No point giving Governor a toolkit with blunt instruments
Mervyn King is no doubt looking forward to taking delivery of the new tools he was promised last night by the Chancellor in his Mansion House speech.
George Osborne hasn't yet detailed exactly what the Governor of the Bank of England will have at his disposal in order to “take effective action in response” to “the macro issues that may threaten economic and financial stability”, but Mr King has made it clear he believes his lack of firepower up until now has represented a serious flaw in the regulatory system.
The Governor is right, of course. With hindsight, it seems obvious that a regulatory system which does not even have a mechanism for taking into account phenomena such as credit bubbles, let alone the powers or mandate to target them, is too narrowly focused.
And yet, the way we have been talking about the financial crisis in recent days, with a focus on how the Bank might seek to impose maximum loan-to-value ratios on mortgage lenders, or even to cap lending to earnings multiples, suggests there is a misconception about what happened during those |tumultuous months of 2008.
It is worth a quick history lesson: Britain's banking system was not brought to its knees because the nation's mortgage lenders were caught out after years of making overly risky loans. On the contrary, in 2007 and ever since, bad |mortgage debt has risen very modestly. Arrears and repossessions remain well below the levels seen in the early 1990s.
No, this was a crisis of mortgage funding. As the residentialmortgage-backed security market gummed up, almost overnight, lenders found themselves unable to fund new |advances. Northern Rock's |Together mortgage, its 125% loan-to-value product, is now seen as the height of irresponsible lending, but it wasn't defaults on the deal that killed the bank but a funding catastrophe.
Should the Bank of England keep a close watch on the lending policies of Britain's biggest mortgage providers — and the impact their behaviour might have on financial stability? Of course. But to say this means the Bank should prevent banks from lending more than 75% of the purchase price of a property, or restricting borrowers to loans worth only three times their earnings, is to miss the point.
In truth, the supply of lending to would-be mortgage borrowers already looks likely to be constrained for years to come.
Who, in any case, would be most disadvantaged by a cap on loans to value of, say, 75%? |Certainly not those who are already on the housing ladder. In fact, first-time buyers would be hardest hit by such a crackdown, reduced to scrabbling around for deposits that most would have no hope of saving.
The worst-case scenario is that home buyers locked out of the market by these caps might resort to unsecured borrowing — at three or four times the cost of mortgage finance — in order to make good the shortfall. That would present a far greater risk of a significant rise in bad debt levels and repossessions.
None of this is to say that Mr Osborne is wrong to present the Governor with a shiny new toolkit — just that it is very difficult to work out which specific micro measures one should use in order to manage macro-prudential risk.
This is uncharted territory.