This is the biggest line of credit the Treasury and Bank of England have ever given to the British banking system. It is more extensive than the help being given to banks by the monetary authorities in the United States and Europe. It is happening because the supply of mortgages is drying up, threatening a collapse in house prices. And it may not be enough. To see what is happening, and why, you have to appreciate that the banks do not have enough funds of their own to meet the demand for mortgages.
In very round numbers, the country needs about £100bn a year to meet mortgage demand – last year it was £108bn. But the banks can only meet about half of that from their own funds; last year they lent less than £40bn directly. They used to be able to cover the gap by selling on mortgages to other lenders, some of which are abroad, some of which are specialist lenders set up for the purpose.
But, for six months, it has been impossible to sell on those mortgages, the result of the crisis in global financial markets. That was because a lot of the debt that was traded turned out to be dud and, as a result, there are no buyers even for good-quality debt.
We see the result every day in the mortgage market. New homebuyers have to stump up sizeable deposits; existing buyers find it harder to roll over their mortgages on reasonable terms.
The banks simply don't have the money. They have so many of these loans on their books that they cannot sell to anybody and they have had to cut right back on the flow of new loans.
The Bank of England's announcement yesterday was to allow the banks to swap up to £50bn of their mortgage debt, which cannot be traded, for government debt, which can.
That does not solve the problem in the medium term because all it does is clear the backlog of existing debt: new mortgages are excluded from the scheme. But clearing the backlog is an essential first step to get things moving again.
The banks can use the government debt they take on to their books as collateral, against which they can go on to the markets and borrow more money to make mortgages again.
The Bank of England calls the plan a "special liquidity scheme". It is special because it is seen as a temporary measure for up to three years. The assumption is that, within a year or two, the money markets will have recovered their confidence and banks will be able to trade mortgages as they could before. If things don't come back to normal, well I suppose everyone will have to think again.
It is about liquidity because the Bank of England and the Treasury are very clear they don't want the taxpayer to have to take the risk of people not paying back their mortgages. They have had to do that at Northern Rock, which was bad enough, and they certainly do not want to do so for the rest of the mortgage industry. So these mortgages, which they are offering to swap for Treasury bills, are not of the US-style sub-prime variety.
The mortgages have to be top quality; the banks have to offer a margin over and above the value of the government debt they are getting back; and the Bank has built quite a decent margin of profit into the deal.
So it is not cheap money for the banks, for they are, in effect, getting money at the same price as they would were they to borrow on the inter-bank market, the market where banks lend to each other on a day-by-day – actually second-by-second – basis.
Those rates are still high, for the gap between Libor (the London Inter-Bank Offered Rate, pronounced lie-bore) and the Bank of England's official rate has been about 0.75 per cent instead of the usual gap of some 0.15 per cent. That is part of the money market problem where the banks resist lending to each other and hoard cash instead. So do not expect banks suddenly to resume mortgages on easy or cheap terms. Easy mortgages are out of the window for several years. But do expect further cuts in the official rate of interest and I think we can assume that the present mortgage famine will not now get even worse.
We can assume that because we know now that if this £50bn is not enough, the authorities will do more. The Government – and this is a government decision because the Bank of England could not do something on this scale on its own – knows that if people cannot get mortgages the housing market will crash and if the early 1990s are any guide, the economy will head into recession.
The Government is not doing this because it wants to be nice to the banks. It is doing it to save the mortgage market. The political flak it may catch as a result would be as nothing when set against what would have happened were mortgages to dry up entirely.
See this as a bandage over a wound. The mortgage market has a chance to heal and gradually it will. There may well be some fall in house prices, which is helpful in the sense that it cuts the amount of money people need to borrow. Mortgages will remain tight. We will all have to save more. But this should stop the housing market becoming really ugly and for that at least the scheme deserves a welcome. Phew!
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