The government’s big plan for the economy seems to hinge on one thing.
Get the banks lending again. If the banks lend again, house prices will go up again. Everything will be hunky-dory and people will vote for the incumbents come 2015.
The latest crafty idea to encourage this was the ‘Funding for Lending’ scheme launched back in the summer by the Treasury and the Bank of England.
Judging by all the ‘mortgage war’ headlines you’ll have seen in the papers recently, it might seem that it’s worked.
But it’s a little more complicated than that…
The problem with banks
The business of banking is pretty simple at heart.
You borrow money at one rate. You lend this money to someone else at a higher rate. You pocket the difference.
As long as the person you lend the money to pays you back, and the person you are borrowing from doesn’t demand their money back unexpectedly, you’re laughing.
Right now though, the banks certainly aren’t laughing. On the one hand, there are a lot of potential bad loans on their books. They are rightly nervous that a lot of the households they’ve lent money to would be unable to pay them back if interest rates were anywhere near ‘normal’ levels.
No wonder. As we’ve noted before, the economy is infested with zombies.
One in three commercial property loans is subject to some sort of forbearance, reports The Guardian. One in 12 companies can only pay the interest, not the capital, on its debt. As many as one in 12 mortgages is in forbearance too. So the quality of the loans written by banks remains poor.
On the other hand, it’s become more expensive for them to borrow money themselves. The ‘wholesale’ money markets have never really recovered from the 2008 financial crisis. So there are fewer avenues for funding for the banks. And that makes their cost of borrowing more expensive.
So you can see why they are reluctant to lend. Their own supply of money has become more expensive. The people they lend to have become less reliable. As a result, they feel a bit over-extended and vulnerable. They’d rather have fewer loans outstanding, and more funds available to back them for when things turn bad.
It won’t help that the Bank of England has just warned that banks need to be more honest about the state of their balance sheets. The Bank reckons there’s still a potential £60bn hole in the banking sector’s finances, that lenders will have to fill at some point.
The funding for lending scheme is a gift to bankers
That’s a pretty daunting set of problems. So how is funding for lending meant to help with all this?
In effect, the scheme allows banks to borrow money from the Bank of England at dirt-cheap rates. In return, the banks must not allow their lending levels to shrink between now and the end of 2013. On top of this, the more they lend, the more they can borrow, and the cheaper the rate.
So the deal is: don’t shrink your loan books, as you are itching to do. In return, we’ll give you cheap funding, which means you’ll make more of a profit on the loans you write.
How’s it worked? Well, just as you’d expect.
Because banks now have access to cheap lending, they’re not under as much pressure to raise money from other sources. That includes ordinary savers. So savings rates are lower than they otherwise would be. In other words, savers are being done over by the Bank of England yet again, in favour of the indebted and the banks.
According to comparison site Moneyfacts, the average savings rate for a fixed-rate Isa for example, is down from 2.82% to 2.42%. Similar falls have been seen across the board.
So what about all those poor deprived first-time buyers out there and others desperate to get hold of a home loan? Well, again, as you’d expect, they’ve not had a look in.
Banks aren’t stupid. They’ve instead used the cheap money to ramp up the competition to secure customers who are the very best credit risks.
As Sylvia Waycot at Moneyfacts points out, before the scheme was launched, there were 389 mortgages available for people with a 40% deposit. Now there are 498 – an increase of more than a quarter.
I don’t know about you, but while I’m a property bear, I think even I’d be happy to lend to someone who had already put down 40% of the property price, if I knew I had ownership of their home as security.
What about mortgages requiring a 10% deposit: the riskier end of the spectrum? There were 263 available before Funding for Lending came out. Now there are another 21.
In other words, funding for lending is good for bank profits. They can get cheap money and use it to write very safe loans. In the long run, that might enable them to mend their balance sheets that bit quicker.
But if you’re a struggling small business owner or a would-be first-time buyer, don’t expect it to make your life easier. And if you’re a saver – well, you should be used to getting a raw deal from the Bank of England by now.
There’s one way to make the housing market really pick up, at least in terms of sales activity – and that’s to let prices fall, by raising interest rates. The Bank will refuse to let that happen for as long as it can. But it’s an inevitability. The big question is just ‘when?’
Meanwhile, looking through the Halifax house price data, something struck me. According to the lender, the average house price across the UK – as of October – is now around £158,000 (seasonally adjusted). In April 2009, the bottom of the post-crisis crash, the price was around £154,000.
In other words, we’re just a kick in the backside away from the low. That’s quite an eye-opener for anyone who thinks the property market has been flat or even rising over the last few years.
What’ll happen next? Well, we’ve just had our annual property Roundtable in the office. It was as heated as ever – you can find out what our experts had to say in next week’s issue of MoneyWeek, out next Friday. (If you’re not already a subscriber, you can claim your first three issues free here.)
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