Cicero Policy Briefer

Issue 26, July 2008

Where now for the mortgage securities market?

By John Rowland

During what Mervyn King dubbed the “non-inflationary, consistently expansionary (NICE) decade”, the ability to originate and trade mortgages clearly widened access to mortgage finance and increased competition in the mortgage market. Mortgage securities remained an arcane, if lucrative, backwater of interest only to City money men.

For all the reasons I do not need to rehearse here, residential mortgage-backed security (RMBS) has suffered one or two minor reputational issues now that the NICE times have passed. No longer are mortgage securities simply a funding model, they are shorthand for the failure, greed, and even criminality of the worst excesses of the US sub-prime crisis. The decision of US prosecutors to charge two Bear Stearns hedge fund managers with misrepresenting the performance of their fund to investors simply reinforces this view of a market that was out of control and is now out of action: deceitful borrowers, reckless lenders, rapacious investment bankers, and clueless investors all connected in a vicious circle of avarice.

My sense is that many in Parliament and beyond, who knew little of this world before, intuitively feel suspicious about the model – relying on too much financial jiggery-pokery and not on good-old fashioned balance sheet lending. Moreover, even those much closer to the ins and outs of the mortgage industry in the Government and FSA were burned by the Northern Rock experience and do not want a repeat of the experience. Many would not be bothered at all if the market never came back from its current hiatus.

And in some respects they have a point – recent market experiences have highlighted some serious failings in the way the model has operated. There has been much wailing and gnashing of teeth as a result. However, this episode has been a long way from proving the model is fundamentally flawed and the time has surely come for the industry to look beyond this period of pain and introspection towards the future. If it wants the market to come back it needs to think about not only what steps it needs to take itself, but also what it would like Government to do. In short, it is time to engage in the public policy debate because it affects the future of the industry.

The first priority must be to rehabilitate the reputation of the securitisation model in general. The reputational contagion from the US to the UK market should not be underestimated and part of the challenge will be to educate those who do not have expertise in financial services that there are clear distinctions between the US market, with its piggy-back loans and teaser rates, and practice in the UK market, where repossessions, while rising, are not at the hugely destructive levels that they are in some areas of the US. The industry must also show that the lessons from the problems of recent months have been learned and that the chances of them happening again are minimised. The perverse incentives for credit rating agencies, for example, are being looked at. This, of course, is all good stuff but it is the absolute minimum.

Secondly, and crucially, there is a job to do to persuade policy makers - and wider influencers such as the consumer lobby - that if the faltering mortgage market is to be unfrozen then the securitisation market needs serious support from policy makers, not just tinkering around the edges. This means that lenders and investment banks need to find their voice – not just to say that things are really bad, but to communicate coherently why this market is important and why it needs support from Government to get it restarted.

Now is the time: with voters feeling the pinch and with mortgages more expensive and harder to come by, a stimulus for the securitisation market could help ease the pressure. This very area is under scrutiny from HM Treasury, partly through the auspices of the Crosby Review, so the next few months offer a key opportunity to engage in the debate before policy is decided and sentiment hardens. Mortgage securities are an essential part of an efficient mortgage market that has diverse funding models – from high street banks to intermediary lenders, it is clearly in everyone’s interest that the market is in good health.

Up to this point, for various reasons we can speculate about all day, no one firm or organisation has been prepared to grip this difficult issue. Now is the moment for leadership and initiative, not sulking and wound-licking. It is time for all those who have a stake in the mortgage securities market to start offering solutions, rather than problems.

John Rowland can be contacted on +44 (0)20 7665 9539 or click here to email.