A Rescue Package?
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Following on from my last post, a top government advisor has suggested that there could be a solution to the growing problems in the mortgage market but the government may have to put up the cash. David Miles, chief economist at Morgan Stanley and a Treasury advisor on the mortgage market, says that UK banks will soon need to refinance £250bn worth of mortgage loans that have been financed in wholesale money markets.
The argument goes that if the market remains in its current state, the Bank of England, or the government itself, will need to lend £60bn to £80bn to the banks this year to prevent mortgage finance freezing up.
Without this help banks will be severely limited in their ability to issue new mortgages, and will have to charge higher rates in order to attract additional funding.
This, in turn, could lead to steeper declines in house prices, which would make the UK economic slowdown much deeper.
The good news is that the UK banking sector is not as exposed as banks in the US to the problems in the credit markets. Morgan Stanley estimates that 28% of mortgages issued in the UK were financed by banks securitising their mortgage book and selling them to other investors as opposed to around 70% to 80% in the US.
The Council of Mortgage Lenders acknowledges that “there is a potential shortfall” in the wholesale funding and says it has urged the authorities ‘to intervene more aggressively’ in money markets to restore normal market conditions.
There is an argument that the drying up of lending to UK banks is an example of ‘market failure’, where credit markets are over-reacting to fears of a meltdown in US sub-prime mortgages. There is a case, therefore, for government intervention, perhaps by creating an independent agency which could provide short-term funding to the banks while the credit markets are frozen. This proposal bears some resemblance to US agencies such as Fannie Mae and Freddie Mac which buy up mortgage debt from lenders and have helped expand the mortgage market.
But there would be risks to such a plan. Intervention on such a large scale could make it more difficult for the Bank of England to keep money market rates in line with its own targets and might be inflationary. Also, the government may be reluctant to authorise another huge bank bailout when it is still not clear how much of its £55bn liability for Northern Rock will ever be repaid.
