Repairing the mortgage market

Plans tackle the floundering UK mortgage market and ease the credit crunch were put forward this week by a Treasury-backed report.

But, far from being the panacea the market demands, the new report has been given a lukewarm reception by industry stakeholders, meaning Brits looking for remortgage deals or to get on the property ladder may have to wait until 2011 before the lending is eased.

The preliminary findings by Sir James Crosby - deputy chairman of the Financial Services Authority (FSA) and former HBOS chief - state there are no easy answers to the crunch.

So what has gone wrong?

At the core of the problem is the residential mortgage-backed securities (RMBS) market, where banks sell on mortgage debt to raise funds.

Between 2000 and 2007, the total amount outstanding of UK RMBS and covered bonds rose from £13 billion to £257 billion, but when concerns over bank losses rose, investors turned away from the bonds leaving a mortgaging funding gap.

It was this gap and inability to raise funds that led to the near-collapse and nationalisation of Northern Rock.

More recently a prevalent air of mistrust has swept the market – as lenders struggle to identify which institutions are exposed to bad debts from the subprime crisis – forcing the London Interbank Offered Rate (LIBOR) higher, increasing wholesale funding costs, and accentuating liquidity shortages.

In response, Sir James calls on the government to step away from establishing a government-backed agency to guarantee and securitise mortgages – following the US Fannie Mae and Freddie Mac model.

What can be done?

Instead, today's report calls for the funding of mortgages to be left to the market.

Sir James finds the market for funding mortgages is changing, but the government should not seek "a return to previous market structures or levels of activity".

"The authorities must also avoid creating moral hazard; there should be no reduction in the incentives on market participants to behave responsibly," the report states.

Proposals for the government to guarantee billions of pounds worth of mortgage bonds are also downplayed.

The report finds: "It appears unlikely that an implicit government guarantee on mortgage-backed securities would be an appropriate model for the UK to adopt."

The Bank of England currently offers its Special Liquidity Scheme (SLS) to aid lenders by swapping mortgage backed-securities for government bonds. However, this scheme does not cover new lending, only existing securities.

A final report from Sir James will be produced at the time of the 2008 pre-Budget Report this autumn.

Will it work?

Commenting on the report the Royal Institution of Chartered Surveyors (Rics) chief economist, Simon Rubinsohn, said: "The Crosby review highlights a range of options to deal with the current environment, but its failure to propose any immediate changes in the mortgage market suggests that there will be little early relief for the housing market and most particularly for first-time buyers.

"Rics believe urgent action is required with today's Bank of England figures on mortgage approvals demonstrating the scale of the problem."

Explaining the ongoing problems Michael Coogan, director general of the Council of Mortgage Lenders (CML), added: "In aggregate, lenders are unable to meet the consumer demand for mortgages because there is not enough funding available to them. Without action, the situation in the housing market will be worse than it needs to be.

"The housing correction will overshoot, and the knock-on effects on the wider economy will be significant.

"Today’s analysis at last sets down an independent welcome marker that intervention to address the mortgage funding gap is both appropriate and necessary.

"It creates a clear expectation of measures at the time of the pre-Budget report. We now look forward to working urgently with the Treasury over the summer on proposed solutions."

Threat of delay

However, there are concerns at this late hour government action will be insufficient to halt the impact of the credit crunch – which has now being ongoing for the past year – on the UK mortgage market.

Warning further delay could prove catastrophic Peter Williams, executive director of Intermediary Mortgage Lenders Association (IMLA) said: "We would want to stress the importance of early delivery of any recommendations from Sir James Crosby’s final report later this summer.

"A solution which deals with new mortgage lending business is crucial to restore liquidity to the UK market. If there is to be a successful market led resolution, all lenders must be included in the proposals rather than just the deposit takers."

To date government measures have only reactively targeted existing mortgages, but it now appears unlikely a proactive attempt to restore market confidence is unlikely.

"IMLA is now working with other stakeholders on an industry led initiative which we hope will achieve a market consensus as to how we solve these problems," added Mr Williams.

Home sellers must also play there part, argues estate agent Connells.

"For the housing market to start to function normally, we need the market liquidity issues addressed, an increased supply of mortgages, lenders lifting restrictive mortgage criteria and lower rates passed onto the consumer," commented Ross Bowen, managing director of Connells Survey & Valuation.

"Sellers must also acknowledge their homes may be worth less in the immediate short-term than they hoped."

What happens next?

It appears then, while the government attention to the housing market is welcome, its hands are somewhat tied. Intervention to correct the stalled market will dilute incentives to return to prudent lending in the future and may even precipitate a further crisis.

However, without action the mortgage market will remain frozen, and following the resultant fall in demand for property, house prices are likely to continue to decline.

It is a tightrope for the government to walk, and one for the moment it has chosen to avoid. The industry will be forced to wait until the pre-Budget report later in the year.

Chris O'Toole