Bank of England swapped frozen mortgages for gilts and kept the risk with banks

When asset-backed securities markets closed in late 2007, UK banks were stuck with an overhang of mortgage securities they could neither sell nor pledge. After the collapse of Bear Stearns in early 2008, the Bank of England concluded that this overhang itself was blocking interbank lending and launched the Special Liquidity Scheme on 21 April 2008.

The design was a swap, not a purchase: banks exchanged high-quality legacy mortgage securities, created before 31 December 2007, for UK Treasury bills, paying a fee, accepting haircuts, and for up to three years. Credit risk stayed with the banks and their shareholders; the Bank provided liquidity, and initial use was expected around £50 billion.

Because Treasury bills are almost risk-free and easily traded, banks could fund themselves again and lend to each other. The drawdown window was extended to January 2009 after Lehman Brothers failed, and the last swaps expired in January 2012, by which time the scheme's principles had shaped the Bank's permanent liquidity facilities.

Swap the illiquid for liquid; keep the risk with banks

A swap rather than a sale let banks avoid dumping assets at fire-sale prices.

Keeping credit risk with the banks prevented a taxpayer bailout of losses.

Liquid Treasury bills restored interbank confidence immediately.

A three-year maturity gave banks time to strengthen their balance sheets.

When markets close, do not buy the frozen assets — lend liquidity against them temporarily; keeping losses with their owners preserves discipline while unfreezing the system.

The SLS principles — collateral swaps, haircuts, risk left with the private sector — carried directly into the Bank's later liquidity insurance facilities and the 2012 Funding for Lending Scheme.