And so it falls to former HBOS chief executive Sir James Crosby to douse the flames and offer a safe route out of the funding crisis. His report, Mortgage Finance: Final Report and Recommendations, aims to clear a path through the burning wreckage and rescue the industry from the blaze.
The main thrust of Sir James’ argument focusses on the urgent need for government intervention. Against a dire prediction of net new mortgage lending falling below zero next year and assuming only a modest recovery in 2010, the outlook is grim. Sir James’ central proposal hinges on the auction of approximately £100bn worth of government guarantees over the next two years for new issues of mortgage-backed securities.
The government would decide the type of assets its guarantee could cover, such as AAA-rated covered bonds or residential MBS. The idea is to get lending going again rather than transfer risk to the government. This means that Whitehall would not pick up the tab for any losses incurred unless lenders went bust.
For their part, banks would attach guarantees to new lending for transactions involving change of ownership. Sir James stresses that new lending such as house moves, buy-to-let and first-time purchases would have to be covered for the effects to be felt directly in the housing market. Loans close to 100% LTV or what Sir James delicately terms “borrowers with seriously impaired credit records” would be left out of the equation.
He argues that the guarantees would be priced attractively and threaten no stigma for lenders. Sir James says they would have the knock-on effect of improving the availability of mortgage finance, triggering activity in the market and staving off further house price falls. Everyone would be happy.
Except Darling, apparently. When delivering his pre-Budget report the chancellor merely brushed over the proposals.
“To implement Sir James’ recommendations the government would need to obtain state aid approval from the European Comm-ission and resolve some technical and practical considerations,” Darling says. “But we will proceed to work up a detailed scheme based on his recommendations.”
The chancellor has promised to report back in next March’s Budget but for some of Sir James’ supporters, this is leaving things too late.
His guarantee plan has been met with praise from organisations representing brokers and lenders. This backing may be unsurprising given that 50 industry luminaries worked with Sir James to produce the report.
The Association of Mortgage Intermediaries is one such supporter. It has been lobbying for a similar MBS gold standard for about eight months.
“We welcome the proposal for temporary guaranteed securitisation,” says Chris Cummings, director-general of the Association of Mortgage Intermediaries.
“We have consistently called for this measure, most recently in our Solutions to the Credit Crunch paper, which we sent to the government and the Crosby report team.”
The Council of Mortgage Lenders also had some input into Sir James’ report and it too lays claim to the guarantee plan.
“In autumn 2007 we put forward the proposal Sir James has recommended in his recent report – to encourage new covered bonds and securitisations backed by guarantees to coax investor funds back into the market,” says Michael Coogan, director-general of the CML.
And the trade body is angry that Whitehall will take so long to respond to the report.
“The chancellor’s statement that there will be a report on the Crosby recommendations by next year’s Budget is simply not good enough – it is another missed opportunity,” adds Coogan.
But the plan is not without its critics. There are those who hear the word securitisation and want to run a mile, including Liberal Dem-ocrat shadow chancellor Vince Cable. For him, support for the MBS market means returning to the practices that got us into trouble in the first place.
“Sir James’ proposal for the government to guarantee MBS is inappropriate,” he says. “It would be irresponsible to go back to a failed model of mortgage lending.”
Even Bank governor Mervyn King, for all his earnest talk about the importance of resuming lending, is unmoved by the plans. Echoing the chancellor’s response, King says that securitised assets represent “a form of lending that for good reason has fallen out of favour”.
Fellow banker and former member of the Monetary Policy Committee Willem Buiter is more sympathetic to Sir James’ view-point. Buiter, professor of European political economy at the London School of Economics, says the authorities should afford the report more than a “deafening silence” but also thinks the proposals don’t go far enough.
“The £100bn is too little,” he says. “We need to do more than guarantee MBS. I agree that it is an essential part of the story but it is not sufficient.”
Buiter would like to see more wide-ranging measures alongside the guarantees – something akin to the US’ bad bank initiative whereby financial institutions are relieved of the toxic assets held on their balance sheets. Other options cited by Buiter include a more flexible version of the Special Liquidity Scheme and additional government involvement, such as forced lending or nationalisation.
Tony Ward, chief executive of Home Funding, says the limit-ations of the guarantee plan add up to a fundamental flaw.
“The problem is that it is only available for new mortgage lending in the future,” he says. “Unless you can free up on-balance sheet lending, this is going to be a problem.
“The guarantees are offered on a recourse basis. Banks that want to get at them can’t, meaning that only the most prime lenders will be able to access them.”
Sir James concedes that no single measure can be implemented in isolation. In the longer term he says the government needs to address the transparency of the MBS market. He suggests im-plementing standards at an international level to ensure that the global banking sector functions more effectively.
But right now, as many in the industry know, time is of the essence. Sir James makes a good case for the need to open up the securities market in the short term.
“Intervention which addresses the closure of mortgage-backed funding markets will bring about increased competition and improve the availability of mortgage finance,” the report states. “Injecting some sort of guarantee looks like the best option.”
Steve Khan, proprietor of The Mortgage Trading Consultancy, says that although the government is dragging its heels, at least Sir James has come up with a viable solution.
“Without action, we will be exiled from the securitisation market in the next few years,” he says. “If something can be done in the next few months it would be extremely helpful – I’m amazed nobody has suggested this before.”
Questions remain unanswered
When we saw the interim report by Sir James Crosby in July we felt we would need to wait for the full version before we could understand what was being proposed. In short, we wanted more.
Almost half a year on we can see the full monty, which lays out what Sir James believes to be the answer to the problems identified by the government when the report was commissioned. Sadly, he paints a bleak picture for mortgage funding in the immediate future.
Sir James’ key recommendation is that the government should guarantee at a commercial rate the interest and principal on residential mortgage-backed securities or covered bonds for new mortgage lending. Alongside this, the Treasury has expressed its support for the development of industry standards on transparency and standardisation, and dialogue on the issue of applying fair value accounting principles to the market.
But in the report’s small print there is a vital caveat. It warns that all proposed solutions are “subject to practical considerations”. This raises some interesting questions, such as will the proposals work in practice or are they theoretical? And if they can be implemented, will the market have moved on in six months’ time to the point where the solutions are no longer viable?
The report does not provide enough information on the practical implementation of the proposals and the devil is always in the detail. We expect it to come from the government next spring and its response will either be a cause for concern or good news for the market. Without this feedback we don’t know where we stand, so once again we’re left wanting more.
How the changes proposed in the report will play out is hard to predict and with such an uncertain global economic outlook, many questions remain. For now we have to wait on chancellor Alistair Darling, who will report on the plans next spring as he prepares to introduce the 2009 Budget and shares the government’s findings on the raft of measures introduced in the pre-Budget report.
In the meantime, it is clear that the mortgage market and the economy can expect to face an extended period of uncertainty along with challenging business conditions.
There have been signs of house purchase activity steadying in recent months but the winter is usually a bad time for deals. Policymakers will keep their eyes peeled for further indications of activity in the new year.
As we await the government’s response to the Crosby report we will continue to operate our mortgage business in the way that has served us well in the past two years. We will maintain our position as a traditional balance sheet lender with a quality book and strong securitisation from our parent, Banco Santander.
Chief operating officer Abbey for Intermediaries
Cold comfort for intermediaries
I welcome the Crosby report. Sir James arrived at a conclusion similar to the one the market has been advocating and seems to agree with the Association of Mortgage Intermediaries about a gold standard for suitable credit via government guarantees. He also acknowledges that the mortgage market will struggle to secure sufficient finance to allow it to operate effectively in the near future.
It should be noted that the guarantees would not let lenders off the hook if they have non-performing debts and the government wouldn’t take on risks thanks to the proposed insurance scheme. Sir James also says that defaults on AAA-rated sterling mortgage-backed securities – which represent more than 90% of wholesale-funded deals – remain a remote prospect.
But only AAA-rated bonds identified by two or more ratings agencies would qualify for the guarantee, and even then it would be made by auction to control the size of the issuance.
The make-up of those assets needs to be clarified although it is clear the guarantee will only apply to new purchases and not remortgages. For example, the report seems to indicate that deals with maximum LTVs of 95% will be included, but it could mean 90% LTV deals depending on which page you read. The size of the LTVs involved will be crucial to luring back first-time buyers.
Buy-to-let qualifies for the proposals although sub-prime deals are forbidden, but we’ll only be sure what the government will do when next year’s Budget is unveiled.
Whitehall expects that up to £100bn of maturing securitised debt will be refunded from the £250bn of government-guaranteed debt provision announced on October 8. Lloyds TSB and HBOS have been the main issuers so far but the government says it is assessing how the scheme is working and whether the provision has any implications for Sir James’ proposals. It is hoped this review will be completed by Christmas.
What Sir James’ report does not mention is also illuminating. It does not discuss the wholesale warehousing of prime mortgages stuck in the system. It could be that some of these will be unlocked by the credit guarantee scheme but there is no mention of this.
There is anecdotal evidence that hedge funds are buying lines of distressed warehouse funding at huge discounts. Sir James believes lenders that dug themselves into a hole will have to dig themselves out, as the prime lending market is the main concern.
While Sir James expects a few years of zero net growth in the market, he sees that big deposit-based lenders will continue to offer cheaper deals direct and thinks the broker sector will fade away due to falling activity in a declining sector. His assessment is honest but does not bode well for brokers or consumer choice.
The Mortgage Practitioner
Chancellor’s excuse for deferring action until the spring is pathetic
In view of the rapidly changing market conditions since Sir James Crosby’s report was commissioned in the spring and the delay in its publication, I suspect it has been redrafted more than once in the past few months.
Despite the suggestion in his interim report that he might end up recommending no action, I am pleased Sir James has picked up on one of the main proposals put forward by the Association of Mortgage Intermediaries and the Council of Mortgage Lenders, i.e. kick-starting the mortgage-backed securities market by offering government guarantees, albeit only on quality deals.
Sir James makes three main recommendations:
But one aspect of the first recommendation is too restrictive. The proposal is that the guarantees should not be available for remortgages. Bearing in mind that the Bank of England’s Special Liquidity Scheme is available for mortgages completed up to December 31 last year and that around 70% of current business involves remortgages, many of which are on lower LTVs than purchases, the scope of the scheme would be enhanced if remortgages were included.
Chancellor Alistair Darling has lamentably failed to recognise the need to get the ball rolling immediately.
“To implement Sir James’ recommendations, the government would need to obtain state aid approval from the European Commission and resolve some technical and practical considerations but we will proceed to work up a detailed scheme based on his recommendations and seek approval to proceed,” he says.
This is a pathetic excuse to justify deferring action until next year’s Budget. It will be too late by then.
It is ridiculous for the government to have surrendered to the EC the power to dictate whether or not we can support our domestic mortgage industry. It is also regrettable that as a consequence Darling has been able to avoid committing to the scheme, although at least his comments suggest he expects Eurocrats to kindly allow him to do so.
The market needs help with funding now. Since the Crosby report has been months in the making and the Treasury must have seen its key recommendations before publication, it’s a pity there wasn’t an announcement that the proposals had received the go-ahead and that the first guarantee auction would be held in January.
senior technical manager
Gesture politics from Brown & Co
So Sir James Crosby’s long-awaited report has finally arrived, not with a fanfare or a bang but with more of a whimper. I suspect I am not alone in finding its content and conclusions underwhelming.
To be fair to him, he always faced an uphill struggle. When the report was commissioned in April it was more to do with gesture politics than a real intention to tackle the crisis on the government’s part. But Prime Minister Gordon Brown & Co had to be seen to be doing something, so enter Sir James.
The report has been overtaken by events. Things have moved faster and had a more profound effect than anyone could have predicted. The collapse of Lehman Brothers added a new dimension to proceedings and the global aftershocks are still being felt. Along with the rest of us, Sir James had his work cut out just to keep up.
The report contains little that is startlingly original. It may serve as a commentary on the causes and effects of the crisis and its main recommendations may make sense, but overall it fails to add much to the debate. That said, it hits the nail on the head in one important respect – the continuing lack of mortgage finance and its negative implications for the UK housing market and the economy.
And while Sir James has identified the steps that should be taken, he has no power to implement them. He is at the mercy of his political masters who through their dithering continue to demonstrate why the crisis is hitting the UK particularly hard. Delaying further action until next year’s Budget – almost a year after the report was commissioned – is absurd, as is the requirement to seek European Commission permission to proceed.
As has been the case from the beginning, the solution lies with the market itself. There is an important role for the government and banking authorities to play but this is largely confined to preventing the financial system from collapsing while preparing the ground for recovery. The government has acted but Sir James’ recommendations alone will not fill the funding gap.
This gap was created by the lack of liquidity previously provided by the wholesale money markets, in particular the collapse of securitisation conduits for mortgage-backed assets. According to Bank of England data, the demise of securitisation has taken £740bn of lending out of the economy. It is misguided to believe that this can easily be restored by government pressure or incentives. Sir James recognises this.
What is important is that we continue with the process of rebuilding banks’ balance sheets and confidence. Until this is done we will have to live with a compressed market but don’t take my word for it. “There are no quick or easy fixes to this crisis,” says US President-elect Barack Obama. Sadly, he’s right.