The scuttlebutt from Tucker of the Bank

The exchange of emails between the bank of England's Paul Tucker and top civil servant, Jeremy Heywood, gives a fascinating insight into the hand-wringing going on during the fevered financial conditions of October, 2008.

And it could strengthen Tucker's position.

Remember, Lehman Brothers had collapsed the month before, opening a severe, new phase in the credit crunch: banks would avoid lending to each other if at all possible for fear of losing their money.

Then on 8th and 13th of October, The UK government had launched a dramatic rescue of the banking system, pumping money into RBS and Lloyds and making hundreds of billions of lending available, partly through a new Credit Guarantee Scheme.

There had been a bit of a recovery in interbank lending in the US, but not in sterling. Paul Tucker said "that's been true only of HSBC in sterling and one bank can't turn a whole market".

Jeremy Heywood was highly exercised about UK LIBOR, the cost of lending between UK banks, staying high. On 22nd October, he points to gossip or "scuttlebutt" that "Sterling 3 month LIBOR is high because Barclays are bidding it" and says there are lots of questions about what they are "up to".

This feeds into the current scandal about Barclays being fined £60m by the FSA for trying to rig the level of LIBOR during the financial crisis - and the suggestion that Tucker might have signalled to Bob Diamond of Barclays that it would be OK to submit artificially low quotes for the calculation of LIBOR, to help everyone calm down.

Two points about this...

1. The FSA's criticism largely concerned US Dollar LIBOR, not sterling LIBOR. They are two closely related, but different markets.

2. Barclays had an incentive to spew out high LIBOR quotes which suggests a new explanation for Tucker's comment (as reported by Diamond) that its LIBOR submissions didn't need to be "as high". This is the really interesting bit.

Crude interpretations of Diamond's contemporaneous note on his telephone conversation with Tucker on 29th October have alleged that the Bank of England man was giving the green light to Barclays to put in made-up, lower LIBOR submissions - giving a nod and a wink to fixing LIBOR.

But the Tucker/Heywood exchange concentrates on why Barclays might be quoting high. And it homes in on the new Credit Guarantee Scheme which the government had brought in to help banks raise money.

The crucial point to remember is that banks would pay well over the LIBOR rate to borrow under the CGS because there was a fee to pay for getting government help.

So there might have been an incentive for a bank like Barclays, which needed to borrow, to let it be known that it would pay above LIBOR for money. That way it might get hold of the funds at a discount to the CGS, without being seen as so desperate that it had to go cap in hand to the government.

Interbank lending had ground to a virtual halt, so LIBOR submissions had become pretty creative in any case. They didn't mean that banks were actually borrowing at those rates - just that if they did borrow, that would be the approriate level.

Seen against this background, Paul Tucker might well want to argue that his suggestion that Barclays "did not always need to be...as high" was simply pointing out that the bank was over-quoting to get ahead of the pack and avoid the ignominy of using the CGS.