Pass on the cuts cry Darling and Brown

April 15th, 2008

Both the Chancellor and the Prime Minister have recently been urging banks to pass recent interest rate cuts on to their consumers in what looks like a sign that panic has set in at 10 and 11 Downing Street.

Darling said, ‘said it was time lenders “played their part” after being helped by the Bank of England putting £15bn into the markets amid the credit crisis.’ He also urged banks to “come clean” about their potential bad debts.

Brown, for his part, has promised new measures to ensure that Bank of England interest rate cuts are passed on to mortgage holders. “Although the Bank of England has cut rates in recent months, the banks have not always been passing those reductions to their customers,” Brown said in an article for Sunday’s News of the World tabloid newspaper.

Mr Brown added: “If the world’s largest banks could come together quickly and agree as a group to come clean about the potential bad debts they face, we could reduce the uncertainty and risk they face and restore confidence back into the markets.”

At the moment the government cannot force banks to pass on the cuts but it can make clear its frustration and the Government intervention is the toughest yet.

The Bank of England last week cut UK interest rates to 5% from 5.25% in a bid to spur the economy amid the global credit crunch. It is its third cut in interest rates since December. The largest mortgage lenders have said they will pass on the cut to their mortgage customers who pay variable rates. But experts have predicted the cost of borrowing will continue to rise.

Darling was forced to concede that the present turbulence was “the biggest economic shock since the Great Depression”. However, despite the mounting evidence of house prices falling he denied we are heading into a housing crash.

Analysis of this situation reveals two wide gulfs that are getting wider all the time. The first is between what the government can say and what it can do. With little or no means to force banks to pass rate cuts on to their customers expressing disapproval is about as far as Brown and Darling can go. Similarly, there is a gulf between what the government say and what they do. Despite claiming to want to ease the burdens of those least well off in the economy they double the starting rate of income tax. And despite claiming to want to maintain a stable and flourishing housing market they insist on pushing through the unpopular housing information packs (HIPS) at a time when the housing market needs to be kept as simple and low-cost as possible.

The economy, above all else, needs sounds leadership at this difficult time. That, however, is the opposite of what is coming out of Downing Street. That is as worrying as any news from the credit or housing markets.

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HSBC bucks the trend

April 11th, 2008

They say the exception proves the rule and the bright exception to the gloom in the credit market has been revealed. While other banks are slinking out of the credit market with their tails between their legs Britain’s biggest bank, HSBC, is trying to lure in tens of thousands of mortgage customers whose fixed rate deals are expiring with other lenders.

From Monday 14 April, HSBC will match peoples’ expiring fixed-rate deals for a further two years. However the offer will be open for just five weeks, new customers will have to put down a minimum 20% deposit, and they will be charged a large fee.

An HSBC spokesman said “this is not too good to be true”. HSBC, which relies less on the financial markets to raise the funds for its mortgages than other lenders, is keen to take advantage of the weakness of its competitors in the mortgage market.

The bank is expecting huge demand for its latest offer and will use three times the usual number of staff to handle applications. Its minimum mortgage rate under its deal will be 4.54%.

The bank stressed that it would be fussy about whose business it took on, and that it was not seeking to hoover up hundreds of thousands of mortgage holders who may have taken a mortgage recently with only with a small deposit.

But the bank admitted it was exposing itself in some instances to offering new mortgages at what would now be exceptionally low interest rates, in some cases even below the Bank of England’s current base rate of 5.25%.

The bank estimates that 72% of its eventual customers will pay a fee of less than £1,000 and that 57% will pay less than £600. Its deal will be open to people whose fixed rate deals are due to expire by 30 June this year and the maximum loan will be £250,000.

More than a million households are expected to face higher mortgage bills this year as their special deals end. Many other lenders, including HSBC’s own internet bank First Direct, have been withdrawing their mortgage products in the past few weeks, as the credit crisis makes it harder for banks to borrow money.

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A look to the future, instead of the past

April 9th, 2008

The full effects of the Credit Crunch are yet to be realised, but politicians and economists around the world are already thinking about how to stop it happening again.

The Shadow Chancellor, George Osborne, has outlined his preliminary plans in a speech to Harvard Business School on an official visit to the US. Although given thousands of miles from home and only vaguely reported in the British press there are signs that this could have been one of the most important policy speeches Osborne has yet made.

In the speech Mr Osborne signalled a willingness to consider radical reform of monetary policy with far-reaching consequences for the Bank of England. He said “The credit cycle demonstrates starkly that controlling retail inflation is not enough. Recent threats to stability have come not just from the demand cycle but from the credit cycle.”

This means that governments and regulators across the world, but especially in the UK and the US, were wrong to regard the sharp increase in borrowing by households, companies and financial institutions as a benign phenomenon.

Mr Osborne believes that the monetary authorities, in our case the Bank of England and the Federal Reserve in the US, need to take greater account of inflation in the price of houses and other assets when endeavouring to promote economic stability.

But he concurs with the chairman of the Chairman of the Federal Reserve, Ben Bernanke, that economic instability might actually be exacerbated if central banks were to use only interest rates to control both asset prices and consumer price inflation as conventionally measured.

Thus there may have been times in the past few years when a sharp rise in interest rates to restrict the growth of credit might have had a dangerously deflationary effect on the wider economy.

Osborne is therefore attracted to a proposal put forward last year by a former member of the Bank of England’s monetary policy committee, Charles Goodhart, whose effect would be to impose restrictions on how much banks can lend during years of strong economic growth and would ease those restrictions when the economic cycle turns down.

As a theory it is attractive. It would work by giving the Bank of England the power to oblige banks to hold more capital in their balance sheets relative to their loans or assets when the economy is growing strongly and less capital when, like now, it would help if the banks could be encouraged to lend a bit more.

However, it is important to remember that what got us into the mess we’re in wasn’t direct lending by our banks: it was the way they packaged up loans to homeowners and highly leveraged businesses into securities for sale to investors. So unless the largely unregulated providers of credit are somehow brought into the regulatory net, it’s not clear that imposing new capital constraints on banks will have much of an impact. It is heartening, however, that there is recognition of the mistakes made in the run up to the credit crunch and a desire to avoid such irresponsible behaviour in the future.

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