Guarantee scheme details will be key to its success

Another year, another bank bailout. But will this one be successful in doing what the previous one has failed to do and kick-start lending in the mortgage market?

The stock market doesn’t think so, responding badly to the announcement of the package with banking stocks in particular plummeting even further.

Much of the problem seems to be the lack of hard facts and at the moment we only have sketchy details.

What struck me as the central part of the government package is the 100bn mortgage guarantee scheme to underwrite lending between banks and financial institutions as recommended in Sir James Crosby’s report.

Before the credit crunch hit, the securitisation market was a key source of funding for the mortgage market, responsible for a third of all lending, according to government figures.

But investors have since refused to buy mortgage and other asset-backed securities, limiting banks’ access to funds for lending.

Investors had their fingers burnt in the sub-prime crisis and regard all these assets with suspicion.

Sir James has suggested that the guarantee scheme, to be launched in April, will be for mortgage-backed securities based on the safest mortgage lending or AAA-rated securities.

These guarantees can be auctioned to the highest bidders among banks, rejuvenating the securitisation market, which is all but closed.

It means banks will be able to generate cash and increase their funding, which should boost new mortgage lending.

The scheme means asset-backed securities, which are out of favour, will effectively become government bonds, which are much more attractive.

The guarantee will mean that bad loans can’t be wrapped up with the good ones so investors know exactly what they are getting, which was not the case in the past. This should restore some confidence, which is in short supply.

But it has its critics who believe this scheme could create a state liability lasting decades. Admittedly, finding an exit strategy will be difficult if the market for asset-backed securities never recovers.

But without a guarantee scheme, it is hard to see how lending levels will ever recover.

Another valid criticism is that there was no extra detail once the official announcement was made.

More clarity is required of the individual points within the guarantee, which the government must make public sooner rather than later so that it can be fully digested.

I can’t see why this guarantee-based scheme wouldn’t work. New lending has lower LTVs than in the past, reduced risk appetite levels and increased pricing, so there are plenty of attractive loans to tempt investors.

With few investment options available at the moment, it would make a compelling investment if done in a transparent format that remained closely linked to the bank, like a covered bond.

These are uncharted waters but without some strong leadership from the top and more detail to flesh out the proposals, we are going to continue to struggle to navigate them.