The acute vulnerability of the mortgage market
Readers of this column will be well aware that the measures taken by the British government to prop up the banking system and limit the depth of our recession were an emergency life-saving procedure - and that they created all sorts of dependency problems for the British economy that will take years to fix.
Think of our banks, in particular, as hooked up to a life support machine of guarantees and loans. If that drip-drip of sustenance was turned off with a sudden click of the switch, well the banks themselves would become pretty poorly again - and, perhaps, more importantly there would be a profound and unpleasant impact on all of us, their customers.
Mortgage banking is one business that remains hooked on taxpayer support in a way that most would say is unhealthy: via the Special Liquidity Scheme, our banks have dumped mortgages in the form of mortgage-backed bonds on the Bank of England in return for Treasury Bills, or the equivalent of cash, worth £178bn; and the Treasury has guaranteed fund-raising by banks to the tune of £134bn through a Credit Guarantee Scheme.
In effect, that is £314bn of credit provided to mortgage providers by us, by taxpayers.
And what do you think would happen if we demanded all that money back tomorrow? It's doubtful that a single new mortgage would be provided for some time.
Fortunately, that is not going to happen. The Bank of England wants its £178bn of bills back at the end of 2012, which is also when the majority of taxpayer guarantees expire that banks have taken out under the Credit Guarantee Scheme (although the final maturity of the CGS is 2014).
But for banks, 2012 does not seem that far off.
Any banks providing mortgages with a maturity of 25 years will see 2012 as more-or-less the day after tomorrow, or too soon for comfort. It would not be prudent or rational for banks to significantly increase the volume of long-term mortgages they award, knowing that they have to repay some £300bn to their creditors - in this case us, as taxpayers - in just a couple of years.
Which is why the recent recovery in the supply of mortgages and in the housing market looks somewhat fragile.
And it is also why the Council of Mortgage Lenders - the lobby group for mortgage banks - warned the government last week about the possible implications for the mortgage market and for the housing market of sticking to the schedule for repaying taxpayers.
The mortgage banks' case is supported by the Bank of England's last Financial Stability Review, which makes a number of important points.
The Bank of England says that the ideal solution would be for the deposits of household and corporate customers to grow by 10% a year (which is not far from the growth rate before 2007) and for lending to grow at say 4 or 5% a year. That would close the gap between what banks lend and what they borrow from customers over four years.
Now the good news is that individuals are saving more. The bad news for banks is that we're putting a disproportionate share of our new saving into unit trusts and products other than bank accounts. So according to the Bank of England, household deposit flows to UK banks increased by only £6bn between June and December - which is a veritable drop in the £300bn ocean of taxpayer credit that needs to be repaid.
What's just as troubling for banks, and for those who may be thinking about taking out a mortgage, is that banks are having to pay considerably more to retail savers for their wonga: the increment over the official Bank Rate paid by banks on fixed rate savings bonds has gone from next-to-nothing two years ago to almost two percentage points today.
And if banks are paying more to savers for their money, they will charge borrowers more.
So what about wholesale sources of funding? Although it was banks' excessive dependence on these flighty, unreliable sources of finance that took too many of them to the brink of collapse in the dire conditions of 2007 and 2008, wholesale finance is not by definition evil.
Wholesale finance would be okay if it could be made relatively secure for the long term and was not too pricey.
But here's the thing. The so-called securitisation market, where banks package up bonds for sale to investors, has not recovered properly yet. The market remains sick and small, although it has re-opened. It is not remotely possible (even if it were sensible, which is moot) for banks to wean themselves off taxpayer support by securitising mortgages and selling them.
The other important wholesale market, for short and medium term bank debt, is also a long way from functioning normally. And one historically important source of wholesale funds for British banks, the US money market mutual funds, has become much smaller, due to regulatory changes in the US.
There's a final indignity. Let's say banks were to succeed in tapping wholesale markets for longer-term finance that made them less vulnerable to unpredictable swings in the supply of money. Well that would cost them an extra £5bn a year, according to the Bank of England, based on the current structure of interest rates - whose cost would be passed on to borrowers (yikes).
In other words, there is an acute risk of mortgages becoming either scarce or very expensive or both, if the government were to insist that taxpayers get their £300bn back in 2012 or so. And that in turn would almost certainly prompt a further housing-market dip.
But what if the government were to extend the £300bn of support? That too would be dangerous, because it would risk seeing the £300bn of bank succour classified (either formally or in the eye of investors) as part of our national debt, at a time when public-sector borrowing is rising far too fast.
And adding a further £300bn to the national debt would further undermine the confidence of those who lend to the government, at a time when their confidence is a little bit too fragile for comfort.