CML news & views

In the aftermath of the credit crunch, the government and the Bank of England embarked on a series of policy initiatives to support the economy, consumers and to ease conditions for firms, including mortgage lenders. The authorities responded on an even greater scale to the financial crisis of a year ago.

Over the coming months and years, however, many of the schemes launched in response to events since August 2007 are due to be scaled down. In some cases, this will mean not only that measures that have helped to underpin mortgage and housing markets will come to an end, but that capital and liquidity injected into the system will have to be re-paid.

Some of the first effects of this process will be felt in the next few months when a number of measures intended to help lenders and borrowers will begin to unwind.  Some of these are measures that were introduced to improve the functioning of financial markets; others were designed to encourage housing market activity or to protect borrowers in difficulty. Today, we look at those measures that are due to come to an end shortly and try to assess what impact their withdrawal will have. 

Long-term action

Over a longer period, the process of unwinding all the measures intended to bolster the financial system – and housing and mortgage markets – will take place on a much larger scale. Clearly, policymakers will want to manage this in a way that minimises market disruption. It should be possible to achieve that but, given the scale of the measures that have been implemented, it may take some time to do so.

Conditions in markets have improved significantly since the financial crisis a year ago and confidence has risen. But recovery is still at a delicate stage. Lenders therefore urge policymakers to continue to show flexibility in response to evolving market conditions, and to be prepared to continue to intervene with appropriate measures to provide support as necessary.

• October 2009 – closure of the asset-backed securities guarantee scheme.  This scheme allows a government guarantee to be attached to sales of highly-rated residential mortgage-backed securities (RMBS) in order to encourage their purchase by investors. Since the onset of the credit crunch, the market for RMBS has been closed. Recently, however, there have been tentative signs that a market is beginning to re-open for high-quality mortgage assets.

No firms are believed to have sought to use the scheme, which was announced in January. Signs that a market for high-quality RMBS may be re-opening indicate that investor confidence is slowly returning, in any case. 

What the events of the last year show is that the government and the Bank of England need to be prepared to intervene with appropriate policy measures to ease conditions in dysfunctional markets. It will be important for the authorities to continue to show flexibility in adjusting the policy response to changing market conditions.  

• December 2009 – closure of the drawdown window in the credit guarantee scheme. At the end of the year, the window is due to close and banks and building societies will no longer have access to the government’s credit guarantee scheme. When it was first introduced in October 2008, the guarantee played a crucial role in helping sustain investor confidence in funding markets. It was an important mechanism enabling lenders to continue to issue bonds to investors. 

Over the last year, confidence has improved and government support may no longer now be necessary. While a sudden deterioration in market conditions could occur, it is not expected. So, a renewed need for a credit guarantee scheme is not anticipated. Nonetheless, it will be important for the authorities to continue to show flexibility in response to market conditions and to be ready to implement any policy measures that might be required to sustain market confidence.

Measures affecting consumers

• December 2009 – end of stamp duty holiday on homes costing up to £175,000. To help sustain activity in a rapidly slowing property market, the government raised the threshold for stamp duty from £150,000 to £175,000 on 2 September 2008, initially for a year. In April’s budget, the stamp duty “holiday” was then extended until 31 December 2009.

Responding to the original announcement of the stamp duty holiday, we described it as “something of a curate’s egg – good in parts.” Transaction costs have been reduced for some buyers, which is welcome. But we estimate that at least half of all home-buyers are still liable for stamp duty.

It is difficult to say whether the stamp duty holiday has encouraged more home-buying than we might otherwise have seen. The number of transactions has been very low because of reduced access to mortgage funding, falling house prices, the recession and concerns about security of employment. Against that, it is difficult to gauge the effect of any stimulus to the housing market created by a comparatively modest tax concession. 

Although our market commentary in September noted tentative signs of recovery in the housing market in recent months, the extent to which the stamp duty holiday has been a stimulus is unclear. We are wary about how much further the recovery in house prices can go in current market conditions, and believe that some of the recent firmness in prices may be due in part to a lack of houses coming on to the market.

We must not overlook that the end of the stamp duty holiday – and the reduction of the threshold from £175,000 to £150,000 again – will also have a dampening effect on an already weakened housing market. Perhaps the greatest overall impact of the holiday will prove to have been on the timing and pricing of property transactions around the threshold figures.

We believe that this autumn’s pre-Budget review would therefore be a good time for the government to announce a comprehensive and long-overdue review of stamp duty.  Reform is needed of a tax that distorts the housing market. And if it was implemented at this stage in the cycle – when the number of transactions is so low – it would have a minimal impact on government finances.

• December 2009 – an end to the freeze on payment of income support for mortgage interest (ISMI) at its current standard rate. On 2 September 2008, the government announced a temporary, two-year reduction in the waiting time for ISMI from 39 to 13 weeks, and an increase in the capital limit from £100,000 to £175,000. In the pre-Budget report later that autumn, the government increased the capital limit again to £200,000.

Then, on 22 December 2008, there was a further announcement that the standard rate for ISMI payments would be maintained at 6.08% for six months. In the 2009 Budget, payment at that rate was extended until December 2009, when it is due to be reviewed. At this stage, there is no indication what the review will conclude, and we do not know the rate at which ISMI will be paid thereafter. 

Historically, there have been concerns that ISMI has not always been paid at a rate sufficient to cover fully the mortgage payments of all borrowers who qualify for help.

Now that ISMI is paid at a more generous rate of 6.08%, that is less of an issue than before. It is still the case, however, that the rate at which ISMI is paid may not be high enough to cover the mortgage costs of all borrowers, particularly those with sub-prime mortgages. 

But, despite this, it is possible that the standard rate will drop from 6.08% when it is reviewed in December.

And it is also possible that, in December 2010, the temporary improvement in access to ISMI will be reversed and the waiting time for benefit will go back to 39 weeks. 

In August, when we reported an unexpected decline in the number of mortgage possessions in the first half of this year, it was widely interpreted as a welcome sign that concerted measures to keep possessions in check – including better support from ISMI – were having a positive effect. 

We warned, however, that with the economy still weak and unemployment rising, the number of possessions is expected to rise, and there can be no room for complacency over the need for measures to help borrowers in difficulty. The government needs to commit to maintaining support in order to achieve its aim of avoiding possession wherever possible.

ISMI is one of the main strands in the safety net of support for struggling borrowers.  Indeed, for many years, we argued that the old 39-week waiting period and £100,000 cap on qualifying loans represented significant gaps in protection for borrowers. 

Improvements to ISMI have therefore made a welcome contribution to wider efforts to extend more help to borrowers in difficulty. We remain concerned therefore about any moves to reduce government support for borrowers while arrears and possessions are at current levels and expected to rise.

Recovery remains weak

We are now at the beginning of a stage in which policy measures intended to support the market will begin to unwind. Most of the larger adjustments have not yet begun and will occur over a long period. But as each measure is reduced or reversed, it will reduce support for firms and consumers at a time when housing and mortgage markets remain weak, and prospects for recovery are delicate. The timing of withdrawal of support will therefore be crucial. But we do not expect the measures anticipated in the coming months and in the longer term to trigger another bout of market disruption. 

Looking further ahead, policymakers, firms and consumers must plan and prepare for the removal of measures that have underpinned financial markets on a huge scale:

• Banks and building societies have received £185 billion in cash from the Bank of England under the special liquidity scheme. Clearly, this is a major commitment for those firms affected and their capacity to re-pay these funds will be partly determined by confidence in the market for the mortgage-backed securities that the Bank holds as security against this advance.
• More than £100 billion of bonds sold with a government guarantee under the credit guarantee scheme are due to mature between 2012 and 2014. Again, the capacity of firms to manage their way through this process will depend partly on the strength of demand at that time from investors for bonds not backed by a government guarantee.
• The Bank’s policy of quantitative easing has injected around £175 billion of liquidity into the economy. This will also have to be reversed at some stage.  No timetable has yet been set for the withdrawal of this cash from the economy, but government and commercial securities bought by the Bank will have to be re-sold at some point, reversing the flow of liquidity.

Conclusion

Policy measures implemented by the government and Bank have helped avert an even more cataclysmic financial crisis than the one we have experienced. The process of reversing these measures is now due to begin, even though recovery remains weak. But it will not be completed for a number of years. 

The scale of the policy measures due to be reversed – and the sums of money involved – would be difficult to digest even with a normally functioning wholesale funding market. The authorities will therefore need to be flexible in adjusting policy to promote recovery and respond to evolving market conditions.