to have a clear understanding that bad assets have been written off. We have got to be clear that where we have got clearly bad assets, I expect them to be dealt with.”

What exactly does he mean?

* Other elements are likely to include

1] Letting banks exchange punitive preference shares (at 12 per cent coupons) for government equity. This could be resisted by Lloyds as it would push the government stake over 50 per cent. RBS, which is already majority-owned by taxpayers, would probably accept

2] Implementing the Crosby report. This means giving government guarantees (perhaps for a small fee) on mortgage-backed securities. In theory the move would loosen up the log-jammed MBS market and enable a boost to mortgage lending.

3] Put billions of pounds into Northern Rock and alter its remit. Instead of the lender being wound down it would be expected to increase its loan book.

January 18, 2009 12:43pm in Bank of England, Banks, Treasury, UK economy | Comment