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A British subprime mess

• Robert Peston
• 4 Dec 08, 04:22 PM

Michael Coogan, the director general of the , is grumpy with me (and said so today on the News Channel), because he thinks I implied yesterday that the big surge in repossessions that the CML expects next year will be due to our biggest banks and building societies seizing homes.

I was amazed he drew that implication from yesterday's blog (see "Repossessions 'to rise to 75,000'").

To be honest, it never crossed my mind that I was singling out any particular type of lender as being more responsible than others for the rising trend to repossessions.

I merely pointed out that the CML had briefed the government that it expects repossessions to rise to 75,000 next year, within a whisker of the record number of homes seized in the last recession, in 1991.

But Coogan's explanation of why he's grumpy is jolly interesting. It's that he sees subprime lenders and specialist lenders - those brief-lived corporate creations of the debt bubble - as the main contributors to the spike in repossessions.

Most of these higher-risk lenders are writing no new business. In 2007, there were 37 subprime lenders happy to lend to customers perceived as less than blue chip. Today there are almost none - and there's also been a collapse in the number of lenders offering self-certified mortgages.

I'm unclear whether Coogan categorises Northern Rock in this non-mainstream category - since it was funded largely in wholesale markets, as were most of the subprime and specialist lenders.

Also the Rock's Together Mortgages were anything but mainstream, in that they gave homebuyers and re-mortgagers the ability to borrow up to 125% of the value of the relevant property.

The resonant point is that Together borrowers are finding it much harder than other Northern Rock borrowers to repay (doh!).

Anyway, if Coogan is right and the repossession increment is principally caused by a rise in arrears at firms providing subprime and secondary mortgages, then it will be harder for any government policy to reduce the rise in repossessions.

How so?

Well, with the future so bleak for subprime and specialist lenders - in the sense that they were too dependent on wholesale markets that are unlikely to recover for years, if at all - those lenders are primarily interested in getting their money back as soon as possible.
And as their borrowers fall into difficulties, these lenders may have little incentive to help those borrowers over the hump - even if they receive support from Gordon Brown and taxpayers, as per yesterday's mortgage guarantee scheme (see my note, "Taxpayers Mortgage Guarantee").

The subprime and specialist lenders will have noticed (ahem) that property prices are still falling sharply, and that there could be a massive financial cost to them of waiting two years before seizing and selling a property.

Bottom line?

I wonder whether Gordon Brown's evasive action to stem repossessions next year will prompt the CML to reduce its expectations of repossessions next year by any significant extent.

We could yet see a return to the repossession levels of the early 1990s (and to repeat what I said yesterday, the 75,000 number for home seizures in 2009 is not yet the CML's formal forecast - but is its expectation based on current trends).

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Why punish savers?

• Robert Peston
• 4 Dec 08, 08:15 AM

Part of the reason we're in such an economic mess is that, over the past few years, we (that's individuals and businesses, in this case) borrowed considerably more than we saved.

A cause both of the initial funding/liquidity crisis of our banks and of the subsequent solvency crisis was that the loans and other assets of our banks grew at a much faster rate than deposits from customers, such that the gap reached about 拢700bn earlier this year.

To put it another way, consumers and businesses (big businesses, NOT small ones), borrowed considerably more than what they deposited with banks.

We saved far too little in general. But, in particular, we placed far too little cash in the banking system. Or perhaps it's the other way round, that banks foolishly lent considerably more than we had deposited with them: they became lending machines, not havens for savings.

Either way, that gap of 拢700bn had to come from somewhere. And it came from wholesale markets, much of it from money managers and institutions outside the UK.

Since the summer of 2007, in fits and starts, those providers of wholesale funds have been demanding their money back. But those banks had already lent all that money to us, in the form of mortgages or massive corporate loans, so the cash wasn't readily available.

Which is why weaker banks, like Northern Rock and Bradford & Bingley, have had to be wholly nationalised and Royal Bank of Scotland is now largely state-owned.

And it's why the entire banking system is being funded to the tune of 拢600bn and rising by taxpayers, because taxpayers have had to step in to fill the funding gap created by the closure of wholesale markets.

To state the bloomin' obvious, our previous excess of borrowing over saving has now led the banks to lend considerably less than they were (to deleverage, to use the ghastly jargon), which has been a principle cause of the economic contraction that looks increasingly like a nasty recession.

If you're in a recession, what do you do? Well, if you're the Bank of England, you cut interest rates - to stimulate economic activity.

And today , perhaps by one percentage point to 2%, a rate we haven't seen in the UK for more than half a century.

As always, there'll be a massive political and media fuss to ensure that the cut in interest rates is "passed on in full" to borrowers of mortgages and other loans.

The chancellor and the business secretary will presumably warn the banks again that they're keeping a beady eye on them, to ensure that borrowers reap the benefit of the Bank of England's reduction.

But there is a paradox here. Part of the cause of our woes is that we saved too little and borrowed too much.

Yet by cutting interest rates the Bank of England is - in a way - punishing the thrifty and rewarding the feckless.

Although it's not quite as simple as that, because even the thrifty would be in the doo-doo if we plunged into the deepest, darkest recession.

Even so, there is an absolute imperative for banks to reconstruct their balance sheets in a more sound and stable way, and that means funding more of their loans from our deposits and funding fewer on wholesale markets.

For Royal Bank of Scotland and HBOS, for example, its vital that they attract more retail deposits - or they'll suffer very serious long-term shrinkage of how much they can lend (unless, as I've pointed out ad nauseam, we as taxpayers are comfortable financing them more-or-less forever).

So if the Bank of England were to cut interest rates by 1% today, would it be rational for a bank such as Royal Bank to slash savings rates by 1%?

If it did so, wouldn't it be punishing savers whose support it dearly needs?

But Royal Bank and others would only be able to afford to reduce savings rates by less than 1%, if it were to cut lending rates by less than 1%.

It's a dilemma, isn't it?

Small businesses are at the sharpest end of this dilemma, because for all the understandable fuss about banks restricting credit to them, as a group they actually save more than they borrow.

So although most of the banks are committed to passing on the Bank Rate cut to small businesses in the form of lower rates on loans, arguably small businesses would be more out-of-pocket if the meagre amounts they earn on their deposits were to evaporate completely.

For what it's worth, where banks have discretion, I'd be amazed if they passed on the full cut to mortgage holders.

Would that be a scandal?

Perhaps not, if banks were to maintain interest rates on savings accounts at higher levels.

In the scale of alleged bank boo-boos, what's worse? Failing to pass on all the interest rate cut to hard-pressed families, or slashing the retirement income of elderly couples who live off the interest on their bank and building-society savings?

As I say, it's a proper old dilemma.

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