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Crosby report proposes extension of bail-out scheme to new loans

Sir James Crosby’s interim report has suggested the Bank of England’s Special Liquidity Scheme could be extended to new home loans in a bid to revive mortgage lending.

In his preliminary report published today, Crosby, the former HBOS chief executive, said the aim of this proposal is to encourage new issuance of RMBS and covered bonds and therefore mortgage lending in the UK.

But such a scheme could see stiff opposition from BoE governor Mervyn King who has repeatedly stated that new loans should not be eligible for the SLS.

In his letter to the Chancellor, Crosby said despite the launch of the SLS, banks are struggling to increase the amount or extend the maturity of their wholesale funding.

“Given that more than half of their existing mortgage-backed borrowings will need to be repaid over the next three years, their capacity to make new mortgage advances therefore looks severely constrained.”

He warns that such a shortage of mortgage finance will persist throughout 2008, 2009 and 2010.

Crosby added that the current forecasts for net new mortgage lending during this period will prove significantly optimistic.

He also states that the current conditions are damaging the intermediary market. “Faced with much lower volumes and lenders switching back to distributing through their branches, mortgage intermediaries, hitherto an important source of price competition on behalf of consumers, are under intense pressure and many will disappear.”

On extending the SLS to new loans, Crosby warned that it is necessary to take into account the extent to which the provision of liquidity would lead to an increase in the supply of new lending, if used by banks and building societies primarily to rinance re-mortgaging.

He added: “It is also debatable whether this sort of approach would help or prolong the transition to better functioning markets in the long term.”

Crosby said the authorities would have to consider the extent to which intervention along these lines would expose them to significant fiscal and legal risks.

The report also ruled out the option of the UK replicating a US-style government backed agency to tackle the funding crisis, such as Fannie Mae and Freddie Mac.

Crosby said: “It appears unlikely that an implicit government guarantee on mortgage backed securities would be an appropriate model for the UK to adopt.”

He said that stakeholders have proposed various Government interventions, among them a temporary Government guarantee – on commercial terms – the principle and interest on high quality mortgage-backed securities.

Crosby said in the specific case of a guarantee, the Government would need to consider the fiscal, debt management and legal implications and the extent to which a transfer of risk to the Government might distort incentives and create moral hazard, rather than help investors and issuers price that risk more accurately.

The final report is set to be published in time for the pre-budget report. In his letter to the Chancellor, Crosby warns that he may yet recommend that the Government should not intervene in the market on the grounds that such intervention would create more problems than it would solve.


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