Cicero Policy Briefer

Issue 24, May 2008

Sending the mortgage industry to rehab

By John Rowland

In the past month we have seen three public policy initiatives launched in the mortgage market, which was definitive action after a lacklustre Budget that gave little more than a nod to the problems in the mortgage market. The Treasury has finally put the mortgage industry into rehab.

First to be announced was the establishment of an industry working group under the leadership of FSA deputy chair Sir James Crosby. He is cast as a fancy Harley Street consultant and the securitisation market will be getting a medical. He will be looking at ways to improve the mortgage backed securities market, particularly at reporting requirements and the disclosure of the quality of the underlying assets. While the Treasury expects a final report by the time of the Pre-Budget Report there is no doubt that a prescription will be written out considerably sooner.

Second—and most significantly—came the Bank of England sponsored Special Liquidity Scheme, allowing banks to swap their existing, illiquid, mortgage securities for freshly minted Treasury Bills from the Debt Management Office. This, the Treasury hopes, will be the financial liposuction that allows that nasty ‘overhang’ to disappear and for the newly svelte banks to starting dancing together again.

Thirdly, the Chancellor invited the patients to Number 11 for a cup of tea to discuss the next stages of their treatment. The subtext of this meeting was clear—the Government has done something to help the industry, and now it is the turn of the industry to give something back by passing on rate cuts to their borrowers, and not to aggressively pursue arrears and repossessions. We’ll provide you with a programme, but you’ll have to do your bit too.

At first sight these measures seem both reasonable and consistent, but there is in fact a Manichean struggle going on here between the political imperative to keep mortgages cheap and available, and the prudential imperative to get banks to rebuild their balance sheets and not to take on lots of new borrowing.

In the eyes of the voter the latter imperative means more expensive, less easily available mortgages as the industry goes cold turkey. However pursuing the former through public policy, while it might bring some temporary relief of the symptoms, risks artificially sustaining with taxpayers’ cash the conditions that got us in to this mess in the first place.

This is something of a dilemma for the Chancellor at a time when Labour is struggling in the polls. With food and fuel prices on the rise, keeping the cost of mortgage payments down is a priority if Labour is to make any headway in the polls. The temptation, under pressure, is to perform lipo, when a diet, exercise and definitely no fags or booze is what is really required.

So how real is the risk that these measures are predominantly treating symptoms rather than the cause? Well, it must be said that there are two other physicians at work here, Hector Sants and Mervyn King. Both of them are keen on a strict regimen, having seen Northern Rock self-destruct. The FSA will be insisting on tighter controls on capital and liquidity, while the Bank of England’s independence and focus on controlling inflation rather than supporting the housing market will prove a bitter but necessary pill.

In combination the therapy could help. But the Chancellor is under pressure to show results on what could be a fairly drawn out process of recovery. As this article went to press the 1 May elections were yet to take place. However, if they have gone very badly for Labour we will see a major reshuffle in which the banks will get a new doctor. At the risk of having to admit I was wrong next month, his name will be Jack Straw.

This article was originally published in the April 2008 issue of Lending Strategy.

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