Reviving the mortgage market
It wasn’t just Northern Rock that flogged off its mortgages to international investors in the form of asset-backed securities.
More or less every British bank used this global market as a source of cheap funding: something like a quarter of all British mortgages are financed by the sale of mortgage-backed bonds.
With around £200bn of British mortgaged-backed bonds trading, yours could actually be owned by a hedge fund or an Australian pension fund, even if you think it’s on the books of the Halifax.
So when the market for asset-backed securities closed down last summer, it wasn’t just Northern Rock and its shareholders that were mullered.
Most of us were hurt by the disappearance of a source of cheap finance, because it meant that the price of mortgages would rise, and their availability would shrink.
Hey presto, many of us feel a bit poorer and the oomph goes out of the housing market.
Now there’s nothing intrinsically wrong with plain-vanilla, mortgaged-backed bonds.
It’s their twisted, hybrid cousins, the collateralised debt obligations made out of US subprime loans, that have wreaked the serious damage.
The poisoned CDOs have wreaked havoc on the more straightforward mortgage-backed bonds in two ways:
1) There’s been reputational contagion to any security backed by property.
2) Structured finance vehicles, such as the notorious SIVs and the collateralised debt obligations, were big buyers of all mortgage-backed securities, including the British mortgage-backed securities, but they’ve been slaughtered and are no longer buyers of anything.
But even if there’s nothing intrinsically wrong with the simplest mortgage-backed bonds, the market for them refuses to return to anything like normality.
Global investors don’t want the stuff.
It’s all a bit odd, but the loss of their appetite may stem in part from the widespread view that the British housing market has too much in common with the US one, viz that it’s over-valued and heading south.
Certainly that’s the implication of the way that futures markets are pricing the outlook for UK houses. According to Morgan Stanley, futures markets are implying there will be a 10 per cent fall in UK house prices over the coming year.
However it would be pretty serious for all of us if the market for mortgage-backed bonds fails to revive a bit.
If the availability of housing finance in the UK were to shrink over the long term by a fifth, well that doesn’t bear thinking about – mortgage interest rates would rise very sharply and the impact on house prices would be scary.
Which is why on 6 February, the Chancellor Alistair Darling said in a speech that he would “consult on a new ‘gold standard’ for covered bonds and mortgage backed securities” that would increase the confidence of investors that a British mortgage-backed bond is – to coin a phrase – as safe as houses.
Now according to this morning’s Financial Times, there would be “an official seal of approval” – a kitemark – for those-mortgage backed bonds whose underlying mortgages meet the most rigorous lending standards.
The word “official” is certainly resonant.
Does it mean the Treasury would issue the kitemark?
The Treasury tells me there is no possibility of that.
And you can see why it would want to distance itself from that notion. If the Treasury were to put its stamp on asset-backed securities, investors might understandably believe the bonds were guaranteed by HMG.
The bonds might sell like hot cakes. But the Office for National Statistics might insist that the whole lot come on to the public-sector balance sheet – which would put an atom bomb under the fiscal rules that are supposed to keep public-sector debt within reasonable bounds.
Who instead would issue this kitemark? Well it would be very odd if the Financial Services Authority allowed its name as the regulator of banks to be used to explicitly underwrite their fund-raising. That would put the FSA in cahoots with banks, and would wholly undermine its role as watchdog.
So the FSA can’t do it.
Which leaves only the banks themselves, or their trade association, the British Bankers’ Association.
But it’s not obvious why investors would place faith in a seal of approval agreed and policed by the very banks from whom they’re buying the bonds – unless, that is, the bonds were aimed at the innocents in the retail market (that’s you and me, by the way).
Anyway, for years there was a perfectly good system for providing confidence to investors that they were buying good bonds backed by decent assets.
The credit-rating agencies, Moodys, S&P and Fitch, provided certificates of credit-worthiness that were widely trusted.
Their reputation may have been battered by their wholesale failure to spot the risks intrinsic to bonds created out of US sub-prime mortgages.
And anger at them may be well directed.
But if they reform the way they assess the quality of bonds and the way they present their findings, they may be able to win back that squandered trust – and in the process contribute to a resuscitation of the asset-backed bond market.
The Treasury’s idea for a kitemark may well be seen by many banks and investors as introducing a new layer of bureaucracy that would yield little financial benefit.