Cheque please

The Bank of England will inject £50bn into the mortgage market to tackle the credit crunch but it could be a case of too little, too late, says Christine Toner

It’s finally happened. After Imonths of SOS calls to the Bank of England and the government, a scheme has been devised that could ease the mortgage industry’s liquidity problems.

Last week BoE governor Mervyn King revealed plans to inject £50bn worth of liquidity into the banking sector in an attempt to restore confidence.

King says the scheme was devised before Easter after the BoE decided that something had to be done. With the Bear Stearns crisis still fresh in industry minds and rumours circulating that some major players in the mortgage market were struggling, King says he devised the plan himself.

The £50bn Special Liquidity Scheme will see the BoE trade government bonds for asset-backed securities, including mortgage, credit card and loan debts.

These bonds are safer and easier to trade so hopefully interbank lending will pick up as lenders regain faith in the market and in each other.

So how does it work? For the next six months the BoE is willing to accept a variety of asset-backed securities in exchange for Treasury bonds.

Banks and building societies will be able to trade these bonds, thus releasing extra liquidity into the market. Securities based on US mortgages are excluded from the scheme.

After a year lenders will be legally obliged to buy back the asset-backed securities, the idea being that by then the market will be in better shape.

At the BoE’s discretion it can extend the period of the swap to three years. But regardless of the state of the market, at the end of the swap period lenders must buy back the securities. They also retain the interest on the loans.

But some industry figures are concerned there will be a stigma attached to the scheme that may put banks off.

Indeed, in September last year when it was publicly announced that Northern Rock had approached the BoE for a loan, the government was criticised because it was claimed the announcement would hit consumer confidence.

Of course the shambolic NR affair affected confidence even more and this time it seems the BoE is being more cautious.

During the initial six months of the scheme, no-one outside the BoE will know which firms are using it and how much money is involved.

It hopes this will encourage lenders that need help to seek it without fear of reprisals.

But the scheme is not open to everyone. Besides the US mortgage securities that are exempt from the scheme, there are other disqualifying factors.

Only AAA-rated asset-backed securities are eligible, which means allsub-prime mortgages are exempt. And smaller societies and specialist lenders won’t be able to apply. Only lenders that do securitisations or have bought residential mortgage-backed securities before are eligible.

The BoE adds that no securities backed by loans taken out after last December can be submitted because it will not subsidise new lending.

The conditions attached to the Special Liquidity Scheme mean many lenders will not benefit so the prospect of it dramatically turning around the mortgage market’s fortunes may not be as strong as the industry hopes.

“The facility will be relatively restrictive and lenders with non-prime packaged assets will not be able to tap into it,” says Peter Williams, chief executive of the Intermediary Mortgage Lenders Association.

And with sub-prime and specialist lending making up a quarter of the mortgage market, a large section of the industry will continue to struggle.

“What the scheme does not do is give all lenders direct access to the funds,” says Michael Coogan, director-general of the Council of Mortgage Lenders.

“We also await details of how much of the additional liquidity will be recycled responsibly into mortgage products or pricing so that lenders can bridge the gap between how much consumers want to borrow and how much funding is available this year.”

The decision to disqualify sub-prime and specialist lending from the scheme was taken in an attempt to protect taxpayers.

King says the scheme is designed not to protect banks but to protect the public from the banks. Accepting only AAA-rated assets means defaults are less likely. Should defaults occur, lenders will be responsible for exchanging defaulted assets with AAA-rated ones so the onus is firmly on lenders.

In a further attempt to protect taxpayers, the BoE will charge lenders a fee equivalent to the difference between three-month LIBOR and the interest rate for borrowing government bonds, subject to a minimum charge of 0.2%. As a result banks will get considerably fewer bonds for their cash.

But this is unlikely to prevent troubled banks from applying for them because interbank lending has virtually ground to a halt.

The NR fiasco, the Bear Stearns crisis and the rumours circulating in the mortgage industry regarding which firm will be the next victim of the credit crunch have seen banks’ confidence in each other hit an all-time low.

The extra cash in the market delivered by the Special Liquidity Scheme should provide a much needed boost to the confidence of lenders, thereby encouraging them to lend to each other again.

While they could see a difference over the next few months, borrowers are unlikely to feel the benefits in the short term.

But they may find lending criteria relaxing after months of restrictions. More liquidity should mean more lenders will be able to offer more products to more consumers.

But it’s unlikely product rates will fall until LIBOR does. If confidence is restored and easier interbank lending conditions return, LIBOR will fall and consumers should see decreases in product rates.

Borrowers may also see savings rates drop as even marginally restored liquidity will mean banks won’t be so reliant on savings for funding. While the BoE’s figure of £50bn is only an estimate, some have attacked the sum as being too small to help the market. And other industry insiders believe the real figure could be much higher.

King denies these claims and says the Special Liquidity Scheme is not a bottomless pit.

He stresses the plan is not an attempt to persuade lenders to start lending again, nor is it intended to stop a housing market correction.

And he adds the profligate lending seen over the past few years is unlikely to return as the days of easy credit are over.

“The scheme is not designed to send the mortgage market back to the wild lending seen before the turmoil began last summer,” says King. “There needs to be some adjustment in the housing market and it is not designed to impede this adjustment.”

It is also unlikely that the low rate deals offered to clients last year will return to the market as a result of the plan.

Coogan says improved liquidity is unlikely to reverse higher mortgage costs but chancellor Alistair Darling has a more sanguine view.

“This scheme will alleviate the problems that have seen banks reluctant to lend to each other,” he says. “In turn this will support the provision of new lending.”

Publicly lenders have supported the scheme, although few have revealed whether they will apply for the funds.

At the time of writing only Paragon Mortgages had admitted it is considering the option. But most agree it’s a step in the right direction.

One major criticism is the time it has taken for the BoE and the government to respond to the credit crunch.

Whereas the US Federal Reserve jumped into action to tackle the US sub-prime crisis, the BoE sat on its hands. Frustration that the sector had to wait so long for help remains.

“We would have liked action to have been taken more quickly,” says Will-iams. “But this move is welcome and should start to ease the logjam in mortgage funding.”

It’s been a long time coming but at last the mortgage market may have seen light at the end of the tunnel, albeit dim. But the Special Liquidity Scheme is by no means the shining beacon of hope that the sector has been praying for and industry experts are already starting to question its impact.

Liquidity may slowly return to the market but it will be a long time before borrowers feel the benefits. And with sub-prime deals exempt from the scheme, only time will tell if it really is too little, too late.

  • Additional reporting by Mark Skinsley

    Kevin Friend is strategic partnerships director at Mortgages.co.uk
    Whether the BoE scheme will have the desired effect is debatable as it’s not open to those that need it most, such as specialist and smaller lenders. Much depends on how the liquidity is used by the select few with access to it. There’s a good chance we could see small lenders go back to traditional means of underwriting, such as basing each lending decision on individual cases. They could benefit if their balance sheets are able to cope. I don’t think the scheme will go a long way towards restoring confidence in the market but the litmus test will be interbank borrowing rates. If LIBOR falls it will be a good start.

    David Hollingworth is mortgage specialist at London & Country
    The scheme can only be seen as a positive step. I don’t think mortgage rates will drop overnight but the rescue package will help revive confidence among consumers by helping to stabilise the market. An injection of £50bn is a big deal and is the first step on the road to recovery.

    Jonathan Burridge is managing director of Quantum Mortgage Brokers
    The rescue package is about half of what’s needed. The fundamental issue is still confidence so it’s not going to have a significant impact on the market. After all, there is a big difference in approach between the state and commercial sectors. The government should have acted more quickly when the alarm bells went off during the NR crisis but ultimately many problems are outside its control. It’s consumers spending money that count and they don’t want to risk anything at the moment. It’s not the government’s job to ensure the mortgage market continues to make a profit.

    Kevin Jones is managing director of Omega Financial Services
    It would have been more sensible for the government to call a meeting with the heads of various lenders and ask them whether the scheme would result in rate cuts before announcing it. Lenders have already said it won’t have any impact on rates until later in the year. It’s irrelevant political nonsense and will not benefit the market at all.

    Danny Lovey is proprietor of The Mortgage Practitioner
    It looks like the cost to banks will be the equivalent to borrowing at three-month LIBOR. It’s alright for bigger lenders with AAA-rated mortgage-backed securities but not much use for those without them. I can’t see it helping the market overall. The scheme may have come too late to restore confidence but it may hold off further falls. It will serve as a temporary measure, enabling the market to maintain liquidity for the rest of the year. But it’s not going to create a groundswell of optimism because it will only slow down rate rises.

    Mike Fitzgerald is sales and marketing director of Brentchase Financial Services
    The £50bn package is needed but I fear it may be too little, too late. It should have been offered at the end of November because £50bn might not be enough now. If it doesn’t work, what is the BoE going to do next – put in another £50bn or £100bn? I hope it leads to LIBOR moving in the right direction because if it doesn’t work, we can wave goodbye to specialist lenders for the foreseeable future.

    Brian Murphy is lending manager at Mortgage Advice Bureau
    I think £50bn is a lot of money. Hopefully it will help ease liquidity constraints in the market. What it won’t do is free up the industry to allow lenders to offer attractive deals to new customers. Hopefully it will stimulate interbank lending. Banks are getting good mortgage-backed assets and the risk to the wider economy if the banking system grinds to a halt is probably far greater than the risk of pumping in short-term loans. But in an ideal world the government would have acted sooner. After all, the Fed and the European Central Bank responded several months ago.

    David Greenleaf is corporate communications manager at Stroud & Swindon
    The BoE scheme won’t help us or other smaller societies as we won’t be able to access it directly unlike bigger lenders, but if it frees up the market in general we will see indirect benefits. We’re hoping that the scheme will have an impact on LIBOR but it won’t solve our problems overnight. It’s the first step but not the final answer to the market’s difficulties.

    Douglas McWilliams is chief executive of the Centre for Economics and Business Research
    My first impression is that the scheme is a good, targeted piece of intervention. A lot of the problems facing the market stem from banks with non-performing assets on their books that they can’t borrow against, lend out or liquidate. So the concept of exchanging them with government bonds will address this issue directly.

    One hopes this will restore confidence and banks will start lending to each other again, which may benefit consumers in the short to medium term. From the outset of the credit crunch, the BoE seemed to have its head in the sand and was slow to respond compared with the US Federal Reserve and the European Central Bank. It’s now taking direct action but there are no guarantees £50bn will be enough to restore confidence among banks and get the market moving again.

    John Varley is group chief executive of Barclays
    We support the development as it is innovative and substantive. We are committed to making the scheme a success and will be an active participant.

    Stuart Dawkins is director of corporate communications at Alliance & Leicester
    We welcome the BoE’s Special Liquidity Scheme and it will be seen by the financial services industry as a constructive step towards improving market liquidity.

    Sue Anderson is head of member and external relations at the Council of Mortgage Lenders
    The BoE has said it expects the initial take-up to be £50bn but some in the industry think the total value will be greater than that. The funding could have arrived sooner but the important thing is that it’s a positive step from the BoE and we welcome it.

    Once banks start making applications for money we will hopefully begin to see the benefits of the scheme. But we will have to wait and see its effects before we can tell whether it will have a beneficial impact on consumers.

    Jeff Knight is director of marketing at GMAC-RFC
    We support this initiative. While it won’t affect a lender like us directly, we believe it will help restore confidence in the market. Hopefully we will start to see LIBOR coming down as banks start to lend to each other again.

    The key is restoring confidence but I don’t think we can expect things to happen overnight. I think any intervention in the current climate will help as the mortgage sector has such a profound effect on the housing market. And there is no point in saying we should have acted sooner – everything’s easy in hindsight. We are where we are and the extra liquidity is a good thing.

    Richard Lambert is director-general of the Confederation of British Industry
    The scheme should encourage banks to be more willing to lend to one other through the injection of liquidity and from improved confidence that parties will be able to pay money back. Most importantly, the scheme ensures that risks remain with lenders not the public purse.

    Although the plan is not designed to bail out the mortgage market, by re-establishing confidence in the financial services system it should benefit as part of a wider process. The acid test will be whether the measures bring interbank rates more closely in line with the BoE base rate.