House prices seem set to fall in the UK at an alarming rate and talk of a recession is fast becoming part of the current political lexicon. Inevitable the blame is falling on the shoulders of Gordon Brown and Labour’s handling of the UK economy. So what has caused this decline in confidence?
Banks are no longer lending money to us or indeed each other as freely as they did just a few months ago. Over recent years the banks willingness to loan so much money has been driven by a booming housing market. As we all now, the ‘credit crunch’ and now the ‘mortgage crunch’ has precipitated sharp decline in house prices.
All markets have their ups and downs, and in most normal circumstances a fall in house prices is an inevitable event outcome of markets making necessary adjustments. The worry is recent events are more than simple market ‘adjustments’ but the start of a complete collapse in the housing market. House prices could plummet, causing more losses for the banks and then an even further reduction in lending and a total collapse in house prices. This in turn would lead to more homes being repossessed; personal bankruptcies and eventually job losses as firms either close or lay people off due to liquidity problems.
The cause can be traced to the US. Where an oversupply of housing combined with, falling house prices and interest rate hikes created a toxic cocktail. The buyers of the, mortgage backed securities, (securitization) such as Japanese pension funds, central banks and emerging Eastern markets stopped buying the mortgage debt. These Far-Eastern investors were effectively acting like default buyers, and so perpetuated the availability of mortgage credit through their investments. Seeing the collapse of US and now UK markets, these buyers/investors have pulled out. It’s wrong to say banks won’t lend to each other, they will, but only with good collateral like UK government Gilt’s.
Are mortgage backed securities good collateral? The problem for both investors and Central Banks (like the Bank of England) they are unlikely to want to these mortgage backed securities as collateral as they can’t tell whether the content of these mortgage backed securities are good or bad. Also the Bank of England already owns £100bn of Northern Rock mortgage debt. Nevertheless the bank could give confidence to the housing market and banking sector by being ‘bullish’.
They can say to the market these mortgage backed securities are of value; this would inject confidence into the UK housing market and at the same time boost the Government’s investment in Northern Rock. It would be a brave Gordon Brown if he were to instruct the bank to buy these securities. But then such boldness maybe what the beleaguered Prime Minister needs to take in order to undermine his detractors.
