The Government is embarking on a banking market bail-out of an ambition we haven't seen since at least the early 1970s. Will it help? Tim Bennett reports
Why are mortgages hard to come by?
Following a series of huge write-downs related to subprime mortgages just this week the second-largest US bank, Bank of America, declared bad debt losses of $6bn, while Royal Bank of Scotland announced a record £12bn rights issue and fears of more to come, banks have been hoarding cash. This has made it more expensive for banks to borrow money from one another, as indicated by the sharply rising London interbank lending rate (Libor).
This rate is normally close to the base interest rate set by the Bank of England, but recently has been well above it. This in turn has driven up the rates lenders charge for mortgages. Lenders keen to hang onto their cash are also making it harder to borrow by raising deposit requirements and arrangement fees.
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What's the Government doing?
On Monday, Chancellor Alistair Darling unveiled a Bank of England-led Special Liquidity Scheme designed to "un-bung the situation". It's a "banking market bailout of an ambition we haven't seen in this country since the early 1970s and possibly longer than that", says the BBC's Robert Peston.
The aim is to thaw the frozen interbank lending market and, Mr Darling hopes, reverse the rapid shrinkage in mortgage availability by lending Bank of England funds against a wide range of collateral. This will take the form of "high-quality" mortgage-backed securities and credit-card securities supplied by those commercial banks that take part.
How will that work?
Taking its cue from the 28-day $200bn (about £100bn) Term Securities Lending Facility set up for American banks by the US Federal Reserve on 11 March, the Bank of England will allow banks to swap "high-quality" bonds for government securities to a value initially estimated by Reuters at around £50bn, but potentially much more. "There is no arbitrary limit on it," as Governor Mervyn King put it. This British facility will be available for a one-year period, renewable for a further two years after that.
Are there any conditions?
Several. In a bid to avoid putting taxpayers' money at risk if the mortgage-backed securities bought by the Bank of England drop substantially in value, three special conditions are attached.
The terms are "more draconian than expected", said the FT. First off, the Bank of England will apply substantial "haircuts" discounts applied to the assets put forward by the banks, forcing them to provide more than £1 of their own securities to receive £1 of Treasury bills.
There's also a fee for the service of at least 0.2% of the amount borrowed. This is likely to be significantly more, as it is based on the gap between Libor and the three-month Treasury Bill rate so this gives banks an incentive to ensure that Libor falls.
Lastly, any assets bought by the Bank of England will be priced at "observed market prices", a measure designed to head off accusations that the Bank of England might be sacrificing taxpayers' money to take overpriced assets from reckless lenders effectively a state bail-out.
Will it succeed?
It remains to be seen. Early reactions have been positive HSBC chairman Stephen Green said the move should "ease some of the current market dislocations". Certainly, another Northern Rock-style crisis looks much less likely, given that banks now have a way to raise finance from somewhere other than their reluctant rivals or via rights issues.
However, as Roger Bootle at Capital Economics notes, the similar albeit smaller Fed TSLF already in place in America has "so far failed to normalise US interbank rates". That's because banks are likely to hoard, rather than lend, at least some of the extra cash in response to the huge uncertainties created by rapidly-deflating British house prices and the resulting write-down of related securities.
Will it make mortgages cheaper?
Highly unlikely. Alistair Darling's hope is that the move will "support the provision of more mortgage lending", but this is a forlorn hope unless the housing market stabilises. And there's fat chance of that, given that prices in Britain have tripled in a decade and, as Bootle puts it, "do not normally wait patiently for ten years to get back to equilibrium".
And stabilising the housing market is not even the intention, according to Mervyn King, who in contrast to the Treasury believes, "there needs to be some adjustment". Even the Council of Mortgage Lenders cautioned that smaller building societies and specialist lenders, who don't deal directly with the central bank, are unlikely to see much reduction in the rates at which they borrow from larger rivals. So, while the move should unclog money markets, it won't provide much relief for beleaguered homeowners.
Are there any risks for British taxpayers?
Indeed, there are. As the Liberal Democrats' Vince Cable put it, "we cannot have a situation where the banks are able to privatise their profits and nationalise their losses", as the Bank of England becomes what Robert Peston describes as, "the market for mortgage-backed securities". The problem is that taxpayers will suffer should the assets acquired in return for Government paper lose value as increasing numbers of mortgagees default.
After all, if the banks who designed them have disagreed so far about valuations, it seems optimistic to expect the Bank of England or the Treasury to do better. That, however, will not stop them trying potentially at the taxpayer's future expense.
