Oct 12 2007
Mr Darling shows his lack of understanding
Yesterday in the House Alistair Darling gave a dreadful performance on the Northern Rock crisis.
He did not seem to understand that this was a monetary policy crisis, not a specific company crisis. He did not mention Victoria Mortgage which went into administration shortly before the Northern Rock bank run, and did not mention the fact that other financial institutions relying to some extent on money market funds were coming under Stock Market pressure just before he cracked and guaranteed all deposits in institutions seeking short term funds from the Bank of England.
When I asked him why he looked on as the monetary authorities in the UK forced perfectly good financial institutions into trouble through a complete lack of cash in the money markets, he made no attempt to answer. He instead produced a foolish point which shows he neither understands the money markets nor the functions and limitations of regulation.
He said I had proposed removing the latest round of extra mortgage regulation this government has introduced (true) - which was stupid of me because Northern Rock shows we need mortgage regulation- false.
How can anyone make such a nonsensical point:
1. If such regulation “worked” there would have been no run on Northern Rock. We had no runs on mortgage banks prior to the introduction of such regulation.
2. The Chancellor himself says the mortgage book of Northern Rock is fine. He admits the problem for Northern Rock was on the liability side of its balance sheet - how it raised the money it needed - not on the asset side - the mortgages it advanced to people. Mortgage regulation concentrates on the asset side of the banks activities. General banking regulation concentrates on how the bank fiannces itself, regulation I would keep but try to make more effective.
If Mr Darling is going to try to do this difficult job sensibly, he needs to ask for some more advice on how banks and the money markets work. He could start by asking:
1. Why did the Basel internaitonal agreement on banking regulation place more emphasis on caopital adequacy than on liquidity? Was this wise? Banks need to be liquid as well as solvent so they have money when people wish to withdraw funds.
2. Why did the Basel agreement rate mortgages as safer assets than other types of loan? Didn’t this distort markets, encouraging banks to expand mortgage lending more than other kinds? Doesn’t this explain much of the huge property price rise we have seen in many markets in recent years?
3. When Mr Darling lectures the mortgage banks to make available more money on fixed rate longer term mortgages, what does he think this is going to do to mortgage bank balance sheets? If the main source of money for most mortgage banks remains the retail deposit, a variable rate interest account, Mr Darling is urging the mortgage banks to run a huge risk by having to face increased interest costs on their deposits when rates go up, with no matching increase in their income from mortgages. He is, in effect, urging them to adopt a riskier model than the Northern Rock’s!
It’s not easy Mr Darling - try doing some homework before you make such silly comments and asides in the House again.
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John Redwood has been the Member of Parliament for Wokingham since 1987. First attending Kent College, Canterbury, he graduated from Magdalen College...
John,
You make a very good point at (3) about longer term fixed rate mortgages.
Given the way that our banking institutions works, how can these be made to work - the lender either has to charge a premium over its current forecast of short to medium term interest rates (to ensure adequate margin to support the lending) or has to have access to investment funds (invested on coterminous basis at a fixed rate). Given the history of interest rate movements and inflation over the last 40 of 50 years how many people or institutions would have an appetite for such investment.
As ever the Labour Front Bench is more interested in sound bite politics and cheap jibes rather than understanding the complexities of the situation (in this case the UK mortgage market) and offering sensible long-term policies.
Reply: There are limits to how much matching and risk reduction they could do, leaving any mortgage bank more exposed if it writes too much long term fixed rate business.
This just goes to show how important it is for a chancellor to have had an academic grounding in economics or to have had experience in business and finance. Neither Darling or his predecessor Brown has such a background and neither has shown comprehension of macro or micro economics. We cannot afford to have amateurs playing politics with the economy. If the economy breaks down everything breaks down.
I think it is foolish of the Chancellor to guarantee all deposits as this will only give a free-option to other banks and building societies to use the same aggressive business model used by NR and thus creating further problems in the future as risk would not be correctly priced in .
As for Long Term fixed mortgages I don’t know who he is trying to fool. It is just a soundbite !!! It is obvious that a 10 or 15 year mortgage should attract a higher interest rate and a higher Spread over Libor so it will not be attractive to the banks customers . If it was possible to have convenient Long Term Fixed rate mortages the banks and building societies would already be offering them , and some I believe are on offer .
I would be very curious as to how he intends to implement this idea , I am sure he has not got a clue , but it would be funny to see how he would try argue his case. Maybe someone should ask him in Parliament.
Reply: I thought of asking him yesterday, but unfortunately I only get one question. To do what he wants a mortgage bank would have to use futures, interest rate swaps, and securitisation - and even so there would be limits to how long they could protect their position from a basic mismatch between a fluctuating cost of funds and fixed rate of return on their mortgage investments.
Exactly what I was thinking , as IRS and Futures can add to the cost of a mortgage and yet would not be enough to prevent funding risks so the mortage lender would still be exposed to fluctuations on the short-term depo market and adding all those risk premiums would not make it an attractive product compared to the 2 or 3 years mortgages present at the moment. Furthermore in normal market conditions the spread between 2 years and 10/15 years money is usually quite large so that in itself would also make a long-term mortage less attractive . Does the Chancellor maybe has a cunning plan to permanently reduce term money market spreads like his predecessors claims to have single handedly reduced the boom and bust economic cycle?
“To do what he wants a mortgage bank would have to use futures, interest rate swaps, and securitisation - and even so there would be limits to how long they could protect their position from a basic mismatch between a fluctuating cost of funds and fixed rate of return on their mortgage investments.”
John,
Their idea also fails to recognise that a typical mortgage holder does not stay in the same property or job for 10 - 15 years (so the repayment risk varies) and in many cases people borrow more over time - either to reflect their growing needs (e.g. first time buyer to family home) or unfortunately as a result of family breakdowns. A long-term fixed rate mortgage would need to be a sophisticated credit product, which would potentially increase the risk to the lenders.
“2. Why did the Basel agreement rate mortgages as safer assets than other types of loan? Didn’t this distort markets, encouraging banks to expand mortgage lending more than other kinds? Doesn’t this explain much of the huge property price rise we have seen in many markets in recent years?”
In answer to the last question, yes, of course. It’s simple really, asset price bubble = credit bubble = asset price bubble ad infinitum. They are two sides of the same coin. Question is, if you want to keep property prices low and stable, is it better to invent forests of regulation on lending (largely ineffective or unenforceable or circumventable) or just to replace existing property taxes with a tax on the speculative element of property prices?