Jeremy Warner's Outlook: Credit is again mispriced, but it will take more than pointing it out to ease the crisis

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The Independent Online

Once a backwater of Bank of England endeavour that scarcely anyone took any notice of, the bi-annual Financial Stability Report has been transformed by the credit crisis into required reading.

Yesterday's offering, which contained the observation that the repricing of credit risk had badly overshot and that eventual losses would prove far less painful than market prices indicated, has already produced unprecedented levels of coverage and comment.

Previously, the report's writers had felt like lone voices crying in the wilderness, their increasingly alarmist warnings of the build-up of mispriced credit going largely unheeded. How do central bankers better get these messages across? One of the drawbacks of independently determined monetary policy is that central bankers are not, on the whole, terribly good communicators.

Much of their message is hidden behind dry and often arcane language that fails to engage with the press and the popular consciousness. It's only when the crisis is actually upon us, by which time it is already too late, that everyone sits up and takes notice.

The Bank is surely right to point out that credit has again become mispriced, this time on the downside rather than the upside. Prices, particularly in anything to do with mortgage credit, discount a level of default that is highly unlikely ever to materialise, even with rising unemployment and falling house prices.

Even if defaults do reach the elevated levels reflected in market prices, the lender is still left with the property, which will always, presumably, be worth something. The Bank of England hopes that by pointing all this out, buyers will return, confidence will be restored and banks will, as a consequence, begin to lend again on reasonable terms.

Yet, despite the fact that everyone now at least reads the report, the impact may be as ineffective as previous attempts to influence markets. The reason market prices have sunk so low is that many of these securities are so complex, mixed up and opaque that it is impossible to know to what extent they have been infected by the really toxic stuff.

If you think you will be poisoned by what is in the main a perfectly healthy sandwich, then you'll leave well alone. That's what's causing the latest mispricing, and it is not easily sorted out.