Just when you thought things couldn’t get much worse, they did.
The news that Bear Stearns had hit the wall and was sold for little more than a can of Coke and a Mars bar sent the global money markets reeling once again.
Share prices plummeted and the bosses of the big five banks in the UK dropped in on Mervyn King for a cup of tea and tabled a request for an extra £30 billion of liquidity to be pumped into the money markets.
They got £11 billion but, perhaps even more significantly, they also got an indication that the Bank of England may be willing, in the future, for them to use a wider range of collateral, including mortgages, for Bank of England loans.
So much for Mervyn King’s pledge last year not to prop up ailing banks. His change of heart has clearly been influenced, in part, by the recent run on HBOS shares caused by erroneous rumours that the mortgage lender was in financial trouble.
Financial carnage
These developments were unimaginable just a few months ago. Unfortunately, the financial carnage is not confined to the City and lending institutions throughout the country have been feeling the effects.
According to Moneyfacts we are seeing between 400 and 500 mortgage products a week being pulled at the moment and, in the last two months, more than 2,000 products have been taken off the shelves.
The non-conforming sector has been hardest hit – Moneyfacts reports that in March last year there were 32 lenders offering non-conforming deals; today there are just 20. A year ago there were 6,501 non-conforming products and today there are only 1,867.
This represents a drop of 71 per cent and the numbers are continuing to fall. The contagion has also spread to other parts of the market, with prime products having criteria tightened or even withdrawn altogether.
The day before the Easter break, Bath Building Society decided to withdraw all of its mortgage deals other than those on its standard variable rate, saying that it was being overwhelmed by new mortgage applications.
The problem is not a lack of consumer demand but a lack of liquidity in the money markets. Banks have not only stopped lending to each other, but the securitisation and wholeloan sale markets have also gone into deep freeze.
The consequence of these developments is that the market has effectively been set back 30 or 40 years, with lenders having no option but to rely on retail funding. When you consider that 12 months ago approximately 40 per cent of all new mortgage lending was wholesale funded, you realise just what a hole this leaves in the market.
What happens next?
So, with strong demand but a significant undersupply of funding, what happens next? Mortgage queues? Quotas? Perhaps quotas may be the best way to deal with the problem in the short-term.
One of the most disruptive factors affecting the intermediary market at the moment, is lenders pulling products at very short notice and brokers and borrowers having to scrabble around to find alternative deals. It creates a huge amount of work for everyone: distributors, brokers and borrowers. No one benefits.
Lenders could, however, work with distributors to whom they provide quotas. This is a strategy which has already been implemented by Kensington and I’m sure it will spread to others in due course. The benefit is that brokers know that once a lending decision has been made, the funds are secure. No more uncertainty.
This surely has to be a better way of regulating supply than hiking interest rates and tightening criteria. I appreciate that lenders need to manage their margins and we are going to see mortgages become more expensive, but margin management is a different issue to using rates as a valve to regulate the flow of new business applications.
The same applies to lending criteria. Sure, if lenders are concerned about credit quality they need to tighten criteria, but that is different to reducing loan-to-values to reign-in the volume of new business applications.
If you think about it, the mortgage market must be one of the few places where price is used to regulate business volumes in such a direct way. When Sony had problems satisfying demand for its Playstation, it didn’t hike the price until consumers backed-off. It simply gave key distributors quotas until it could provide enough product to satisfy demand.
Quotas may not be liked, but at least they are fair to all concerned. Quotas also mean that products can remain competitively priced and have accommodating criteria. When the allocation of funds is gone, it’s gone and that’s it until further funds are made available.
A key issue
A key issue for lenders is which distributors to allocate quotas to? That’s where they have to take into consideration their distributors previous track records and ability to manage brokers and control credit quality.
This is a time for distributors and lenders to work together for the benefit of intermediaries and borrowers.
I do appreciate that quotas will not necessarily be a development which is universally welcomed by all, but I’m struggling to think of a better alternative. Surely it has to be better than daily criteria changes and product withdrawals, which leaves everyone unsure as to where they stand?
The only other alternative is for banks to start lending to each other once again. Don’t hold your breath.
