UK mortgage rescue plan could come next week -source

By Matt Falloon

LONDON (Reuters) - British authorities are working on a plan to break a lending squeeze gripping the home loan market and could announce details as early as next week, a source close to the situation said on Thursday.

Pressure has been growing on the government and the Bank of England to do more to resolve a mortgage debt crisis that is threatening to slam the brakes on the British economy. News of possible swift action lifted sterling and boosted bank shares.

Banks' fear that high-risk mortgage debt is lurking on balance sheets has driven the interest rates at which they lend to each other well above the BoE's 5 percent benchmark, in turn raising borrowing costs for households and companies.

The new plan is expected to allow banks to temporarily swap mortgage-backed securities for government bonds to help free up their balance sheets and allow them to lend more to consumers.

The package "could come as early as next week. We're working closely with the Bank of England on this," the source told Reuters, on condition of anonymity.

"This is a high priority but the important thing is that we get the details right and we're focusing on that."

Finance minister Alistair Darling is due to meet mortgage lenders next week on his return from a visit to China.

POLL WORRIES

Banks have warned lending could halve this year and, with elections due by May 2010, Prime Minister Gordon Brown's Labour government -- its popularity on the slide over its handling of the economy -- wants to ensure borrowers are not priced out of the market.

It is also desperate to stop another bank getting caught in the crunch after Northern Rock was nationalised this year.

A debt swap scheme, similar to one the United States announced last month, could make banks more willing to lend to each other at lower rates and could ultimately mean the BoE may not have to cut interest rates as aggressively as markets have been betting on. [BOE/INT]

"It should mean that some of those (banking) names become counterparties again rather than just names banks don't want to lend to," said ABN Amro strategist Jason Simpson.

"Libor (interbank lending rate) is a couple of basis points lower, so it's clearly already having a beneficial impact," Simpson said. Three-month sterling Libor eased to 5.90625 percent from 5.92438 percent.

Lehman Brothers estimated there was a 35 billion pound ($69.06 billion) overhang of mortgage loans that would have been securitised if the credit crisis had not hit last summer, and the plan might help ease concerns about this.

"Such a programme by itself might not re-open the primary RMBS market, but it is, in our view, a big step in the right direction," Lehman's analysts wrote in a note to clients.

However, they cautioned that the details of the plan would be vital.

For the plan to achieve its goals, they said it would need to have a relatively long term of one to three years, be larger than previous BoE cash injections of 10 to 15 billion pounds and give banks sufficient flexibility to gain access to cash -- while removing any stigma for using the programme.

Others were sceptical the plan would be enough to fix the credit crisis.

"It clearly alleviates the pressure but, if you look at what has happened in the United States and Europe, you can see that there is still a lot of tension in money markets. It doesn't solve everything," UBS credit strategist Geraud Charpin said.

SHARE PRICE BOOST

Banks have been toughening up their terms and raising loan rates for consumers even though official UK borrowing costs have fallen three times since December.

Consumer confidence has fallen to historic lows and house prices fell in March at their sharpest rate since the recession of the early 1990s.

Shares in UK banks, battered since the squeeze took hold last August, rose on hopes that the lending package would improve liquidity and ultimately profitability.

"What we thought could lead ultimately to rights issues may not be the case now, because what you have is some short-term relief that could be extending to the medium term," banking analyst Mamoun Tazi at MF Global said.

The Bank of England declined to comment and any proposals could be delayed while the details are finalised, in particular how to keep taxpayers from shouldering the burden of risk.

For a more technical story on how the scheme could function, please click on [nL17859538].

(Additional reporting by Clara Ferreira-Marques, Natalie Harrison, Richard Barley and the London Forex team; Editing by Ruth Pitchford)