Even UK guarantee can’t stop housing crash
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.
OH LORD, MAKE US SAVERS BUT NOT YET
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. —