No more nice guy

Globally there is little evidence that the inter-bank lending market has improved as a result of the latest central bank interventions. Banks remain nervous about lending to each other because of fears about solvency. All banks view each other with suspicion. Hoarding capital and boosting reserves has been one way of building financial strength – but this has had the effect of draining money from the market. And because of the fears about solvency, the LIBOR rate, the charge on inter-bank loans, remains high.

In the UK, the Bank of England announced its special liquidity scheme on 21 April. Under the scheme institutions can now swap high quality but currently illiquid collateral, including mortgage backed securities for highly liquid Treasury bills, from the debt management office. This scheme is open for six months and the asset swaps will be for a year, but renewable up to three years (the scheme will close in October 2011).

Initially £50 billion has been made available but the total is open-ended and some suggest it will go higher to more than £80 billion. Because the bills are for less than a year and the scheme is ring-fenced and not part of the Bank’s money market role, this lending does not count as public debt. The scheme is restricted to organisations with deposits of more than £500 million and swaps can only involve assets created before 31 December 2007.

The Bank was clear that this scheme was designed to strengthen the financial position of the banks and building societies. Despite what some in government and elsewhere suggested, it was not aimed at helping the mortgage market – although there was hope that a reduction in rates might follow the move.

But there is no evidence so far of a reduced LIBOR rate. Part of this may be down to the Financial Services Authority (FSA), which has been telling lenders to strengthen their balance sheets. While some are issuing more shares to do this, others are hoarding cash. So while the Bank is putting more money into the system, the FSA is telling firms to build up their reserves and the government is telling us efforts are being made to reinvigorate the mortgage market.

Bank governor Mervyn King then added to the pressure when releasing the May inflation report. ‘The NICE decade is behind us, the credit cycle has turned, commodity prices are rising. We are travelling along a bumpy road as the economy rebalances,’ he declared. (NICE is non-inflationary continuous expansion and it is no more, at least for a period).

King made it clear that there was little likelihood of the further rate cuts the market had been expecting, with the result that the three-month LIBOR rose again sharply. It has been suggested we have now moved from NICE to VILE – volatile inflation and less expansionary.

There is no doubt that the finance market remains dysfunctional. But there have been some glimmers of light. HBOS completed the first mortgage securitisation since the credit markets seized up in August last year. It raised £500 million at 85 basis points above LIBOR – 6.7 per cent. Before the credit crisis, securitisations cost the issuer about 10 basis points over LIBOR, which was close to base rate. Instead of the 10 to 20 basis points HBOS might have paid over the Bank’s 5 per cent rate, the figure is 170 basis points – expensive borrowing and a real indication of the pressure lenders are under on that side and a clear explanation as to why mortgage rates remain high.

Crosby, still on cash

However, there were investors willing to buy and it gave an indication that this can be achieved at a price (and that was with prime assets). This in conjunction with other possible book sales/purchases gives some hope that the market is beginning to ease – but we are a long way short of new liquidity to ease the shortage of mortgages. In that regard, the Crosby review on fixed rates, gold standards and more and continuing work by The Treasury on other market measures is increasingly important.

The Council of Mortgage Lenders’ latest forecast suggests that gross lending (all loans made and ignoring whether new borrowing is cancelled out by the repayment of existing loans) will be £285 billion in 2008, down from £365 billion in 2007, while net lending will halve from £110 billion in 2007 to £55 billion in 2008.

There were 46,500 loans for house purchase in March 2008, down from 48,600 in January (normally the low point) and compared to 88,800 in March 2007. There were 17,800 first-time buyers, down from 32,500 in March 2007.

With Bank loan approval data, property transactions and house price indices all pointing downwards we have what looks like a locked-in decline for the housing market for a sustained period. It is worth recalling that in the last recession in 1989 property price trends were almost continuously negative for three years.

With a contracting mortgage market and a falling housing market it is very clear why government is concerned. However, there are limits to what it can do. A joint announcement by the chancellor and the housing minister in May called for a package of measures including an additional £9 million for advice agencies to help borrowers in difficulty, and more work with lenders on keeping people in their homes.

Later that month Caroline Flint announced a £200 million fund for the Housing Corporation to buy new homes for first-time buyers or for renting. Any would-be buyer with a household income of less than £60,000 is now eligible to apply for a home through the HomeBuy scheme. Finally, mortgage rescue is being dusted off although there appears to be no real expectation this can do a great deal.

House of correction

Now we must wait for the market to correct. But in this frenetic political environment, we can expect more initiatives – the question we must ask is to what real effect? Certainly, it is right to help as many as possible and blunt the worst effects of a downturn. But the real instrument is an active market where households can trade out of difficulty and remortgage away from the expensive deals.

We must recall that in the last recession only 25 per cent of those in arrears were eligible for ISMI, the government income support mortgage interest scheme. Even though a rethink is long overdue – we have a 20th century benefit system operating in the 21st century – we are some way off the recent US Federal government announcement which guarantees refinancing of up to £153 billion in mortgages to more affordable levels via the creation of an affordable housing plan to begin in October.

There is a sense government is rethinking the direction of policy. Home ownership and help to those in difficulty remain important – and the new Community Empowerment, Housing and Regeneration Bill may provide a vehicle for carrying forward an expansion of the rental market.

The funding market contraction will continue and that will create difficulties for a housing market in transition. We are some months away from getting through this.

For most homebuyers the position is utterly sustainable. Price growth has given them a significant equity cushion to ride out any falls and with strong employment overall they have incomes to service debt. The big worry is a wider recession and what we are now seeing is a race between a falling housing market which could trigger wider negative effects and attempted interventions designed to recover the position. Sadly these were started late in the day but our hope is that the tortoise can still overtake the hare!

Peter Williams is executive director of the Intermediary Mortgage Lenders Association.