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Author: Martin Upton

How much is that mortgage in the window?

Updated Thursday, 29th May 2008
As the credit crunch continues to hit borrowers, Martin Upton asks "How much is that mortgage in the window?"

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The past nine months have been traumatic for the global financial markets.

The collapse of the US sub-prime market in 2007 has resulted in many banks incurring huge financial losses as their investments in asset backed securities linked to the US mortgage market plummeted in value.

Yet this was only the first domino to fall over in a calamitous chain reaction of financial events that now threatens the wellbeing of the UK economy and particularly the housing market.

The exposure to losses by banks exposed to the US market quickly led the financial markets seizing up. So called ‘inter-bank lending’ stalled with lenders becoming increasingly wary about which financial institutions to place their funds with. Dumbarton Building Society plaque Solid as a rock? The sign of an early mortgage lender

This quickly led to interest rates in the financial markets rising – an inevitability given the lack of supply of funds – with the result that market rates moved over 1 per cent higher than the Bank of England’s official lending rate (which normally dictates the level of rates in the financial markets).

For institutions reliant for funding on the ‘wholesale’ financial markets – as opposed to the ‘retail market’ of personal savings – this shortage of funds and a squeeze in their cost proved disastrous. The greatest UK casualty was the Northern Rock Bank: with nearly three-quarters of its funding coming from the wholesale markets the bank quickly found that it could not finance its existing mortgage loans and other assets. Ignominiously it was forced to seek help from the Bank of England. What happened next is well known: the personal investors who had funds at the Rock queued to get their money out. This forced the UK government and the Bank of England both to guarantee the Northern Rock’s savings liabilities but also to step in and provide a ballooning level of financial support in excess of £25bn as investors withdrew their money. Eventually in March 2008 – after a failed attempt to organise a sale – the government was forced to nationalise the bank.

For other, more prudent, UK mortgage lenders the ‘knock on’ consequences of the Northern Rock debacle were severe. First they suffered from the higher cost of funds as institutions reduced their lending to the sector – despite the fact that these mortgage lenders had materially less dependence on the financial markets for funds.

With limited funds, falling liquidity and a higher cost of funding mortgage lenders started to raise the cost of mortgages – despite three cuts in UK base rates initiated by the Bank of England taking rates down to five per cent. Additionally funds started to become less readily available with products being withdrawn, and the deposits needed to obtain mortgages rising. Mortgage approvals in April were the lowest since records began in 1993. The days of readily available mortgages – and those offered at 100 per cent of the value of the property being purchased – have now disappeared.

"the nice decade is behind us"

With mortgage availability decreasing the demand for property has fallen. Consequently, property prices have started to fall.  House prices are now, on average, around four percent lower than their peak in October 2007.

The weaker position in the housing market is only making it more difficult for mortgage lenders to borrow money in the financial markets thus reinforcing the vicious cycle – this despite some late efforts by the Bank of England to inject liquidity into the financial markets by taking mortgage backed assets from the mortgage lenders and swapping them for government bonds which may, in turn, be used collateral for borrowing cash.

Perhaps the only winners from this situation are first-time buyers, who may now have an easier step up to that first rung on the housing ladder, and investors, who are now seeing mortgage lenders compete aggressively for their funds by raising savings rates.

As for the housing market – tighter credit, limited funds and the prospect of a buyers’ ‘strike’ spell bad news for house prices and hence for the quality of mortgage lenders’ balance sheets. Mortgage arrears and repossessions may not have risen substantially yet – thanks to the continued buoyant level of employment - but a slower housing market spells slower UK economic growth and, in due course, higher unemployment.

With the added strain of higher food and utility costs and soaring petrol prices household budgets will be coming increasingly under pressure – and there will be less credit available to bail them out. Thus upward pressure on arrears and then repossessions could be the next stage in an uncomfortable scenario for the UK housing market and the mortgage lenders.

As Mervyn King, the Governor of the Bank of England, remarked a few days ago ‘the nice decade is behind us’. Certainly, with the shrinking availability of mortgages, the decade of booming house prices is well and truly behind us.


Northern Rock: a business model unravels
Why do we get into debt? – is debt always a bad thing?
You and Your Money – don't let your money be the boss of you, get help from our interactive
Property slowdown ahead? – expert views
Moneymadeclear – guides and advice from the FSA


You and your money: personal finance in context
Understanding economic behaviour: households, firms and markets

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