Why did the Bank of England (BoE) buy UK government debt?

Why was the BoE firm on ending the purchasing operation as planned? Complex narrative simplified.

For the illustration purpose, consider the following scenario,

1. Sam will have to payback £20K debt that is due within days. Sam intends to sell his used car worth about £22K.

2. Unexpectedly, the used car market collapse and the revised dealer quote is £5K, the value is rapid falling towards "zero".

3. Sam has to make difficult choice, either sell it for £5K, make partial payment and restructure debt or default and file for bankruptcy.

4. Fortunately, Auto manufacturer association (AMA) intervene to stop price spiralling towards to zero. AMA announce used car purchase program from the market for 14 days. AMA is confident that market panic is temporary, the program will stabilize the market.

AMA's purchase guidelines

5. AMA is focussed on price discovery and avoiding moral hazard. if AMA buy at seller's quoted price, it will fuel uncontrollable inflation in the used car market, it will also end up inadvertently rewarding risk takers and penalizing prudent risk managers.

6. AMA announce that it will purchase up to 5000 cars a day in an auction but reserves the right to set maximum price.

7. Interestingly, auction volumes in the first 12 days is lower than expectation. The sellers are expecting AMA to extend auction beyond 14 days and expect them to buy at pre-crisis value or higher.

8. Remember, AMA is focussed on controlling inflation and avoiding moral hazard, they announce auction will end after 14 days as announced.

Sam's dilemma

9. AMA is willing to buy his car for £18K, £4K reduction in value. Sell car at £18K now or wait for few more days.

10. At best, the price recovers to £22K or higher but risk higher loss and bankruptcy.

State of play after 14 days

Not surprisingly, there was significant increase in auction volumes in the last 2 days.

Actors:

Used cars are UK Govt debt (gilts), AMA is BoE and Sam/sellers are pension funds.

To be continued....

Note: Views are personal and certainly not an investment advice. Article is oversimplified for educational purpose.

On a another note, the moral hazard of student loan forgiveness is playing out in US.

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