John Redwood

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The Government backs higher mortgage rates and fewer mortgages

Some weeks late, the Chancellor has at last had something to say about the credit crunch.

Let’s look at the crucial statements from the interview:

“One of the things that happens with low interest rates is that banks look around for better returns”

Yes - exactly. The low interest rates generated by this government’s changing the inflation target to the unrepresentative and low figures of the CPI, allied to the international interest rate background, did encourage banks to look around for new and possibly more profitable ways to lend money. That’s what low interest rates always do, and any sensible government would have realised that before changing the target. If they had wanted to avoid a further burst of extra credit they would have stuck with the RPI, the index that is still used for indexed government bonds and in most pay negotiations.

“Institutions have in some cases been prepared to lend to people without checking if they were ever going to repay it”

No, No, No. This is prejudice by someone seeking to avoid the blame. I know of no bank that ever lends without having an agreement on when the money will be repaid and an understanding of how that will be financed. The problems in the money markets are arising because the money in question has to be repaid after 3 months, at a time when the government and Central Bank is now sending a totally different signal out, that it wants banks to lend less. Nor did banks stop assessing risk. It is,as Darling himself admitted above, a case that when interest rates were very low risks looked lower. Now Central Banks have put interest rates up a lot from the low, risks look different. Some of the funds that went wrong were often thought to be low risk funds, because they thought they were dealing in high quality paper as assessed by rating agencies. Higher interest rates and the wild gyrations of the markets have changed that. The government did not warn banks in the good times to lend less. It is perverse that now banks cannot lend as much they are warned to lend less!

“Institutions themselves need to open their own eyes and be more honest”

I doubt if there are many senior bankers with their eyes shut at the moment. As one who has said we need more information to help the markets, I would not endorse the emerging view that we need more regulation of international banking. I had in mind a quick word from the Bank of England and the FSA to the leading banks, advising them to make a statement of how big an adjustment to profit they felt they might need to make in their next figures to write off any exceptional losses from the market turmoil. Imposing yet more cost and obfuscation on them will simply intensify the lending squeeze, not help resolve the position. The market is trying to form a judgement of how much each big bank has lost on poor quality mortgages, and on lending to support investment in various types of mortgage and short term paper.

We learn Mr Darling is going to discuss these matters with the US Treasury Secretary and with European Finance Ministers. I just hope when he does so he is better informed than he appeared to be yesterday for this strange outburst about a return to “good old fashioned banking.” What he should be doing is:

1. Asking himself if he should in the longer term carry on using the CPI for the inflation target at the Bank of England.

2. Asking many whether now the world’s Central Banks should be turning their attention to fighting falling activity and slowing growth. Japan’s economy is now experiencing falling output, and most forecatsers expect the US and the main EU economies to slow from here.

3. Talking to the Bank of England about how far they propose to allow mortgage and other lending rates to go above the base rate they solemnly set each month, before they too like the Fed and ECB recognise the need to intervene in the money markets to get actual rates more in line with the rates they are setting.

At the moment the system of monthly interest rate meetings at the Bank which this government confirmed as their principal macro economic policy is marginalised when it comes to the rates people pay for their borrowings and the availability of credit. A policy of lecturing banks on how to lend is not going to work. The Chancellor is the elected politician responsible for this problem. He has at last taken a step to acknowledge his responsbility by his statements yesterday. Now he needs to think again, realise his statements were unhelpful, and try behind the scenes to sort out the mess in the money markets which arises from the boom and bust approach to lending which has characterised the last few years.

If he wants a “more honest” approach he should start by publishing proper figures on how much the public sector has borrowed in recent years, including full accounting for Network Rail and other guaranteed borrowing, and full figures on potential liabilities under Public Private Partnerships and Private Finance Initiatives. He will find the private sector reveals more about its finances than the government does on its own balance sheet.