The US authorities once again made the right decision to bail out Fannie and Freddie, their two crucial mortgage companies. They did need to offer more liquidity to prevent a further credit contraction and loss of confidence. In offering to put more money in by buying shares they also reassured investors that capital was available. If they have to do so they will reduce the proportion of the companies owned by existing shareholders, who will therefore be worse off when the markets and shares recover. Such an operation would make existing shareholders pay if the companies do need that extra equity, limiting the so called moral hazard of the bail out.
It is another contrast between the bodged, late and far more expensive bail out of Northern Rock conducted here, with the speedy and more effective reply of the US authorities. The purpose of this bail out is very simply to keep some new mortgage finance flowing to a hard pressed and illiquid housing market. In the UK the much dearer rescue of the Rock has led to a further substantial contraction in mortgage finance as the government runs down the mortgage portfolio of its own bank! The US housing market is already in very bad shape thanks to the general reduction in new credit, as US banks rein back in response to the squeeze following past excesses. The US authorities understand this and have come up with a package which makes more money available for people to buy homes.
The UK new housing market is also now shot to pieces by the squeeze, also following past excesses. So what do the UK authorities do? They spend far too much taxpayers money â€“ and put too much at risk â€“ by nationalising the most aggressive mortgage lender in the market, and then have to prevent it lending, achieving the opposite of what is needed. For this they are praised to the skies by Vince Cable and the Lib Dems. The power of their spin is such that usually sensible commentators think they â€œhad to do itâ€. All other better options, put forward before the event, are ignored.
When the US economy recovers before the UK I do hope all the gulled will revisit this question of whether the Northern Rock model or the Fanny and Freddie/Bear Stearns model worked better when rescuing distressed institutions. I hope some will come to see that the Rock disaster combined all the worst features of regulatory mismanagement and government bungling – the inability to see the disaster coming, a failure to regulate excess credit beforehand, the wrong strategy before the run began when the authorities switched from too easy to too tough, the U turn on moral hazard and the offer of bail out, the dithering over a private sector solution, and then the final idiocy of nationalisation, business reduction and sackings.
The main result of the mismanagement of the UK mortgage market â€“ where the handling of Northern Rock was the most important manifestation of a general incompetence â€“ is the destruction of the new housebuilding industry. The run of lay offs, the cessation of work on many sites, and the plunging figures for new starts can be directly traced back to the way the authorities presided over boom to bust credit in the mortgage market. This was a problem made in Britain, not in the USA where they had their own version. The UK problems are more poignant for a government that was so out of touch it was urging the new homes industry to increase its build rate, unable to understand its own actions meant the build rate would halve or worse!
Some have blogged in to past pieces on my site urging some expansion of mortgage credit on both sides of the Atlantic to argue that the correction is what is needed, the losses serve the bankers and property people right, and a good recession in these areas will purge the excesses. My answer is simple â€“ you are getting that anyway. The authorities have done quite enough on both sides of the Atlantic to so tighten credit that property prices are falling and will fall further. Mortgages are much scarcer than before, builders are losing their jobs â€“ for the masochists among you who want more pain you will see plenty of it.
My advice to loosen conditions is based on wanting to limit the time of the downturn and to give people some hope of improvement in due course. For every â€œgreedyâ€ financier my critics may be cheering to see under pressure there will be several builders out of work. This sharp correction of prices and sharp reduction in the availability of new credit will not just hurt a few well paid people in the City that always have their critics. It is hurting many others, and will hurt many more, as the effects ripple out through estate agency, surveying, building, DIY, home furnishing and all the other trades dependent on a strong housing market.
Even the puritans thought there came a point where the punishment had purged the sin. Those who want the authorities to let more mortgage businesses go to wall are the advocates of deep recession. I want to start looking forward to recovery. There will be job losses and price falls enough for all save those who think all lending is an original sin that requires perpetual suffering.