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Mae day appeal

The UK economy is in difficulty, the US economy in greater difficulty but the wholesale money markets are broken, with the securitisation market effectively closed. “Effectively” because deals could probably be done at prices that would be unacceptable to the sellers.

There are times when free markets need a helping help from governments or central banks and this is one of them, just as was the case in 1998 after the demise of Long Term Capital Management and after 9/11.

Last week, the Institute of Fiscal Studies and Professor David Miles of Morgan Stanley put forward a radical proposal to address the current problems.

Miles has estimated that unless the mortgage securitisation market is reopened, lenders might face a £70bn shortfall in funds this year. Net lending in 2007 was £108bn and so this is almost twothirds of annual net lending.

No doubt, if lenders continue to be starved of funds from normal sources, those which are deposit-takers would continue to bid up for deposits and probably compete for funds by offering even higher rates above bank rate than are currently available.

This would, of course, mean new floating-rate mortgages also being offered at a higher margin over bank rate and partially negate the Bank of England’s attempt to revive the economy by cutting bank rate.

As well as new purchasers, this would also affect existing borrowers, apart from those on a long-term rate, as they come to the end of their deal and either do a product switch with their existing lender or remortgage.

The sharply increased bank rate-Libor spread has eroded lenders’ margins since August last year, although the spread is now much closer to normal levels.

However, if lenders can only get additional funds in future by bidding up savings rates, they will increasingly have to choose between further rationing (by price and criteria) of new mortgages or offering them at higher rates, or more probably a combination of the two.

If competition reduces even further, and there is precious little at present, except understandable competition in the sub-prime market to have rates high enough to avoid getting many applications, lenders may be tempted to price new tracker mortgages at a rate which allows them to also at least partially recoup the running loss they will now be making on many trackers sold more than a few months ago as these were offered on the assumption that the bank rate-Libor spread would average 16 basis points (0.16 per cent) over the term of the deal.

The IFS/David Miles proposal is for the Government to set up a Fannie Mae/ Freddie Mac-style agency that would buy, or lend against, the collateral of mortgage-backed securities.

Lending could be for a given period, which would have the advantage of reflecting the temporary nature of the assistance, and the agency could set a safety margin between the amount lent and the market value of the collateral.

I understand that the Treasury is giving serious consideration to this proposal.

Ray Boulger is senior technical manager at John Charcol

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