Mervyn’s muddle
The has conspicuously and gamely resisted the temptation to follow the lead of the and by pumping cheap money into the London banking system in response to the collapse of confidence in credit markets.
It has stuck with its business-as-usual system that if a bank needs extra funds at the close of business for any reason, that bank can only borrow from the Bank of England’s emergency facilities at a one percentage point premium to the base rate.
But here’s the funny thing. The current base rate, which is supposed to be the reference point for the interest rates that affect all of us, is 5.75 per cent. But the benchmark commercial rate for lending between banks, three-month sterling , is 6.74 per cent.
Now in normal market conditions three-month LIBOR has typically been about 0.125 per cent higher than the base rate.
So what’s really striking is that three-month LIBOR has converged with the Bank’s emergency lending rate of 6.75 per cent.
Or to put it another way, that emergency lending rate has become the new reference point for the British economy.
And, in the current crazy market conditions, that’s a rational phenomenon.
Why? Because banks don’t want to lend to each other, or to other institutions, because they are not sure what’s under the bonnet of those borrowers (it’s the toxic fumes from sub-prime and CDOs that’s still putting them off).
In such circumstances, the benchmark interest rate for the economy has naturally become the emergency lending rate of the lender of last resort, the Bank of England.
And it will stay that way, unless and until banks somehow regain their poise and confidence – or the Bank of England provides copious additional loans at a lower rate.
So there is quite a risk that mortgage rates will rise and what businesses pay for finance will increase too.
But to state the bloomin’ obvious, the system is not supposed to work that way.
It is the base rate that is supposed to anchor the economy, not the emergency lending rate.
So the Bank of England has something of a dilemma.
It is rightly reluctant to slash interest rates and be seen to be bailing out all those negligent hedge funds and investment banks whose avarice precipitated the current crisis.
But it surely doesn’t want to penalise all of us, in the form of a sharp economic slowdown, just to teach those hedgies and bankers a lesson.
I don’t suppose Mervyn King, the Bank’s Governor, looks for divine intervention terribly often. He may require it this time.
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It doesn't seem right nor fair that regular businesses and consumers should be expected to bear the brunt of the fall out from the banks and hedge funds crazy behaviour. Let the banks and hedge funds bear the consequences of their own behaviour.
If they are bailed out, why would they curb their behaviour next time?
Interesting piece. What I'm not seeing so far is any explanations, suggestions or predictions of how long the current situation is expected to last.
As I understand it, the asset-backed commercial paper (short term lending to businesses, up to about 6-9 months term) market has completely seized up. This has now been followed by the interbank lending market, with institutions unwilling to lend to each other for longer periods than a few days at a time. To my mind, this reflects concerns that banks are hiding losses, and that they will be forced to reveal them in the near future. In that environment, it's understandable that banks wouldn't want to lend for periods longer than a few days, as there's a significant risk that if they lend for any longer they may not get their money back!
What would be good is for someone to explain by what means this situation might be resolved, or what might trigger it to improve. Is it simply a case of waiting for confidence to return? How long might that take? Are we talking weeks, months, or years?
Is it just the Hedgies and Banks that need to be reined in? There appears to be a large portion of personal leverage - in the form of 5x and interest-only mortgages, credit cards, buy-to-let speculation, etc - that is over-extended and needs to be checked by a rate of interest that encourages only sensible borrowing.
Lowering the base rate would surely reward the financially irresponsible, which sounds dangerous.
This whole article could be summarised with the following phrase: OUCHHH!
It is going to hurt!
It's a really tough position to be in: the Bank doesn't want to be seen to be rewarding incompetence, greed and failure but if it punishes the banks it punishes the wider economy.
Having said that perhaps it is time the heat was taken out of the wider economy anyway. Consumers need to rein in their spending so there is room for the "real" economy to start investing again.
Consumer rates are not generally linked to LIBOR but to Base Rate. So he's not clobbering the rest of us at all. Also 3 Month LIBOR is usually about 0.35% above overnight which is what the Bank of England Emergency Facility is, so the comparison is somewhat dubious
The BoE doesn't know how many banks are subsidising any under-performing loans - or even if any of their borrowers are behind with their payments at all. The ³ÉÈË¿ìÊÖ doesn't know either. Nobody knows.
Rumour has taken over from knowledge.
It's quite likely there are no credit problems within any of the major banks.
One solution would be for UK Banks to end the uncertainty by confessing any credit difficulties to the BoE who could provide appropriate remedies. If that's not happening, it should be.
Tom, the position is relatively simple but like many other things it is dressed up in finery to try to make it sound much more complicated to justify big fees and bonuses.
Firstly in order for people to keep up with the Jones's and because many people thought property was a one way bet (the price is only going to go up!) many people were encouraged to take out loans that they simply could not afford. This is how it works.
There was a huge amount of money swilling around in America mostly Chinese and Japanese money that bought US treasury bonds with the proceeds of their exports to the US,
When there is an excess of money looking for somewhere to be invested the required return on investment falls (interest rates) drop. Quite literally many banks had a load of money sitting in their vaults doing nothing.
To make money banks loan this out to customers that pay interest. If you have more money than current customers require to borrow you have to find new people to lend money to. This is where the so called NINJA loans come in. In order for people to pay for the loans you tie in a fixed interest period with a low rate (muich like we do in the UK).
In order to loan out money to people with little or no credit history you have to either ignore the likelihood of them defaulting or you pass the risk on to someone else. In other words find a sucker to take the dodgy loans off your books.
You get a merchant bank to package these loans up and sell them on to a third party who wants to invest in a safe property fund that has been confirmed by credit rating companies such as Standard & Poors or Moody's or AM Best as high grade loans. The third party thus thinks their investment is safe as houses, if you would appreciate the pun.
The problem then is you have your money back and have to find someone else to lend it out to. And so the spiral grows ever larger and larger and the eventual bust wore and worse.
Move forward two years and the US Federal Reserve has raised interest rates considerably and the people that borrowed at low rates cannot pay the new increased interest rates and so huge numbers start to default on their loans. With large numbers of properties being foreclosed the local housing market falls, or in some cases crashes badly, which means that one way out of the problem i.e. sell your house and get out is often gone.
The money has gone round several times and all these safe loans have turned out to be toxic. This isn't a problem to the original lender who has sold on the debt or the merchant bank who had earned lots of fees for arranging the deals to sell on the loans to third parties.
The problem is simple no one really know exactly who has bought all the structured products as they have been round so many times.
The problems with banks and LIBOR (London Inter Bank Offer Rate) is that if you do not know how strong other banks are you are not going to lend them money. In a normal stable market banks lend and borrow money all the time to each other to cover when they have trades outstanding that they haven't had the money in on.
It's just like getting a cash advance on your credit card but with much bigger numbers involved. As long as you have the money to pay back the next day you are fine. The problem at the moment is that individual banks have no confidence in just who has been left with the loans. It's like a financial version of pass the parcel with no one knowing who has been left with the dud loans when the music stops.
If you don't believe you will get your money back from the other bank you don't lend it to them.
I believe the Bank of England has done an excellent job in keeping money available when required but at terms that should ensure a degree of sanity into the market.
Trust me I very much doubt this is has all come out just yet.
I am neither an economist nor a banker. What I dont understand is why ordinary people, worlwide, are expected to pay for the lack of scrutiny, management and conscience of any sort amongst the bankers and credit brokers of USA ( and UK?). In most other "professions" heads would roll for creating worlwide negative impacts of this magnitude.... in banking and economics will it happen? Doubtful! Steve
I don't see the problem. This is the way debt based monetary systems are supposed to work.
Debt increases exponentially. Catastrophic corrections are absolutely inevitable in such a non linear system. Trying to support it is futile, you're fighting an exponential function.
By supporting the system, the central banks are simply prolonging the inevitable and making the ultimate result worse. Some banks have to be allowed to fail, it has to be allowed to crash
Surely this is excellent news for Mr King? To return inflation to its target level, the Bank expected to need to raise its base rate to at least 6%, which might finally deflate the asset price bubbles, and so damage the real economy whilst leaving the blame for that invidiously at the MPC's door. As it is, we have the prospect of necessary tightening without the need for a Bank Rate rise.
I would be happy to receive 6.75% on my Barclays deposit account for a while if it would help bail them out.
As usual the goodies are on the top shelf and only crumbs fall for the likes of me.
Of course from a UK perspective none of this has resulted in the stronger economy Gordon Brown claims he's created.
The reality is that the smart alec's in the City whilst getting personally rich are quietly wrecking this country's ability to compete in the real global economy.
None of this will be a problem - houses will continue to go up and up in price, debt will always be cheap and borrowed money need not be repaid. Just refinance your way out of trouble - job done.
Why shouldn't everyone be punished? It's not just the banks who've enjoyed overborrowing while interest was low. The whole economy's contiued to grow due to low interest rates and irresponsible lending. We're about 5 years overdue a drop in growth.
Personally I can't wait as houses will hopefully become more realistically priced.
Excellent write up and timely piece of message. The current liquidity crunch or subprime crisis is the result of irresponsible practices by banks and other financial institutions. In order to maximise profits, the banks often forget the basics and indulge in some crazy products(so called innovative products such as CDOs which are rated as AAA products by the ratings agencies).Clearly, this is a problem with the banks. The Federal reserve or the Bank of England should not bail them out by cutting interest rates. In fact the central banks should concentrate on Inflation and real economy (In my view, the stock markets do not reflect the real economy as they are often the market for speculators).
Err, why does everyone want these irresponsible investors to be punished? This will only result in misery for everyone, especially if a high street bank goes bust. This is why the Fed was so quick to lend cheap money... to stop the wider economy being effected. I think the BOE should be doing the same.
The current situation has been very well explained but what is the way out? Surely, central bankers have agreed a broad set of action points at Jackson Hole to tide over the current crisis. What is it?
My view is that BoE will not lower interest rates this year unless one of the High Street Banks is at risk.
The froth from the system would have gone by the year end leaving only the most respected companies in business.
A 'market correction' in dollar and sterling at that point (to yen, yuan and rupee), first quarter of next year, would be the catalyst to next year's growth.
A little pain for 3-6 months will go a long way to put British economy back on track. Also remember, FTSE falling down to 4100 will not be the end of the world. A correction in asset valuations will also be needed to trim the fat out and allow it(economy) to run on its own.
The Governor probably knows this but can't say this for obvious political and market reasons.
OK,
So what are the consequences of this? Is everyone not just going to borrow money from the BoE? What risk does that put the BoE and Sterling at? What does it mean for mortgages? Does it put the BoE under pressure to raise interest rates to make banks borrow from each other? Can they just raise the emergency lending rate and leave the base rate where it is? Apologies if these are stupid questions :-)
The Bank’s emergency lending rate of 6.75 per cent is o/n rate so it seems inappropriate to compare to a 3 month libor rate. Given that there is a lot of uncertainty in the market resulting in the unwilliness of people to finance at a longer duration than o/n you get this convergence of the rates
An increase in mortgage and business loans rate is not punishing for all of us. For the majority of low income population this will be a welcomed development. Higher mortgage rate should mean a fall in property prices making buying a first property or trading up an achievable task. A reduction in profit of some businesses may lead to lower bonuses for some but this is hardly a development to lose sleep on. The interest rates have been too low for far too long and what is happening now shows that the resultant imbalances have to be addressed despite any political fall out.
The Bank’s emergency lending rate of 6.75 per cent is o/n rate so it seems inappropriate to compare to a 3 month libor rate. Given that there is a lot of uncertainty in the market resulting in the unwilliness of people to finance at a longer duration than o/n you get this convergence of the rates
Gary you are living in planet la la land if you think house prices will continue to rise.
We are overdue another property price crash like the one that hit Britain ion the mid 1970's and early 1990's.
I suggest you speak to one of the many people who ended up handing back their keys in the early 1990's as interest rates rose and property prices fell. Norman Lamont may have said "je ne regret rien" many others found their lives and finances ruined after black wednesday!
In those days we had something called Mortgage Indemnity Guarantee Insurance which nearly forced some insurers and lenders out of business.
House prices fell in many areas across the UK in both the 70's and late 80'sand early 1990's.
If you don't believe me just read the attached.
Rob
This bubble in credit and financial instruments (toxic waste/derivatives/asset backed instruments) has been building for sometime and the Central Banks did nothing to discourage it in fact they fanned the flames of this bubble with low interest rates and printing of money (Monetary Growth).
The Central Banks are right to allow this bubble to come down but, it will not be in a controlled fashion, as they may wish, we are at the Tip of a Mega Financial Iceberg.
US Institutions sold this junk paper all over the Globe and nobody questioned it so when the house of cards begins to collapse the fall out is being felt globally.
JR as the 3 month LIBOR rate is 6.7975% comparing it to the emergency lending rate of 6.75% seems pretty fair to me.
The Bank of England is sending a strong message to banks to sort their houses out and get out of the practice of lending long and borrowing short. It has established a floor to allow banks to borrow at a fair rate, in the current market, of 6.75%. Surely the convergence of these two rates shows that there is some efficiency and sense coming back to the market. It's simple banks can borrow on an emergency basis at 6.75% and this will force them to get their finances in order.
If you, as a bank, have to borrow external to your reserves (from the B of E) at 6.75% and can only lend out at increments in addition to 5.75% this should bring some order and sense to residential and unsecured loans in the UK. Its simple economics supply and demand.
Your local building society if it has stuck to what it should do won't be affected as it should be balancing its loans and investments like it always has done.
It is interesting to note the problems at Northern Rock an old style mutual that went to the stock exchange and in its drive for profits rather than mutuality the sub prime fiasco has come back to bite it on the rear.
The big question is how much are banks in the UK exposed to the sub prime debt and how much do they stand to lose? Banks and investors have failed to disclose how exposed they are which is pushing up the Libor rate as they remain silent. When each UK bank admits to how much it is expected to write off in losses confidence will be restored to the inter-bank lending markets. Most banks generate enough profits to cover any loss even if the loss is several billion pounds.
Can you explain the difference in tenor between the Bank of England's official lending rates and 3-month libor please? Also that yield curves are not written in stone and it should not be taken for granted that there is always a positive curve and that the 3-month-libor is about 1/8 above the MLR. Otherwise the picture can be misleading.
The BOE is irrelevant and, in the scheme of things, so is the UK economy. The current financial system is based on the belief that the US is a benchmark borrower that will always be able to repay its debts. Becase of this belief the US has been able to fund itself and has largely remained immune to the kind of inflation that has affected lesser countries like the UK and Germany. The US has been printing endless amounts of money, just like the Reichsbank in the 20's, but in the form of US Treasury securities This has allowed the Americans to avoid a chronic devaluation of their currency. If Bernanke chooses to bail out the financial sector by cutting rates to 4% or lower there is always the possibility that the Japanese and Chinese would be unwilling to continue to fund the US, which would put enormous pressure of the dollar. The Chinese arfe unlikely to do this as they require the US treasury market to soak up the excess liquidity in their own market as allowing this to be lent domestically would probably result in a major crash in their own market. The Japanese also have a tightly regulated market and every investment opportunity they have had over the last 40 years has lead to financial losses so they continue to invest in JGB's and the post office saving system. As for the UK, well a property crash is inevitable at some stage but it will be temporary and provide some amazing opportunities for liquid investors.
We live in a capitalist economy so good luck to all that can get credit even if you have a dubious credit history. If the banks wish to take this risk so be it.
The only problem I see here is the fact that Std & Poor and other credit rating agencies have misled consumers by rating these bonds as AAA. A day after the crisis they change the rating to junk.
Surely this is fraud, by misleading investors. The same thing happened to Equitable Life pension schemes, yet these people are not prosecuted.
Until the police prosecute these people there they will continue to commit fraud in the future.
I think you need to stress the difference between a liquidity crisis and a bad debt crisis. The sums involved are very unlikely to bankrupt the hugely valuable UK banks, what is at issue is a liquidity crisis whereby banks whose business models involve revolving short term finance to cover long term debts suddenly and unexpectedly find the sort term finance unavailable or very expensive. For each bank the sensible strategy becomes to avoid lending liquid funds to other institutions in case the borrower becomes uncreditworthy and the lent out liquid funds suddenly become illiquid.
At this point the lender of last resort rate comes in to play. The central bank will obviously always provide liquidity to any bank suffering a loss of creditworthiness to prevent a systemic failure so lending banks with liquid funds can be confident that liquidity will be available at this rate hence libor not going far above this value.
In terms of solutions it is more problematical. The suggestion that if a bank can prove itself sound with respect to US property exposure is no longer the key factor driving confidence - after all XYZ bank could have zero exposure to US property but if it lends 3 month libor to ABC Bank and ABC Bank suffers a liqidity crisis then so does XYZ Bank and potentially so on through the system.
If any one does have a good answer I'm sure the Governor would be pleased to have it.
> As for the UK, well a property
> crash is inevitable at some stage
> but it will be temporary and
> provide some amazing
> opportunities for liquid investors.
Yes. Hm... how much cash to keep in
reserve, that's the question? And would
there be a stock market crash at the
same time as the housing crash? This is
really getting me going!!!
Good point Toni, the US has been living beyond its means subsidised by Chinese, Japanese and Asian governments willingness to buy US treasury bonds for several years.
Now if the scenario you paint occurs and they shun US treasury stock well then we are all in for a really bumpy ride.
If you don't need to move house and you have borrowed sensibly to buy a house then this shouldn't be a huge problem to you. It may even bring some sense back into the UK property market.
The LIBOR GBP is one thing, but the greatest concern by far must be the continent. Here, as Robert pointed out, the ECB has been pumping funds into the interbanking system with gay abandon and to the detriment of all but with a clean bill of sub-prime health. To every action there is an equal, but opposite, reaction. Witness the volatility in the European overnight rate and inflation of the EURIBOR, and hope the knock-on effect may not prove overwhelming.
It would seem that we are all about to pay for the greed of the institutions who were so eager to underwrite these high margin, but ultimately high risk loans so they could reap their own financial rewards. The sad thing is that the consumer will eventually pay for their folly as these losses will feed through into the wider market via higher charges for everyday financial services that we all depend upon.We should also question the strength of the global economy and be able to undertsand how much the sub-prime market fed into consumer demand and underpinned growth with what has turned out to be a very unstable base.
In the worst case scenario of a melt-down in the dollar, then the repercussions would, of course, be global - China would suffer more than any other country as everything they make is exported and their global economic growth has benifitted a tiny proportion of their society. This is not news and everyone should remember that prior to the SE Asian crisis in 1997 the journalists were constantly telling us how the Thai economy would outstrip the Italian economy and possibly the British economy within x years! The Koreans invested in Wales which they saw as a low cost manufacturing base for Europe, (Korea was one of the poorest countries in the world in the 50's. Of course it all counted for little when the bubble burst, Just as when in 1989, journalists often told us that the value of metroploitan Tokyo was the same as California. China will be the same, although I doubt the politbureau will allow the economy to collapse prior to the showcase Olympics. An ex-girlfriend already told me that finding maids in Shanghai is a nightmare because they have all quit to play the stockmarket! Something like 200,000 new broker accounts per week apparantly - That is something that the PRC government should be really concerned about.
We have all 'eaten' too much and there is nothing left in the cupboard, the Bank of England has no magic wand, we will all have to take our medicine and work and 'save' for a few years.....
Does intervention at any level mean people will have learnt from their mistakes and be a little more prudent, or think the risk is acceptable becuase they were "bailed out" and think that therefore the initial risk is less than first imagined, so now let´s go and take more risk???? as isn´t that the nature of lending anyway. It´s just a matter of how good you are at assesing how and when you get your money back
The bank should absolutely not give in to sentiments such as those in this article.
The hedge funds and banks certainly shouldn't be bailed out but it is also the general public that need to learn a lesson that one day you have to pay back what you borrow.
The general public have lapped up cheap credit and now they have to pay just like some funds and banks. If the Bank bails out the consumer they will just go on spending and getting in more debt and the crash in the future will be even harder. Too many have cashed in on the grave mistake of Greenspan and other central banks cutting rates too aggressively in the past. The Greenspan 'put' has let some financial elements think that the central banks will just bail them out every time. This must stop.
The banks are not that stupid (well at least they realise when the party is over). That is why LIBOR is now at elevated levels. Unfortunately the consumer is that stupid and needs to be taught a lesson.
The pain will be harsh but when you build a global economy on consumer credit what do you expect?
The responses of the BoE and the Fed and ECB to the present turmoil are not really comparable. The BoE pays interest on reserves, meaning that the banks already had a large stock of reserves at the BoE before the crisis got going - £22bn on average during July. The banks were therefore automatically able to take this much money from the BoE at the MPC repo rate on any day they liked, so money market rates were less likely to rise towards the penalty rate (1% over the repo rate) payable on the standing lending facility than in the US and eurozone, and there was less chance that any individual bank would need to access the standing lending facility.
The banks do have an average reserves target to meet over the MPC month though, and if they have persistently drawn down their reserve balances they will probably wait until the last day of the MPC month, when the penalty is reduced to 0.25%, to make this up. It so happens that the end of the present reserves maintenance period is tomorrow (5/9), so the use of the standing lending facility tomorrow will tell us more about the liquidity pressures that the UK banks have faced during the past month.
The other part of the bind is that a higher interest rate is initially inflationary, so you can't just turn the ship around and head back to port -- the higher rates have to stay until inflation has been squeezed out. So where are we headed? Inflation? Deflation? Maybe a bit of both?
How about this for a way out...
Everyone holding one of these CDO based things is allowed to go to the issuing body and say "either you tell me the real value of the underlying bonds within [x] days, or you buy this one back at the same price you sold it, plus some interest as a penalty for messing me about".
You have to allow some time for the process as each generation will need to ask its issuing bank what it is worth before it can tell the people asking it. However it should not take too long because reputable dealers in these things should know what they based the bonds they issued on.
By the end of [x] days, everyone either knows what their bonds are worth (which may be nothing) or can force a bond which cannot be valued out of existance by returning it to the issuing body.
Of course some issuers will provide answers in terms of "your bond is worth X plus n% of the value of these named bonds which we have but will be returning to the issuing bodies under these rules for a value of Y". Anyone saying that will be regarded as having given a true answer and cannot be forced to repurchase their own bonds under these rules.
In all cases the amount of confusion in the market is reduced. If too much confusion remains repeat the cycle allowing more forced repurchasing of the bonds.
Some of the bonds will turn out to be worthless. In which case, they are either ones known to be "toxic" in the first place and folk left with them knew the risk they were taking and so the chain ends, or the holders (still left with the loss) go to the appropriate ratings agency demanding an explanation for the rating they were given. I hope these rating agencies carry some form of professional indemnity insurance...
I'm forced to wonder if during this backtracking it might be discovered that some of these bonds have become self-supporting rings.
So, the King has no clothes, what a shock. I live in one of the craziest property markets on Earth, Las Vegas. With so much income depending on tips, "Lie to Buy" is considered part of the way of life. Now the chickens are coming home to roost. This is another example where the totally free market leads to abuses and problems. The financial industry has been practising the "..just until I get my bonus" method for far too long. The seliing on of bad debt to stimulate the appearance of growth was bound to bite us sooner or later. I have never been so happy to be a renter as I am now. As for the homeowners who have big loans they lied for and may be forced to move, grasp your ankles and brace yourselves.
As some before me have said, the current situation is primarily at the creation of the US (Greenspan keeping rates far too low in the 90's, low yields on T-bonds due to excess liquidity in Asian economies). It will be the course of the US correction which will ultimately decide what happens everywhere else.
As far as I'm concerned, the central bank cutting the base rate to provide liquidity is totally out of the question at the moment. Lending institutions have to be made to realise that when they distort the price of assets and risk, it is they who will have to make the eventual self-correction.
Ian firstly you are correct the 3 month libor is 6.79750 but should you be comparing the rate the BOE are willing to lend overnight (6.75) to the libor overnight rate which fixed today at 6.11? I take on your further points (and the simple econ 101 lesson) -- interesting view on NR.
Years ago as a novice I began to explore the world of politics. A trade union officer advised me to read the financial pages daily; I recommend this advice to others.
I can best summarise all this by quoting the chorus of a song a teacher colleague and I wrote and performed for staff socials and at masonics and the Buxton Festival Fringe.
Make of it what you will, but it certainly seems to apply to the current financial crisis (what crisis?)
Take no notice of gossip and rumour,
Lies innuendo and chatter,
The people that matter, they already know,
And the people that don't know, don't matter,
You'll be told when the time comes,
Well that's what they say,
But never ask why they think so,
For the people that know never tell you,
And the people that tell you, don't know! KD
(aka the mushroom theory of management)
Merv is acting like a mug. His stance in the face of this financial crisis looks amateurish compared to the emergency overnight liquidity measures being provided by the Fed, ECB, BoC and BoJ. How bad must things get before he decides to do something? Businesses are facing a de facto 1% rate hike, which will filter through to mortgage rates before too long. Would he really tolerate causing a UK-wide recession as a side-effect of teaching a few investment bankers a lesson in financial prudence?
Spain has had a big property boom in recent years,I believe with 800,000 new properties a year being built-which is clearly over supply.Is there a chance the financials of this market might follow the US pattern ? ,( i.e. falling prices,forclosures and re-packaged debt no one wants).
Robert,
Here's my suggestion. Perhaps the BoE should increase the "spread" between base rate and emergency lending rate i.e. the opposite of what the US Fed. has done. Why? Well, if the BoE reduced the base rate by (say) 0.25% and INCREASED the emergency lending rate by (say) 0.25%, then, all of those (banks and individuals) with good credit ratings would be rewarded with lower rates - and additional liquidity would be more easily available in the wider marketplace at a time it is needed, but those who have been irresponsible and can't demonstrate good credit ratings (iffy hedge funds and their clever bankers), would have to take more of the painful medicine of higher rates for crisis loans from the BoE or expensive LIBOR rates. I would suggest that this stratgey be followed until LIBOR stayed below the emergency lending rate as this would then imply that a proper market for lending had been restored.
There are a number of things going on here, from reports I have read:
The BoE is unlikely to raise the base rate much more as it is already quite high and this will affect mortgage borrowers directly and potentially cause a mortgage defaulting problem in the UK. I believe the base rate will remain relatively unchanged for a little while now as the recent rate rises feed through the economy and inflation drops.
The BoE is looking for stability. They are sitting at a poker table with the local banks and slowly over time they all have to declare their hands. I don't believe the BoE will allow any of them to close. As mentioned above, all that will happen is they will have to borrow expensive money and their profits will fall which is the right result to imprudent practices.
Initially it was thought this was just a US problem, but clearly some of the toxic debt has been sold overseas so there is some exposure in other countries which needs to be dealt with. I liked the "pass the parcel" metaphor ! I believe stability in the UK will all be restored by Christmas and you'll be talking about this in hindsight at that point.
What does it mean for the wider global economy ?
Well it has been well documented that the US has had a great time living off the abundance of funds lent to it by China. In fact it appears the default option for the Chinese surplus cash was "lend it to the US" and that the vast majority of it's reserves were invested back in the US.
There have been reports that the Chinese Finance Ministries have been criticised for putting too many of their "golden eggs" (earned off the hard work and sweat of the people's labour) in one place (the US) and that Chinese funds need to be more broadly invested around the world in various countries. Partly as a result you have seen China buying up assets and investments around the world. I think the days of cheap and easy money lent to the US are going to get fewer as investors find that there are other good investment opportunities around the world. This means the US has some hard work ahead. It is a highly productive nation however it is hugely indebted. We have already seen the US dollar slide, i believe this is only set to continue.
Many countries in Asia pride themselves on having decent foreign account surpluses. Australia celebrated "zero debt day" after it worked 10 years to reduce it's foreign debt to zero. How many years do you think it would take the US to get to zero debt day ?
My word, what's wrong with 6.75% or so emergency prime. I'm old enough to remember when a residential mortgage rate of 7.75% on 15 years was considered quite good.
perhaps we have become spoiled with very low mortgage rates and no down payment requirements -- a return to a little common sense regarding large and small purchases wouldn't be a bad idea.
Let's hope he hangs on to his hat in the face of political pressure. At the moment the BOE is just about the only central bank of note that is taking the right course. At the very least rates should be held on Thursday and there is still a strong argument for increasing to six percent. We are in for some pain but a cut in rates would make that pain much much worse in the long run. I sincerely hope Mr. King and his team do not take any notice of the ignorance of politicians and they do not feel pressurised by the inappropriate actions of the European and American central banks.
THE AMERICAN SOLUTION TO MORTGAGE CRISIS. JUST LOOK AT THE THOUGT PROCESS!!
ITS JUST ABOUT HOW DO I LOAN MORE AND MORE AND MORE!!!!
"I've been in this business for a quarter-century and I've never seen it this bad," said Christopher George, president of San Ramon-based CMG Financial Services, a vendor of home loans. "This is huge."
The latest calamity consists of the virtual vanishing of jumbo home loans, which are used to finance mortgages that exceed $417,000. Rates for those loans have spiked in the last few days. Jumbo loans normally carry a rate of 0.25 percent more than standard loans of $417,000 or less. But this month, jumbo loans are at least 1 percent higher than standard, or conforming, mortgages.
With the median price of East Bay homes well above the $417,000 barrier, jumbo loans have become a nonstarter for the ordinary borrower. And that's made life tough for consumers and mortgage agents alike, as banks jettison a growing array of home loans and potential borrowers. "We're dealing with drastic change on a daily basis," said Scott Doruff,
a certified mortgage planner with the Fremont office of Carzino Mortgage Banking Group. "Lenders are pulling their programs off the shelf. If they still offer a program, they increase the cost the loan, charge more points, demand a higher interest rate."
Some banks still offer jumbo loans. But they charge such a high rate that the loan effectively disappears, said Guy Schwartz, manager of CMG's Walnut Creek office.
"The bank prices it so high that they're sending a signal: They don't want to do the loan at all," Schwartz said.
As a result, loan officers and home finance brokers have been forced to fashion new loan products that would be feasible for borrowers and palatable to nervous banks.
Plenty of alternative kinds of loans are being floated by loan agents, said John Holmgren, principal owner of Oakland-based Holmgren & Associates and president of the East Bay chapter of the California Associate of Mortgage Agents.
"Fully half of the loans that we had in process had to be massaged in some way," Holmgren said.
Among the workarounds: Holmgren suggests that borrowers obtain loans with fixed interest rates of five to 10 years. Or they could find a co-signer. Or they could provide a larger down payment.
"We are just starting to come up with some solutions," said Kris Raman, president of American Funding Solutions in Dublin. "This whole thing only started a few days ago."
Raman has proposed that borrowers obtain a first and second loan that together would total as much as $600,000.
The first mortgage would total as much as $417,000 and be a conforming loan at attractive interest rates. The second loan on the house would reach as much as $200,000. Of course, the interest rate on the secondary loan would be about 8 percent or 9 percent, which would be about 2 points higher than the first mortgage, Raman said.
CMG Financial plans to offer 30-year loans that begin with a fixed rate of about 5.5 percent the first year, 6.5 percent the second year, and 7.5 percent the third year. Starting in the fourth year, the loan would be re-evaluated for a market interest rate and the payments could be recalculated, George said.
Both CMG Financial and Carzino Mortgage offer a product called the ³ÉÈË¿ìÊÖ Ownership Accelerator. This loan enables people to pay the principal first on their home loans and let the interest be based on the remaining balance. The idea is to pay off the loan years earlier than normal.
Despite the move Thursday by the Federal Reserve to inject $24 billion worth of additional liquidity into the financial system, mortgage agents believe that is only a first step.
"This will not have an immediate effect," Holmgren said. "They are sending a signal that will hopefully restore confidence. But it could take one to four months before order is restored in the mortgage market."
They believe fundamental problems related to slow home sales, flat residential values and increasing foreclosures will continue to haunt the housing market perhaps through the rest of 2007.
"There is a lot more the Fed has to do," George said. "Cutting interest rates is the bottom line."
George Avalos covers jobs, insurance, finance, petroleum and economic development. Reach him at bayareanewsgroup.com.
I would suggest that this will act as a wake up call - bankers should price risk accordingly, and consumers should only take on the amount of risk they can afford, and be penalised rather than being allowed to go bankrupt and then be given credit cards to run up only months later.
banking the only industry in the uk to recieve goverment help.
Robert - Any Nip/Tuck could be disastrous in longer term -- let the market come with solution and expose crooks sitting on big money!
The banks dont want to lend to each other so leading to a high LIBOR this will probably stay high since the banks can take money from the BOA why bother with each other. They probably will until the BOA just cant justify it anymore and we will see the problems resume. Dont believe me? Well think back only a short timeago america and europe had to bail them out releasing billions of cheap money into the economy available to the banks. Did it help? Nope we are still here. As for the Libor dropping slightly (which I expect it will as at the end of the day they want to make money), well thats a tempory thing. The banks no matter what have to work out where the bad debt is and fess up too each other. But this will have far wider ramifications as it will effect thier investers however the delay is effecting everyone.
Over the past 10 years savers have suffered at the expense of borrowers; it's about time the savers (who are in the majority) got a decent deal. The governments figure for inflation is a nonsense, the real street level must be nearer 8/9%. Everyone knows that governments of whatever ilk manipulate statistics to suit their own ends. Have MP's had their salary inreases intoduced by stages. I will leave you to ponder! Signed an ex Banker.
Surely there is a time when risk versus reward has to be truly looked at, and the architects of these financial problems need to be held to account not only in their annual salaries and bonus's, but also the forfeiture of their jobs if they are found to be wanting in their decision making.
Bank/Public purse should not be used to fix the unfixable, otherwise when this precedent is set it will be used to further all sorts of unjust financial causes.
By the way my company has overspent and I may be looking for similar support!!!!!!
Although not a banker but a smallish investor, the reasons for the American 'sub prime' mortgage saga
are not difficult to fathom -too many lenders who took too serious a risk, lending to those with no or inadequate collatoral; the problem for me is to understand the consequences of such managerial incompetence on such a huge scale over so long a period which has effected the financial market world wide; and I abhor the critics who foster 'Mervyn's muddle' simply because he is so convenient to blame,when in reality it is not him but tens of thousands of managerial incompetents.Bruce Shaxson.