Fresh from preliminary lab testing, the Bank of England has unleashed a powerful new anti-subprime tool, the Special Liquidity Scheme. Here’s how it works: you bring in your mortgage-backed securities (or, as we understand it, any toxic anything you can find lying around), the bank puts them through a giant meat-grinder, and out comes a pile of shiny-new government bonds. This is for a limited time only, so hurry to your local BOE window with whatever you’ve got. Act now and they’ll also accept old shoes, oil drums, Russian nuclear waste, day-old bagels and the gum you just scraped off the bottom of your shoe this morning. Bond supplies are capped at $100 billion, so, just like happy-meal toys, they won’t last. But why let Bernans have all the fun?

The Bank of England Monday launched a plan to allow banks to temporarily swap £50 billion ($100 billion) of mortgage-backed and other securities for U.K. Treasury bills, in a bid to ease the current credit crunch.

The central bank said that by tackling an overhang of assets on bank balance sheets, the plan should improve the liquidity of the banking system and increase confidence in financial markets. It said that financial markets aren't working normally and that failure to intervene in this way would risk a wider impact on the U.K. economy. (Read the bank's statement here).

The central bank said that the swaps will last for one year but be renewable for up to three years and that the risk of losses on the securities will remain with the banks. It said the swaps will be available only for assets in existence at the end of 2007.

The bank will swap bills for a range of high-quality assets including AAA-rated securities backed by U.K. and European residential mortgages. The BOE will be supplied with the bills by the Debt Management Office, an agency of the Treasury. It said that haircuts, or the discount charged for riskier assets, would be determined by the value of those assets. In each case, it will determine the necessary margin between the value of bills borrowed and the value of assets required as collateral.

As the Bank of England prepares to quickly take on banks' securities, U.K. banks are expected to raise tens of billions of pounds in capital and also increase write-downs in coming weeks. The write-downs are expected to put United Kingdom banks more in line with U.S. banks, which have been more aggressive in discounting securities that have seen their value evaporate during the credit crisis.

Prime Minister Gordon Brown has said that any measures to unclog the mortgage market would have to be matched by better bank disclosure of losses. The goal of both the government and banks is to jump-start corporate lending and reignite funding for consumers at a time when some banks have sharply cut their mortgage businesses.

Royal Bank of Scotland Group PLC is expected to lead the way. On Tuesday, Chief Executive Fred Goodwin is expected to announce that the bank plans to pitch a £10 billion stock issuance to investors and also write down as much as £7 billion. Monday, RBS issued a brief statement confirming that it is considering a rights issue, but offered no further details. Merrill Lynch & Co., Goldman Sachs Group Inc. and UBS AG tentatively are set to handle the stock sale, according to a person familiar with the situation.

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