Not long to go now before plans for the biggest government bailout of the UK banking system in history emerge blinking into the cold light of day.
Details are still thin on the ground, but the broad outline is now clear enough. In an attempt to restart the stalled British mortgage market, the Government will stand ready to lend the UK banking system anything up to £100bn of taxpayers' money.
These monies would be borrowed against the collateral of prime residential mortgages, on which banks would be required to take a significant haircut to safeguard the Exchequer against the credit risk involved. There would also be some kind of penalty fee charged for the privilege.
The Government would be further able to claim that there was no real risk to the taxpayer in that the issuing banks would continue to assume liability for arrears and outright defaults.
The taxpayer would only suffer if the issuing bank actually went bust. In all other circumstances, the bank's shareholders will bear the costs of any deterioration in the value of the collateral. In return for the mortgages, banks would get Government securities, which, unlike home loans, can easily be turned into cash to help alleviate bankers' medium-term funding difficulties.
The hope is that the mere announcement of such a plan may cause the market to start functioning again of its own accord. Once bankers know that mortgages can be traded for Government securities, they may be more willing to start lending against them again. Now where have we heard that before? Much the same thing was said when the Bank of England began lending to Northern Rock.
Use of taxpayers' money on the scale envisaged is big and unprecedented stuff which wouldn't be contemplated at all except in circumstances where there were extreme economic risks in doing nothing. In recent weeks, these risks have grown alarmingly. The consequences of letting the present situation ride might be an extreme credit famine triggering a possibly serious economic recession.
The costs of both mortgage and corporate credit would rise significantly from already elevated levels, and many would find difficulty in securing such borrowing even in circumstances where they could afford it. Disposable incomes would in turn become further squeezed, leading to a downward spiral in demand across the economy. If this analysis sounds positively apocalyptic, it is also all too easily argued.
Britain has the second largest mortgage market in the world after the United States, and its importance to the UK economy is far bigger. The problems of the mortgage market are also affecting lending to small- and medium-sized enterprises, with charges rising and credit lines being reduced. The economic consequences of the credit crunch, so far relatively limited, threaten to run out of control.
In an interview with the BBC this week, the Prime Minister said that buying up mortgage loans with Government securities was "not necessarily the first thing you would do" to bolster confidence in the mortgage market. Yet it is ever harder to see what else might do the trick.
Government kite-marking of mortgage-backed securities and all the other fiddly little measures that have been suggested by ministers to address the funding problem amount to little more than rearranging deck chairs on the Titanic.
For the time being, no one is prepared to lend at reasonable rates against mortgages. If the Government cannot be persuaded to step into the breach, the markets will do their worst and credit costs will reach levels not seen since the early 1990s. Where then would be Gordon Brown's claim on economic competence?
The Government blames the imported problems of the American mortgage market for its woes, yet the US can hardly be blamed for the easy credit and rampant house price inflation that have characterised the UK economy in recent years. Though these phenomena mirrored closely what happened in the US, failure to do anything about them is an entirely British lapse in policy. The Government cannot blame anyone but itself.
Bankers don't operate in a vacuum of their own creation. Greedily, and perhaps recklessly, they took advantage of the climate of easy money to make hay, but they weren't responsible for it.
The root causes of the present crisis lie in a worldwide glut of liquidity which policymakers failed to address. The UK Government was all too happy to take the credit for the boom, which it has repeatedly attributed to its own brilliance in macro-economic policy. Now that the bust is fast approaching, it is said to be someone else's fault.
If it wants to avoid economic calamity, the Government has little option but to oblige the bankers. Both the US Federal Reserve and the European Central Bank have tried something similar to what is now proposed for the UK, though not for the sort of longer-term money the British banks are hoping to secure. The Government money would be lent on a one- to three-year basis, which is where the bulk of the funding difficulties are arising.
If all this sounds vaguely familiar, that's because it is. Broadly it mirrors what was done at Northern Rock, where the Bank of England initially attempted to tide the bank over its funding difficulties by lending against the collateral of the mortgage book. It backfired badly but predictably, culminating ultimately in nationalisation.
The more generalised lending programme now proposed avoids the problem of stigmatisation that sunk the Rock, yet, whatever the Government says, there are obvious risks involved. Where does this nationalisation of Britain's stock of mortgages end? And will it have the desired effect of making cheaper credit more available? Whatever the answers, the banks will be made to pay a high price for going cap in hand to the taxpayer.
More regulation, to the ultimate detriment of financial innovation and economic growth, is now a certainty, as too are rights issues enforced by regulators to repair balance sheets damaged by the meltdown in credit markets.
Surprising resilience of equity markets
Rumours of the planned banking rescue sent stocks soaring yesterday, highlighting one of the deeper mysteries of the present turmoil in financial markets. This is that though credit markets have suffered a calamitous correction, equity values have been comparatively unaffected. The FTSE 100, for instance, is just 10 per cent off its peak of last summer. Are equity investors in a state of denial?
Possibly, but actually there is more logic to the resilience of equity prices than it seems. Look beneath the headline of the indices and there has in fact already been a massive bear market in the sectors most likely to be affected by the credit crunch. Many banks, where the earnings outlook grows grimmer by the day, are off 50 per cent of the summer peak. Anything to do with the consumer economy or property markets has also suffered crushing declines.
Buoying the market are oils, mining stocks and defensives. Logically, these too would suffer if there is a worldwide recession. Historically, oil and mining stocks have proved highly cyclical. The fact that commodity prices haven't so far responded to fears over the health of the world economy is down to the belief that rapid industrialisation in Asia has led to a permanent step change in demand, where commodities become valued as scarce resources regardless of the cycle.
There is obviously something to be said for this argument, yet it is also about to be severely tested on the anvil of practice. If there's no worldwide recession, then equity prices are in the round probably justified at present levels. If policymakers fail, and the economy suffers a hard landing, then all bets are off.Reuse content