December 1, 2008 | posted by Michael Baxter in Banking, House prices |

Alistair Darling was pleased this morning. As you know, these days Mr D owns a bank. To be precise, we all own a 57.9 per cent stake in RBS. This morning, our bank did as it was told.

RBS has now agreed to provide its mortgage borrowers with six months’ worth of grace if they fall behind with their mortgages.

At last we are seeing banks wake up to a bit of reality – they can now see what most of us felt was blindingly obvious for some time.

It is one of those occasions when an analogy with football seems rather apt. It seems there is a talent that great footballers must have, which is not quite so obvious. Sure, they must have good ball control, pace, fitness and determination, but they all need to have a knack for reading the game – for a kind of positional sense, which comes with an understanding of the wider rhythm of the game. The player who does that runs off with the ball, and in the process takes a couple of defenders with him, and creates a space for someone else. The great football player can read the game.

In business, however, it often seems that we tend to forget that we don’t work in isolation. In a particular industry, if demand exceeds supply, new companies will enter the market, existing companies operating in the sector will up production – before you know it, supply has exceeded demand.

Companies tend to react to the same circumstances in the same way.

In his book Origin of Wealth, Eric Beinhocker told the story well. In his story, you are a manager working for a large maker of, say, widgets, and you obtain market intelligence suggesting demand is set to surge. So, you make your presentation to the board, get additional investment agreed, and production is upped. For a while, you are the company’s star, and then it all goes pear shaped, you just can’t sell all the widgets you produce. Production is cut back, job losses mount, profits turn to losses. Then some time later at an industry exhibition, you meet up with your peers working in competition. After mutually all agreeing how tough times are, you discover they all saw the same intelligence, and consequently upped production in tandem.

A few years later, your firm acquires another piece of intelligence suggesting demand is set to surge. Has the company learned its lesson by now, does it avoid the mistakes of the previous cycle? It doesn’t, and it doesn’t because you lost your job in the last round of job cuts, your successor was recruited from outside the industry, and she repeats the same mistakes you made.

If you get behind with your mortgage, it may well make sense for your bank to start taking legal steps to take possession of the property pretty quickly. But it makes no sense if there is a sudden surge in the number of people behind with their mortgages – if banks start possessing properties in tandem, there will be a rush of properties coming on to the market, house prices will fall, and the banks will find it to be less likely that the properties they sell will cover the size of the mortgages they are secured against.

That is surely why Stephen Hester, the new boss at RBS said: “We need to recognise our customers’ needs and fulfil them where we can. Not because of any moral pressure – although we understand it – but because it makes commercial sense.”

One assumes other banks will follow suit – Northern Rock, which is of course another bank we own, has come under all kinds of flak for repossessing properties. They will almost certainly follow RBS’s lead. No doubt HBOS will follow, too.

Alistair Darling seems to be cock-a-hoop over it all. A Treasury secretary said: “Alistair Darling is very pleased with this. It was done without legislation, just pressure from us. We want to avoid repossessions at all costs.”

To be honest, it does make sense, although, a lot depends on how the banks manage this. If they insist that mortgage holders who have fallen behind catch up quite rapidly, then they are merely pushing the problems further forward. If, on the other hand, they just extend the timeframe over which the mortgage is paid, or simply add the debt on to the total size of the mortgage, so that the cost of repaying the missing six months is amortised over, say, 20 years, then really this is something of a win–win situation.

Of course, it is bad news if, even after six months, those behind still can’t pay their mortgage, but it does seem likely that on a national scale the money saved via unnecessary repossessions, will be greater than the money lost through the banks being too sympathetic.

Is there a downside to this? Well, yes, there is, but it is difficult to know what can be done about it.

The truth is, the sooner house prices reach bottom, so that the recovery can begin, the better. The big problem in Japan 18 years ago, was the protracted period over which asset prices fell.

True, it is a good move from RBS. It makes sense for them, and it is morally the right thing to do, but in the long-term, it is doubtful whether the move will help the housing market, or accelerate the timing of an eventual recovery.