An excellent idea

No, really, I think this is a great idea.

Willem Buiter, a founding member of the Bank's Monetary Policy Committee and now a professor at the London School of Economics, has proposed two Government-led solutions.

The first involves a temporary socialisation of the interbank market. The central bank becomes the universal counterparty - meaning banks lend to and borrow from only the central bank.

In the short term it would have to be the central bank of course. In the longer term, well, a slightly different structure could be built.

But I think that Buiter's hit the nail squarely there. The current problem is the counterparty risk, the thought that the borrower might go bust. Remove that risk and liquidity will flow again.

Before anyone goes mental over this idea though, say, the socialisation of banking, it's not actually that odd an idea. We do it in other financial markets all the time. LIFFE is the counterparty in all those futures and options deals. You don't have to worry about charging Joe Bloggs Trading Limited a higher price than Citibank because of the different liklihoods of default. That's what the cetralised exchange is there to do.

Similarly with the Stock Market, the London Metals Exchange, Lloyds' insurance market and so on. Counterparty risk is carried by the market itself. So why not in interbank lending?  

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