FYI | Jul 28 2008
By Greg Peel
The US Congress has passed a bill which permits the use of taxpayer funds to buy capital in the distressed “government-sponsored” mortgage lenders Fannie Mae and Freddie Mac if necessary to prevent their demise. New legislation also provides for tax relief for homeowners, a new regulator for Fannie & Freddie and a US$300bn anti-foreclosure program.
This move has generated heated debate in the US as to whether the government’s plan to effectively nationalise half of all US mortgages if need be is the pinnacle of the “moral hazard”. Should all US taxpayers be penalised such that the mortgages of those who overextended themselves through greed be saved, and relief provided? Or are those Main Street distressed mortgage holders merely the innocent victims of more systemic and concentrated greed on Wall Street?
Either way, no one wants to contemplate what might happen if nothing were done at all. There is a similar problem building in Britain. From the very outset of the subprime crisis, Bank of England governor Mervyn King was reluctant to follow the US Federal Reserve down the path of aggressive rate-cutting, or to inject billions in liquidity as both the Fed and the European Central Bank were quick to do. But when Northern Rock went under, the “moral hazard” argument quickly took a back seat.
It is now several months since all UK bank deposits were guaranteed by the government, and since the BoE first provided the capacity for UK banks to swap existing mortgage debt for government bonds in a similar emergency liquidity scheme to that provided by the Fed. But the effects of those measures is now “wearing off” as the cost of new mortgages in the UK begins to blow out. The UK mortgage market was worth 100bn pounds in 2006, the financing for which was split 60/40 between traditional bank deposit backing and the securitisation market. Now that the securitisation market is dead, and the global credit squeeze remains, the number of new mortgages issued in the UK is rapidly trending towards zero.
Mortgage refinancings are also suffering from interest rate blow-outs. The risk is that the UK housing market, which is already teetering, collapses completely. This would create a foreclosure snowball. Former HBOS CEO Sir James Crosby is currently in the process of preparing a report for the government on the current state of the struggle for funding in the UK bank sector.
However before that report is due, Chancellor of the Exchequer Alistair Darling has asked his advisers to prepare a plan which would provide for banks to swap new mortgage debt for government bonds, similar to the existing scheme of old mortgage debt for bonds provided by the BoE. Mervyn King is once again said to be reluctant.
Commentators have again raised the “moral hazard” issue, but, as in the US, concede that the consequences of not acting do not bear thinking about. To act swiftly would be to avoid even greater cost further down the track. Crosby is expected to recommend some form of government intervention in his report, due in October.
