Even UK guarantee can’t stop housing crash

By J Saft
November 28, 2008

James Saft Great Debate – James Saft is a Reuters columnist. The opinions expressed are his own –

Britain needs to reflate its mortgage markets to save its economy and its banks. Problem is, few want to borrow and there is precious little money to lend.

British property prices are down about 15 percent in a year and mortgage approvals are down 52 percent. Given the freeze in the securitization market and the scarcity of savings in Britain, new net mortgage lending may even fall below zero in 2009, according to James Crosby, former head of UK mortgage bank HBOS, who authored a government report on the mortgage market.

While the Crosby report rightly points out the damage that such an unprecedented fall would do to employment and the economy, it is also worth pointing out that it would be dire indeed for another segment — the banks, which ultimately will suffer the losses as borrowers fall into negative equity and default or lose their jobs and default.

Britons simply don’t save enough to supply their banks with enough to lend to fund the debt requirement implied by their housing prices. That circle was squared in the old days by borrowing money from abroad, either through banks borrowing and re-lending or via securitization.

The solution to this advocated by Britain, as laid out in the Crosby Report and endorsed by finance minister Alistair Darling, is to plaster a government guarantee on up to 100 billion pounds of mortgage securities.

The securities would only contain house purchase loans and would be highly rated by, you guessed it, the same agencies that rated the old, now discredited stuff. The securities would also exclude nasty high loan-to-value loans, or loans made to people who have already demonstrated they are not that good at paying back money.

The theory is that investors may not want to buy mortgage backed securities, which look a bit dubious given the expected fall in house prices, or lend to British banks, which look a bit dubious for the same reason and several others, but will be very happy to buy bonds that while backed by the British government  pay a fair whack more than government debt.


There are, I think, some problems to this approach.

“I’m all in favor of finding ways of encouraging a sustainable rate of mortgage lending but I’m not entirely confident that the best way to do this is to resurrect a form of lending that for rather good reason has fallen out of favor,” Bank of England governor Mervyn King told parliament this week.

And even if we all agree to forget recent experience with securitization, there is the issue of who, exactly, is going to buy these guaranteed bonds, and who will buy all the houses these loans will fund.

The idea that there are real money or central bank investors out there who will pay a great price for these bonds is not supported by the evidence. Look at the United States, where the government has been slapping government guarantees, or wink, wink “implicit” guarantees on all sorts of financial paper.

Goldman Sachs, which used to borrow on its own name, this week sold $5 billion of bonds under a Federal Deposit Insurance Corp guarantee. The bonds paid about 200 basis points over equivalent government bonds.

That’s crazy, I hear you say. To paraphrase Keynes, the markets can stay crazy longer than you can stay solvent.

Or look at paper issued by Fannie Mae and Freddie Mac, which are under government conservatorship and enjoy an “implicit” guarantee. Their bonds have done so stunningly badly in recent weeks, as foreign central banks deserted them in droves, that the U.S. government was forced to go in and buy them up themselves.

My best guess is that, even with a fat premium, the world will have all it can handle of sterling denominated British government risk in the coming years.

On the other side of the equation, you have to wonder which buy-to-let investor or potential house buyer is out there who is a) a good risk, b) possessed of a 20 percent down payment and, c) willing to buy an asset that is losing two percent of its value a month.

So, it’s looking like the fall in British house prices will be deeper than expected, and probably deeper than deserved. If you look at the U.S. experience where a higher percentage of loans were securitized and thus tended to end up not on bank balance sheets, that is bad news for the banks.

Ask yourself what would happen to Britain’s banks under similar circumstances. It might only be as bad as the 1990s, but it could be worse.

Bank liabilities in the United States are about 20 percent of the size of the economy. In Britain, the figure is 285 percent.

Ask yourself then what might happen to Britain itself.

–  At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. –


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Cash is king………..Gold is even better, it’s not made of paper.

Posted by Dave Krugerand | Report as abusive

Real estate markets during the past five years have been completely out of touch with reality, but until recently have been full of eager (or, shall we say, *desperate*) young buyers convinced that they have to get into the game *now*; that the market is “hot”, and that they will be able to “flip” their property for a handsome gain after a year or so. Of course, they put a paltry five or ten per cent towards the purchase, and in addition need two incomes to make the mortgage payments in the interim — no problem, right?!

Time now for a reality check, folks! Negative equity is here for the foreseeable future, as real estate makes a long-needed correction to saner, more sustainable levels.

If you’ve bought real estate in the past three years, you are going to have to hang in there for a further five years before things return to the levels of November 2007. Good luck!

Posted by LGinHfx | Report as abusive

Things are going to get very nasty indeed. The bust will be so bad in the UK that people who have lost everything will just give up, result, no binmen, no nurses, no supermarket workers, just anarchy. It will be every man or women for themselves in the UK in two years’ time.

Posted by Andrea Johnson | Report as abusive

I cannot help but be moved by the plight of Kiki, the recently unemployed architect mum who has had a sudden reckoning with the realities of the credit crunch. I suspect she may not be on her own in feeling the cold winds of the recession. It must be a huge psychological adjustment. I’m no expert Kiki, but I suggest you suspend payment on the credit cards now–and save what resources you left. As you say, what’s the use of a credit rating in a crash? AS you are lucky enough in the US to have a non-recourse loan, there’s little the banks can do against you. You are no more indebted than Citibank or the rest of the financial geniuses that got us all into this mess. Tell them you are an unemployed mother and negotiate a reduced and minimal repayment plan now before the RUSH. Good luck with your job search… What part of the US are you in? The economy is going to vary very much form place to place.

Posted by snasht | Report as abusive

Just back from Iceland: they are coping very well with this crisis. But there are some key things we need to pay attention to. The Icelanders have a very disciplined and law-abiding society. They work hard and are well educated. Looking at the UK and USA, with our legions of ill-educated and feral people, our toxic race conflicts, out-of-control immigration, and things are not going to go as well when the crunch comes. The Icelanders are keen on design and making high-quality products; not slobbing about and doing a half job. We need to change our ways if we hope to come through this.

Posted by Bob Macdonald | Report as abusive