Summary:
Robert Peston on Sir James Crosby's assessment of the outlook for mortgage finance. Darling worried by risk that the chronic shortage of mortgage finance could lead house prices to fall much further and faster than would be warranted on the basis of notional economic fundamentals. Discusses the importance of MBS to mortgage lending and the UK economy. Consequences of the credit crunch: demand for MBS dried up; no cash for mortgage lending; only five or six banks still able to lend; lending more expensive; lending only to the most reliable borrowers; rising number of defaults; exacerbating house price fall and weakening consumer demand. Crosby's likely to recommend action. Either Bank of England becomes the market-maker of last resort for mortgage-backed bonds; or government guarantees, on commercial terms, billions of pounds of better quality tranches of new mortgage-backed securities (i.e. taxpayers underwriting a huge slug of the mortgage market). Significant risks to the health of the economy from doing nothing. (Published: 29/07/08)
Notes:
- Sir James Crosby, FSA
- assessment of the outlook for mortgage finance
- forecasting that a chronic shortage of mortgage finance for homebuyers and homeowners will continue throughout this year, 2009 and 2010
- importance of mortgage-backed securities (MBS)
- finance from the sale of MBS was equal to two-thirds of all net new mortgage lending in the UK by 2006
- total stock of UK MBS was a staggering £257bn out of total residential mortgages of £1200bn by end 2007
- equivalent to around a fifth of the value of the British economy
- consequences of the credit crunch (almost exactly one year ago)
- demand for MBS completely dried up
- still almost impossible for any bank to issue mortgage-backed securities
- no cash to meet even the current reduced demand for mortgages from homeowners who need to refinance their debts and from prospective homebuyers
- leading banks are expecting the net increase in mortgage lending to fall to £60bn in 2008, from £110bn last year and a similar amount in 2006
- drop of 45%
- shrinkage that reflects a collapse in mortgage approvals for house purchase
- banks also struggling both to raise other forms of wholesale funding and to extend the maturity of their existing debts
- squeeze on the money they have available for new mortgages is exacerbated by their obligation to repay around half of their existing mortgage-backed borrowings over the coming three years
- likely to be a rise in the number of mortgage holders who can't pay their debts
- mortgage finance is now only available to those with utterly reliable earnings and deposits equivalent to at least 25% of the value of what they want to borrow
- what little lending there is is now dominated by the UK's biggest five or six banks
- small banks and building societies making almost no new loans
- many mortgage intermediaries expected to disappear
- shortage of mortgage finance likely to exacerbate the fall in house prices and the weakness of consumer spending
- recommendations
- government needs to attempt to re-open the market for mortgage-backed securities
- to prevent the banks becoming so strapped for cash that the housing market would go from decline to meltdown
- two possibilities
- Bank of England becomes the market-maker of last resort for mortgage-backed bonds
- Bank agrees to lend to almost any financial or investment institution against the security of mortgage-backed bonds bought by the relevant institution
- Bank would be guaranteeing that if the market for such bonds were shut, it would make sure that the bonds did not become totally illiquid
- government guarantees, on commercial terms, billions of pounds of better quality tranches of new mortgage-backed securities
- i.e. taxpayer would be providing a promise that it would pick up the tab in the event that the value of of those securities was impaired by a huge rise in repayment difficulties or defaults by mortgage borrowers
- i.e. taxpayers underwriting a huge slug of the mortgage market
- other possibility: government should not intervene, on the basis that such intervention may create more difficulties than it would solve
- but: would be significant risks to the health of the economy from doing nothing
- Darling deeply troubled by the risk that the chronic shortage of mortgage finance could lead house prices to fall much further and faster than would be warranted on the basis of notional economic fundamentals
- wants to prevent house prices overshooting on the way down, just as they overshot on the way up, and thereby wreaking massive damage to the economy
