Today we will hear a statement from the Chancellor announcing a much heralded statement offering up to Â£50 billion of near cash to the banks in return for some of their mortgages.
How is this done?
The government itself will borrow the money, by issuing bonds â€“ IOUs â€“ on the taxpayer.It will lend this money to the banks. It will secure these loans with banksâ€™ mortgages. It will require a discount on the mortgages â€“ in other words it will accept the mortgages for say 90 pence for every pound of mortgage. This discount will give us, the taxpayers, some protection against mortgages within the packages of loans that go wrong and are not repaid, and against failure to pay the interest on some of them. After the transactions the banks have Â£50 billion more of government bonds which can easily be sold in the market for cash, whilst the government has security of around Â£55billion of mortgages. The interest received on the mortgages should exceed the interest on the loans. The government/Bank will ask for top up of security if the values of mortgages continue to fall.
The taxpayer will not be out of pocket if the government judge it correctly, but the taxpayer will be at some small risk until the transactions are unwound once the crisis has gone away. At some point the government and taxpayer have to get rid of the mortgages again and repay the borrowings with which they have paid for the loans based on them.The exact arrangement is more akin to loans to the commercial banks, which gives the taxpayer more protection than buying the mortgages.
Good news or bad news? Will it sort out the mortgage market?
This transaction will of itself help in alleviating the shortage of cash in markets, and on its own should lead to new lending by the mortgage banks. As the mortgage banks acquire more cash/short term government bonds so they can lend more money to people seeking mortgages. It was a shortage of cash to meet depositors requirements and the lack of confidence in Northern Rock that led to the run on the Rock. If money and government bonds had been available like this in September 2007 there would not have been a run on the Rock.
However, it has to be seen in context. There are at least three other considerations which will limit the impact this helpful proposal will have:
1. At the same time the authorities are tightening regulation of the banks, demanding that they keep more cash on deposit at the Bank of England for any given amount of lending. Every pound of additional cash they have to keep cuts the value of this package, as it becomes a circular process. The authorities demand more cash for security from the banks. The banks do not have such cash. The authorities then give them the cash to meet the tougher requirements. No-one can borrow an extra penny, as the new cash is frozen.
2. The larger banks are international. Whilst the money will be offered to the UK subsidiary and intended for the UK mortgage market, in practise international banks look at the balance of their global business. Not all of the extra money, after allowing for bigger reserve requirements, will necessarily find its way into the UK mortgage market.
3. The UK market still has the problem of Northern Rock, which remains a negative influence on reviving the mortgage market because the government nationalised it. If instead of nationalising Northern had been offered this kind of support, it could now be offering new loans on a significant scale. Because it is under strict controls to repay the Â£24 billion taxpayer debt, and under strict surveillance not to be too competitive as a subsidised bank, it cannot play an important role in reviving the mortgage market in the UK.
So will it work?
It is a helpful package. Whether it is enough depends on how much further the authorities go in tightening reserve and cash requirements, and how quickly they want the Northern Rock money back.