When trying to understand the current credit situation (and, more importantly, trying to judge when the market may start to recover) it is interesting to see the way in which the industry, commentators and markets have shifted from one extreme to the other.
One extreme was the easy and abundant availability of credit. Before the onset of the current credit famine, credit had become too cheap and did not reflect the true risk represented. Lenders were driven by the desire to originate more and more loans, which was itself fuelled by investment banks getting rich on structured products/securitisations and the associated fees. This led to a relaxation of risk management and higher LTVs with more aggressive criteria.
For example, self-cert for employed applicants and self-cert buy-to-let are just two products which conceptually highlight these extremes. An employed applicant can, by and large, prove their income – so why do they need a product designed for self-employed people other than to inflate income?
A self-cert buy-to-let mortgage will either have a tenant in place with a passing AST rent or will be vacant but with a valuer’s estimate of the market rent achievable for that property. Again, as a concept, a self-certified product would only be required if the property/asset could not service the loan.
There are examples of where these niche products genuinely work but they must be products driven by a desire to innovate and sell rather than manage risk effectively. Similarly a 125 per cent LTV mortgage is another example of whether a sales/origination motive has won over a prudent risk management approach.
The polar opposite is now true and some equally extreme opinions are forming and hardening.
For example, there is now a view appearing in the financial press that all sub prime loans are bad and anyone with adverse credit should not have access to a competitive mortgage. This is not only an unbelievable position to take but one which would also create an economic underclass.
Another view gaining popularity is that to intervene in the mortgage market would be moral hazard and reward those whose excess has led us to this position. This is a common theme from Vince Cable of the Liberal Democrats – a party that clearly has the luxury of never being elected into power and therefore can operate in a world of academic theory rather than economic reality!
The lack of mortgage finance could cause a sustained and prolonged depression for the wider economy – and whilst allowing the market to find its own solutions is a central economic virtue, politicians need to be pragmatic and have a duty to mitigate the problems we now face.
Leaving aside the problems in residential lending and looking just at commercial mortgages, we are no longer able to fund new customers as the wholesale finance market has failed. We have provided over 13,000 small and medium-sized businesses with long-term competitive mortgage finance independently of their relationship bank.
Some of this market share would have been won from existing lenders but the majority would have otherwise been denied access to term finance. The overwhelming majority of our customers have used this finance to invest in their business and its future, creating vital growth for the economy. The vast majority of these customers are now being denied the means of financing further investment.
Another view at this extreme is that wholesale finance, securitisation, rating agencies and investment banks should be highly regulated or not return. This puts us in danger of chucking the baby out with the bathwater. Absolutely, there were huge failings in how this market operated but it is a central part of the financial system – and one designed to protect the commercial banks from the consequences of defaulting borrowers, which we can now see in evidence.
This passing of risk to independent investors is a sound and viable system but one that has been polluted by bad lending practices as a sustained property boom hid the underlying performance and investors failed to understand the true risk. The market will learn its lessons and evolve – but to suggest this failure is a good thing demonstrates a fundamental misunderstanding of how the current financial system operates.
A balance needs to be struck between the two because as bad as the excess of easy credit was, the prospect of widely restricted credit is potentially significantly worse. There is a great unwinding underway and the likely prospect is that actually the polar extreme of prolonged limited credit is with us for a considerable time. A balance between the two extremes is the ideal, but in reality history teaches us that we continue to lurch from one extreme to the other – it is unlikely that anything will be different next time.