“I may yet recommend that the Government should not intervene in the market, on the grounds that such intervention would create more problems than it would solve” concluded Sir James Crosby in his letter to the chancellor yesterday, accompanying his report on mortgage finance.
The much awaited, and much discussed, interim analysis on mortgage finance from Sir James Crosby was published yesterday. “In my opinion,” said Sir James in the accompanying letter, the shortage of mortgage finance “will persist throughout 2008, 2009 and 2010, and I suspect that current forecasts for net new mortgage lending during this period will prove optimistic, perhaps significantly so.”
And in a nutshell that is it. The lack of mortgage finance will persist for some time, it may be that the government should just sit back and do nothing.
The report pulled no punches against the mortgage intermediaries either. “Faced with much lower volumes and lenders switching back to distributing through their branches, mortgage intermediaries, hitherto an important source of price competition on behalf of consumers, are under intense pressure and many will disappear.”
Sir James explained that by 2006 mortgage-backed securities had grown so rapidly that “such funding equated to around two thirds of net new mortgage lending in the UK. By the end of last [year] mortgage-backed securities were worth no less than £257bn.” To put that in context, total residential mortgages were worth £1200bn.
Banks can create credit. They have never been restricted to lending based solely on the amount of money their customers have deposited with them. But the new capital adequacy rules (Basel II) have in any case restricted their ability in this regard. Sir James said the new International Accounting Standards will force banks to operate with less leverage in their balance sheets.
So banks must adjust to lower leverage, and this, said Sir James, “will take years rather than months.”
Lenders are charging more for risk. This will have the effect of increasing their margins, and compensating the banks for any write-downs they may incur. “I expect,” said Sir James, “that the increase in prices will more than compensate banks for higher credit losses.”
“In the meantime, it is hard to see why banks will increase their currently depressed appetites for risk. While there is still good availability of finance for those borrowers who offer significant security (i.e. have reliable earnings and seek to borrow 75 per cent or less of the value of their property), the availability of finance to all other consumers is considerably reduced and likely to remain so.”
As house prices fall, presumably credit will become even more scarce. And on this Sir James said: “It is impossible to separate the effects of a shortage of mortgage finance from a correction in the housing market. Nor can anyone identify its effect on consumer spending with any precision. However, my discussions have identified a broad consensus that such a significant and prolonged shortage of mortgage finance must take its toll of both. That this is indeed the case is most obviously evident from the unprecedented reduction in housing starts we are likely to see this year.”
So that’s pretty damming stuff. What can be done about it?
“Banks and their trade bodies, notably the Council of Mortgage Lenders and the European Securitisation Forum, are looking at a number of ideas to stimulate the demand for mortgage backed securities. We will continue to engage closely with them on that work.” Ummm, so that means he is still thinking about it.
He added: “Much has been said about the case for launching a US-style agency but I think it unlikely that it would be right to tackle this century’s problems with last century’s solution. In any case it would take far too long to create any such agency.”
When the mortgage markets grew too rapidly and house prices were shooting up, the government did nothing. Now house prices are falling to a level that will ultimately make them affordable among first-time buyers, all we hear about is how the government needs to take action.
In other words, when a booming property market boosts bank profits and engenders an unsustainable boom, government intervention is a bad thing. When banks pay the price for their mistakes, and first-time buyers begin to think that within a year or two they may actually be able to afford to buy, we are told the government needs to act.
Sir James Crosby is right to be so reluctant to recommend some kind of a government-led bail out.
But, in the end, the banks will still be the winners. They will eventually have their cake and eat it.
They will, as Sir James pointed out, claw their money back through higher pricing of risk.
And yet, the case for government interference has not gone away altogether.
As has been pointed out here before, when prices are too high, it is easy to get credit. It’s the wrong way round, but that’s the way of the world.
The danger is that when prices fall to levels that do appear to be sustainable, banks are likely to be less willing than ever to stump up cash. They will be terrified that house prices will fall even further, and in the process, funds could dry up by even more.
That will be the ultimate lesson from this saga. Banks are run by humans, and just like humans they exaggerate the cycle, and make it more extreme than it needs to be. When prices are booming they jump on and push them too high. When they are falling they jump off and push them too low.
The housing market needs to be allowed to correct. But when the excesses of the last few years have been corrected, then, and only then, will it be appropriate for the government to step in. That time is not now.
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