Freedom Today

I come to praise the sub prime mortgage. It has had such a bad press in the last eight months. Sub prime is now used as an excuse to explain why banks fail, shares go down and why fear stalks the markets. All the wise acres and most of the commentators now know the world will not be right until the sub prime is no more. The Regulators are busily slamming doors long after the horse of confidence has bolted. They wish to root out sub prime wherever they find it, put off balance sheet lending back onto stretched balance sheets, and warn people off lending to people who need the money. The new conventional wisdom is that banks should only lend money to people and companies who are already rich. They have discovered that the problem with lending to the poor is they might not be able to pay it back.

I have no time myself for sub prime salesmen who pushed the hopeless and the helpless into a mortgage they could not afford by offering a year or two of easy terms and seeking to play down the reality that at some point a commercial rate of interest kicked in. Nor do I have time for the many who now seem to think people on low incomes should not be able to buy their own home. Home ownership is one of the great breakthroughs an individual or a family can make. There is nothing like the freedom of being able to shut your front door, and then do what you will with the property inside. I welcome all positive moves to make mortgages and homes more affordable for all.

In the USA the authorities do seem to have realised that pushing thousands of sub prime mortgagees into default is not a clever – or pleasant – thing to do. The cuts in interest rates have come thick and fast from the Fed, as they fight to get rates down to a level where more people can hope to pay the mortgage and keep their home where they have mortgage rates linked to market rates. On this side of the Atlantic, we have authorities who see the time as suitable to preach a few homilies about the evil of debt. They are keeping interest rates high to “teach borrowers and bankers a lesson”. They risk bringing house prices down, and with them the dreams of many a heavily mortgaged home owner.

The Credit Crunch so far is a story of two rival traditions responding in very different ways. When the UK experienced a run on Northern Rock it took six months to offer financial support, look around for a private sector buyer and eventually to nationalise the luckless institution. When the US saw a run developing on Bear Stearns it took a week-end to find a private sector buyer, put in place a Fed package of loans and announce confidence boosting proposals to markets, including another interest rate cut.

The US authorities are fully into recession fighting mode. The President, the Treasury Secretary and the Fed act as one, supervising a tax cut plan, boosting the market with substantial liquidity and slashing interest rates. They work together, they each have their clear responsibility, and they give the impression they will do whatever it takes.

The European authorities look paralysed by comparison. The UK budget deficit is too high to allow easy tax cuts. There is little effort to root out the waste and unnecessary spending that would allow tax cuts. The Bank of England and the ECB both have to concentrate on low inflation, unlike the Fed which has a general duty to help sustain economic health. The European Banks keep interest rates inflexibly high, and are sparing with any extra liquidity to their markets. For Northern Rock it was a sad case of too little too late supplied to the market, to be followed by a colossal bill for the taxpayer. The ECB remains mesmerised by the divergent behaviour of the different Euroland economies under its gaze. It watches as the Euro soars, making great swathes of European industry uncompetitive.

Some love the sense of the rich and mighty in the financial world being brought low. Prosecutors sharpen their pencils to take evidence in possible fraud and corporate irregularity trails. Regulators thumb through their huge rule books to see which rules in practise had been broken during the heady days of off balance sheet loans and sub prime mortgages. Politicians sound off with all the certainty of hindsight about the errors of the bankers and the mortgage companies. They should all calm down and grasp these self evident truths.

Lending is important to help the economic wheels go round. You do need to lend to people who need the money, and the poor have every right to expect a mortgage service as well as the rich. Lending was overdone, thanks in no small measure to monetary authorities who kept interest rates too low for too long, and thanks to Regulators who through the Basel rules encouraged banks to push their loans off balance sheet.

We need to get from our current fragile over borrowed condition to a position where normal levels of transaction can take place again. To do so we will need lower interest rates on both sides of the Atlantic, not just in the USA. The banks have to recapitalise quickly, raising money from shareholders, bringing in new shareholders with new capital or by cancelling dividend payments. The authorities have more to do in the days ahead to make the markets more liquid. The problem now is not inflation, but too rapid a deflation.

This entry was posted in Articles. Bookmark the permalink. Both comments and trackbacks are currently closed.

One Comment

  1. Tim Skinner
    Posted April 21, 2008 at 3:38 pm | Permalink

    Who are you to say interest rates are too high (or low)? Are interest rates a matter of whim? Do they not reflect market realities in the same way as does (say) the price of bread? If interest rates reflect market realities, what do you suppose they are? Determining the balance between present and future consumption, perhaps?

    You want to make home ownership available to all, including the poor. Fine, but is that feasible without seeing house prices fall substantially in real terms? Where I live, a modest three bedroom semi-detached house costs ten times average annual earnings: what an incredible burden to have to take on.

    You don’t want too rapid a deflation. Perhaps you prefer to drag the agony out over ten or twenty years? Really?

    Reply: Yes, I want a slow adjustment of house prices to earnings, not a massive collapse of prices which could undermine people’s financial position. We judge whether interest rates are too high or low by the impact they have on jobs, prices and activity.

  • About John Redwood


    John Redwood won a free place at Kent College, Canterbury, He graduated from Magdalen College Oxford, has a DPhil and is a fellow of All Souls College. A businessman by background, he has been a director of NM Rothschild merchant bank and chairman of a quoted industrial PLC.

  • John’s Books

  • Email Alerts

    You can sign up to receive John's blog posts by e-mail by entering your e-mail address in the box below.

    Enter your email address:

    Delivered by FeedBurner

    The e-mail service is powered by Google's FeedBurner service. Your information is not shared.

  • Map of Visitors

    Locations of visitors to this page